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Economic Insights

The IRS offers some relief to those who didn’t withhold enough in the 2018 tax year.

 

In Brief:

  • With the passage of tax reform in December 2017, new withholding tables were not available to employers until mid-January 2018, and some employees didn’t see a switch in withholding until mid-February 2018.
  • As a consequence, some taxpayers underpaid their taxes in 2018, so the IRS has waived the normal penalty for underpayment.
  • The IRS urges everyone to check their withholding for 2019. This is especially important for those taxpayers who faced an unexpected tax bill for 2018.

 

Some taxpayers are getting an unpleasant surprise as they file their tax returns for 2018. They’re finding out that they didn’t withhold enough or make sufficient estimated quarterly payments during the year, and now they have to write out a check to the IRS.

The good news is that the IRS has decided to waive the normal penalty for underpayment in 2018.  You may still have to pay a penalty, but the threshold has been reduced from 90% to 85%. That is, if you still managed to pay, through withholding and estimated payments, at least 85% of the 2018 tax due, you will not have to pay a penalty for underpayment.

Taxpayers are normally subject to a penalty if their estimated tax payments and withholding are less than 90% of the current-year liability or 100% of the prior year’s tax (110% for high-income earners).

Here’s what happened.

With the passage of the Tax Cuts and Jobs Act (TCJA) in December 2017, new withholding tables were not available to employers until mid-January 2018, and some employees didn’t see a switch in withholding until mid-February 2018.

The updated federal tax withholding tables largely reflected the lower tax rates and the increased standard deduction brought about by TCJA. This generally meant that taxpayers had less tax withheld in 2018 and saw more in their paychecks.  

However, the withholding tables couldn’t fully factor in other changes in the tax law, such as the reduced itemized deductions so, without proper withholding or increased estimated payments, some taxpayers would end up paying a penalty for underpayment.

Enter the American Institute of Certified Public Accountants (AICPA) who wrote a letter to the IRS recommending relief for taxpayers who were being asked to deal with a combination of new rules, new withholding tables, and even new tax forms. To ease the burden, the IRS announced on January 16, 2019, that it was waiving the normal tax penalty. The waiver computation was also fully integrated into commercially available tax software.

Here’s the bottom line for the 2018 tax year. If you paid at least 85% of your total 2018 tax liability you will not owe a penalty. But if you paid less than 85%, you will not be eligible for a waiver, and the penalty will be calculated the way it normally would be, using a 90% threshold.

The IRS urges everyone to check their withholding for 2019. This is especially important for those taxpayers who faced an unexpected tax bill for 2018. Those most at risk of having too little tax withheld from their pay include taxpayers who itemized in the past but now take the standard deduction, two-wage-earner households, taxpayers with substantial investment income, and those with complex tax situations.

To help taxpayers get their withholding right in 2019, an updated version of the IRS online Withholding Calculator is now available on IRS.gov. Consult your tax professional for further information and assistance.

 

The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does notwarrant the accuracy and completeness of the information.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

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