Oops! I Did Not Withhold Enough for Taxes. Now What?

As of Jan. 27, 2020, the IRS will start to accept 2019 tax returns. Most taxpayers are watching for their W-2s, 1099s, and other tax related documents to arrive in the mail and are curious to see if their tax situation will be better than it was a year ago with the new tax law changes.

One item of particular interest this year is the amount of withholding, or estimated payments made, throughout the year. Typically, individuals are required to pay a minimum amount (called a “safe-harbor” amount), to avoid being subject to the “underpayment penalty” on their taxes.

Safe-harbor amount? Underpayment penalty? What do these terms mean?

Every year when you file your taxes, there is a calculation to ensure you paid in the minimum amount throughout the tax year. This is called the “safe-harbor” amount. The “safe-harbor” is the smaller of:

• 90% of the total tax liability shown on your current tax return (the return you are about to file), or
• 100% of last year’s total tax liability (for higher income people this is 110% of last year’s total tax liability).

Let’s review an example. If the total tax liability on your 2019 tax return shows $20,000 and your 2018 tax return showed a $25,000 tax liability, then you would have had to pay in 90% of the 2019 taxes ($18,000) or 100% of the 2018 taxes ($25,000). Since $18,000 is the smaller amount, that is the minimum that must have been withheld, or paid in, throughout the year. This liability can be met through withholding (from your wages, pension income, IRA withdrawals, or Social Security income), or from quarterly estimated payments made throughout the year.

If you did not pay at least $18,000 through withholdings and/or estimated payments, you would see an “underpayment penalty” on your 2019 tax return, which would either reduce your refund or increase the amount due.

Last year the IRS recognized that the Tax Cuts & Jobs Act had several impactful changes, and that not all taxpayers were able to accurately figure their 2018 tax liabilities under the new law. To accommodate taxpayers, the IRS lowered the “safe-harbor” amount from 90% to 80% of current year taxes for 2018 ONLY. The lower threshold does not apply for 2019 tax returns!

For 2019, the 90% of current year or 100% of the prior year taxes (110% for higher income earners) is back in effect. It is important to review your wage withholding and quarterly payments throughout the calendar year to ensure you are hitting these marks.

Looking ahead to 2020, the good news is that wage withholding should better match your tax liability. This is due to a new Form W-4 being implemented across the country. Your employer should automatically be making changes to your withholding to better align with your elections (single or married) and this should ensure proper withholding amounts are taken from your paycheck.

Conclusion: If your 2019 tax return shows a large amount due or refund, review your wage withholding and submit a new Form W-4 with your employer. In addition, ensure the quarterly payments plus your wage withholding are sufficient to cover your “safe-harbor” amount of tax to be paid for the current year. Consult with your financial advisor and tax preparer to help you properly and accurately report this one-time benefit.