In February 2018, the IRS modified the federal income tax withholding tables as a result of the reduced 2018 Federal income tax rates incorporated by the 2017 Tax Cuts and Jobs Act (TCJA).
This modification may produce one of the following for you: (1) you are under-withheld, which will result in unexpected tax liabilities upon the filing of your 2018 returns, and perhaps the imposition of penalties for under-withholding; OR (2) you may be over-withheld, which means you are paying too much in taxes.
Issues with under-withholding
We have found, in preparing 2018 income tax projections, that many clients who have not modified their withholding allowances from what they were for 2017 will owe substantial federal tax, and in some cases underpayment penalties, upon the filing of their 2018 returns.
It is also possible that there will be unexpected state income taxes and penalties owed, resulting from the loss of certain Federal itemized deductions under the provisions of TCJA. The taxpayers most at risk of under-withholding are two-income joint filers with adjusted gross income (AGI) of more than $200,000, and single filers with AGI over $175,000.
How much is the underpayment penalty?
The federal underpayment rate is determined quarterly. The current rate is 4% per annum. State underpayment rates are generally higher.
In addition, penalty and interest will accrue on 2018 tax not paid by the due date of 2018 returns in April, 2019. Taxpayers will not want to be caught unable to pay unexpected balances due.
How does one avoid federal underpayment penalty?
1. Pay in 110% (100% for some taxpayers) of the prior-year tax through withholding and/or timely quarterly estimated tax payments.
2. Pay in 90% of current-year tax through withholding and/or timely quarterly estimated tax payments.
Special provisions may apply to taxpayers whose income is earned unevenly over the course of the year. State rules generally follow federal rules.
What should you do in case of under-withholding or over-withholding?
Check your latest pay stub for year-to-date federal and state income tax withholding, and project it out for the remainder of the year. Compare the projected 2018 withholding to your 2017 withholding.
- If it is significantly less, consider increasing your withholding to at least your 2017 level.
- If it is significantly higher, consider decreasing your withholding to at least your 2017 level by reducing the number of exemptions.
Helpful information from IRS.gov
1) Explanation of estimated taxes and underpayment penalty
- IRS Publication 505 (2018), Tax Withholding and Estimated Tax
- IRS Estimated Taxes – Who Must Pay Estimated Tax
2) Federal withholding tables
- 2018 IRS Publication 15-A: Employer’s Supplemental Tax Guide – Supplement to Pub. 15, Employer’s Tax Guide
- 2017 IRS Publication 15 – (Circular E), Employer’s Tax Guide
Tax projection software is available on various websites, but we cannot recommend specific programs.
Councilor, Buchanan & Mitchell (CBM) is no longer taking requests for assistance projecting your 2018 tax and withholding amounts. For assistance with your taxes please reach out to us using the Contact Us form on our website. Select “I’m not sure” in the field entitled “Who Would You Like to Reach?” and a member of our team will route you to the correct individual.
Councilor, Buchanan & Mitchell (CBM) is a professional services firm delivering tax, accounting and business advisory expertise throughout the Mid-Atlantic region from offices in Bethesda, MD and Washington, DC.