Along with the Tax Cuts and Jobs Act of 2017 there was some confusion regarding withholding taxes computed by using the Internal Revenue Service Form W-4. This confusion caused potential penalties for underpayment of income tax by individuals for calendar year 2018.
In March 2019 the Internal Revenue Service issued a news release increasing the safe harbor for some taxpayers. According to this Internal Revenue Service News Release, calendar year 2018 individual income tax filers could have avoided individual income tax underpayment penalties. This “safe harbor” existed if the taxpayer paid at least 80% of the calendar year 2018 tax liability using either quarterly estimated payments, income tax withholdings or a combination of both.
The income tax system is a pay as you go system. A wage earner pays income tax by means of taxes withheld from wages. If there is not enough tax withheld, estimated taxes are required. Self-employed individuals, partners, S corporation shareholders and those who received income with no withholding tax (interest, dividends, capital gains, retirement benefits, etc.) may be required to pay estimated taxes. Payment of estimated taxes is required for many taxpayers. Individuals are required to pay estimated taxes if their prior year tax liability exceeds $1,000 after accounting for withholding taxes from wages, retirement benefits, etc.
Estimated income taxes are generally due four times annually, but are not paid every three months. These “quarterly” payments are due April 15, June 15, September 15 and January 15. If your calendar year 2019 income tax liability is expected to be $1,000 or more you can avoid underpayment of tax penalties by either paying 90% of the current year’s tax or 100% (for some taxpayers 110%) the prior year’s (calendar year 2018) by January 15, 2020.
Determining and paying estimated taxes is not always a simple calculation. If a self-employed individual expects the income tax liability to be greater in calendar year 2019 than it was in calendar year 2018, paying the safe harbor amount of 100% (or 110% for some taxpayers) of the calendar year 2018 income tax liability can avoid the underpayment of income tax penalty regardless of your balance due on April 15, 2020. If an individual had large capital gains in calendar year 2018 but does not expect to have similar capital gains in calendar year 2019, that individual can pay estimated income taxes based on 90% of the calendar year 2019 income tax liability. This method needs to be carefully monitored during the year because if the payments fall short of 90% of the current year’s liability, the taxpayer may be subject to a penalty.
Determining the estimated tax liability and quarterly payments is not always a simple calculation. You should consult with your income tax advisor to determine the proper payments.