Did You Withhold Too Little? You May Owe Tax Penalties

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Did You Withhold Too Little? You May Owe Tax Penalties

When it comes to taxes, less isn’t always more. If you don’t withdraw enough from your salary, you may be startled at tax time by how much you owe Uncle Sam. And the likelihood that you are under-withholding taxes is greater than you may believe.

According to a 2018 analysis by the Government Accountability Office (GAO), one-fifth of taxpayers may owe taxes in 2019 owing to under-withholding. Because of changes in the 2017 Tax Cuts and Jobs Act, the issue was more acute that year. The Internal Revenue Service (IRS) new W-4 form was completely implemented by 2021, and for some, the revisions came as a surprise in the form of a higher tax bill.

However, regardless of the tax year, it is critical to withhold the proper amount from your salary to prevent underpaying the government.

Key Takeaways

  • Due to changes implemented in the Tax Cut and Jobs Act of 2017, almost one out of every five individuals may have owing taxes in 2019.
  • Many persons were dealing with under-withheld taxes as a result of the United States Treasury Department’s failure to update the personal withholding amount to reflect changes in tax legislation.
  • Married taxpayers with several children, those with non-wage income, and self-employed individuals were all likely candidates for under-withholding.
  • Under-withholding fines may apply depending on the amount of the under-withholding and whether or not you compensate for it before the deadline.
  • There are many exemptions available to help you avoid this penalty.

The GAO Report

Your employer is obligated to withhold taxes from your salary in accordance with the IRS’s withholding tables. Withholding allowances were formerly dependent on personal exemptions such as the number of children or marital status, but these exemptions no longer exist as a result of changes made in the Tax Cuts and Jobs Act (TCJA).

  Tax Refund Definition

Income tax withholding is now calculated depending on the employee’s anticipated filing status and the standard deduction for the year. Furthermore, taxpayers have the option of having itemized deductions, the Child Tax Credit, and other tax advantages reflected in their withholding for the year.

If you want to understand more about how tax changes may effect you, the IRS has two papers that might assist. Publications 5307, titled Tax Reform: Fundamentals for Individuals and Families, and 5318, titled Tax Reform: What’s New for Your Business, are excellent places to begin.

Why Under-Withholding Is a Problem

The tax system in the United States is “pay as you go” (sometimes known as “pay as you earn”), which means you must have taxes withheld or pay anticipated taxes throughout the tax year. The TCJA’s deletion of the personal exemption, changes to withholding tables, and the fact that taxpayers were urged, but not obliged, to submit an updated W-4 Form may have resulted in millions of taxpayers under-withholding taxes.

People Who Should Be Concerned

According to the GAO, a married taxpayer with two children earning $180,000 per year, including $20,000 in nonwage income, and itemizing deductions is a potential candidate for under-withholding. In the following situations, you may find yourself under-withholding:

  • You previously itemized but now want to take the larger standard deduction.
  • You live in a two-wage earner family with no children or children who are 17 or older.
  • You make money via self-employment or other non-wage sources.
  • You got a year-end bonus, stock dividends, or capital gains.
  • You must pay the alternative minimum tax or the tax on minors’ unearned income.
  • You made money through property sales.
  • You reside in a high-tax state and are losing a portion of your SALT deductions.
  • You have substantial unreimbursed employment-related costs that are no longer deductible under the TCJA.
  • You have gambling gains that have not been taxed.
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If any of these apply to you, and you also forgot to amend your withholding, you are at a higher risk of under-withholding.

When the Penalty Kicks In

An underpayment penalty may occur if the amount withheld (or paid via anticipated taxes) is less than the lesser of 90% of the taxes owing for the current year or 100% of the taxes owed for the previous year.

If a penalty is imposed, it is normally 0.5% of the amount outstanding for each month it is not paid. In addition, the IRS may assess interest on unpaid taxes. The IRS sets that interest rate each quarter, and for Q4-2021, it is 3% more than the federal short-term rate. To establish your actual interest rate, please visit a tax specialist.

Additional Available Waivers

The penalty may also be waived under these circumstances.

  • You owed no taxes last year.
  • You owe less than $1,000 in taxes this year (after deducting payments already made).
  • Due to a catastrophe, calamity, or other exceptional circumstances, you missed a projected payment.
  • You resigned at the age of 62, which was the reason of the under-withholding.
  • You become disabled during the previous or current tax year and, as a result, failed to make projected payments.
  • You had any other case in which underpayment was not the result of your purposeful carelessness.

Even if you are not qualified for a waiver, you may be eligible for a reduced penalty in certain situations, such as a change in marital status or significant income recognized late in the year.

What You Should Do

Check to see whether you under-withheld taxes. The IRS website has the 2020 edition of Form 1040 and instructions, as well as various supplementary forms and schedules.

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File Form 2210

If you underpaid estimated taxes last year, you must complete Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, together with this year’s income tax return by April 15 or tax day.

Part I of Form 2210, as well as the accompanying worksheet and instructions, must be completed to determine if a waiver applies in your situation.

If a waiver does not apply, you will very certainly be penalized. In certain circumstances, the IRS will calculate the penalty for you, but in others, you must calculate the penalty yourself using Form 2210. For further information, see Form 2210, instructions, and worksheet.

The Bottom Line

Check your eligibility for the waiver as well as any other waivers you may be eligible for.

Check your withholding if you under-withheld last year, whether you qualified for a waiver or not, to prevent this situation in the future. To help you alter withholding amounts, use the IRS’s revised online Tax Withholding Estimator.

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