IRS Form W-4
How Many Allowances to Claim?
2017 Tax Cuts & Jobs Act
Impacts Federal Tax Withholdings
Beginning in 2018, many taxpayers are concerned that they may be having their federal income taxes over-withheld as a result of the 2017 Tax Cuts and Jobs Act (TCJA) which reduced income tax rates and increased the standard deduction.
The trick with estimated taxes is to pay a sufficient amount of estimated tax to avoid a penalty, but not to overpay. That’s because while the IRS will refund the overpayment when you file your return, it won’t pay you interest on it. If you receive a substantial refund from the IRS, that is comparable to giving the IRS an interest-free loan. That obviously is not good financial planning.
Due to the significant changes made by the TCJA, the IRS has updated its Tax Withholding Calculator to better enable taxpayers to compute the proper amount of taxes to withhold from their paychecks. If you are a wage earner (W-2 employee), you should consider using the IRS’s Tax Withholding Calculator to determine if your federal income tax withholdings are sufficient to avoid substantially over-withholding your taxes, and also to avoid under withholding issues which may be subject to underpayment penalties.
With respect to under withholding, keep in mind that the IRS wants to collect the taxes due it as early as possible during the year. Taxpayers who underpay income taxes during the tax year and pay the balance due on April 15 (or later) may find themselves subject to a penalty in the form of interest on the amount underpaid.
To avoid underpaying taxes during the year, IRS wants taxpayers to file estimated tax payments. Taxpayers who are typically required to file estimated taxes are self-employed persons, retirees and nonworking individuals who principally receive interest, dividend, and retirement income along with social security earnings, and employees who do not have sufficient taxes withheld from their paychecks.
Individual estimated tax payments are generally made in four installments. For the typical individual who uses a calendar tax year, payments generally are due on April 15, June 15, and September 15 of the tax year, and January 15 of the following year (or the following business day when it falls on a weekend or other holiday).
Generally, you must pay estimated taxes in 2018 if (1) you expect to owe at least $1,000 in tax after subtracting tax withholding (if you have any) and (2) you expect that your withholding and credits to be less than the smaller of 90 percent of your 2018 taxes or 100 percent of the tax on your 2017 return. There are special rules for higher income individuals.
Usually, there is no penalty if your estimated tax payments plus other tax payments, such as wage withholding, equal either 100 percent of your prior year’s tax liability or 90 percent of your current year’s tax liability. However, if your adjusted gross income for your prior year exceeded $150,000, you must pay either 110 percent of the prior year tax or 90 percent of the current year tax to avoid the estimated tax penalty. For married filing separately, the higher payments apply at $75,000.
Estimated tax is not limited to income tax. In figuring your installments, you must also take into account other taxes such as the alternative minimum tax, penalties for early withdrawals from an IRA or other retirement plan, and self-employment tax, which is the equivalent of social security taxes for the self-employed.
Suppose you owe only a relatively small amount of tax? There is no penalty if the tax underpayment for the year is less than $1,000. However, once an underpayment exceeds $1,000, the penalty applies to the full amount of the underpayment.
What if you realize you have miscalculated before the year ends? An employee may be able to avoid the penalty by getting the employer to increase withholding in an amount needed to cover the shortfall. The IRS will treat the withheld tax as being paid proportionately over the course of the year, even though a greater amount was withheld at year-end. The proportionate treatment could prevent penalties on installments paid earlier in the year.
What else can you do? If you receive income unevenly over the course of the year, you may benefit from using the annualized income installment method of paying estimated tax. Under this method, your adjusted gross income, self-employment income and alternative minimum taxable income at the end of each quarterly tax payment period are projected forward for the entire year. Estimated tax is paid based on these annualized amounts if the payment is lower than the regular estimated payment. Any decrease in the amount of an estimated tax payment caused by using the annualized installment method must be added back to the next regular estimated tax payment.
If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
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About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.