Our income tax system is known as a pay-as-you-go system. This means that as taxpayers we pay our income tax liability for the year as the income is earned. For employees, the income tax is withheld from wages as the income is earned. For self-employed persons estimated tax payments are made in four installments throughout the year. Failure to pay the correct amount of tax throughout the tax year can lead to a penalty for the underpayment of estimated taxes. The following information may be helpful:
How can I avoid the penalty for underpayment of estimated taxes?
Although there are some limited exceptions to the application of the penalty, in general you can avoid the penalty in two ways:
1. If, after taking account withholding/estimated payments, deductions and credits, your tax liability for the year is less than $1,000, you will not incur the penalty.
2. If your estimated tax payments or withholding for the year total the lesser of:
(a) 90% of the tax liability for the current year or (b) 100% of the tax liability for the prior year, you will not incur the penalty.
I always get a refund when I file my tax return. I do not need to worry about the estimated tax penalty.
While this is true, and some people use the tax system as a “forced savings” method, in this situation the government is using the taxpayer’s money during the year interest free. This is a case of over withholding and unless the taxpayer prefers the benefit of the large refund, the withholding should be adjusted.
My employer withholds from my wages/I am self-employed and make estimated payments based on my income. I do not need to worry about proper withholding.
This is not necessarily true. You need to make sure that the tax payments are sufficient to satisfy one of the two tests for avoidance of the underpayment penalty. If the payments are not sufficient, the penalty will be incurred. Additionally, the taxpayer may have sources of income other than employment. Income taxes are paid not only on earned income, but also on unearned income such as interest, dividends, and capital gains. These items of income need to be taken into account in determining the tax liability. If these items of income are substantial, the estimated taxes paid/withheld may be insufficient to cover the actual tax liability resulting from these additional income sources and lead to the imposition of the underpayment of tax penalty.
In the past my withholding/estimated payments have been just right, either resulting in a very small refund or a very small tax liability. I do not need to do anything.
This is where the new Tax Act comes in. Starting with 2018, the law has made revisions to tax rates, tax brackets and standard deductions. It has also done away with personal exemptions and, for the most part, itemized deductions. Hence, it is important that new calculations be made. To help you determine the proper withholding/estimated taxes for 2018, the IRS has a withholding calculator. You can access the calculator by following this link:
What do I do if I need to adjust the tax being withheld from my wages?
As the result of the changes to the law, the IRS issued new withholding tables. These tables were designed to work, as much as possible, with the Form W-4 previously provided by an employee to the employer. Except in the case of an employee claiming an exemption from withholding, the new law does not require an employer to request a new Form W-4 from an employee, nor does the law require an employee to submit a new Form W-4 to the employer. However, the IRS has revised Form W-4 and the worksheets accompanying the form. If you determine that the amount being withheld by your employer needs to be adjusted, then the new Form W-4 should be submitted to the employer.
The IRS is encouraging those who itemized deductions in the past, have more than one source of household income, or have dependents over the age of 17 to review their withholding/estimated tax payment for 2018 in order to avoid surprises next April.
If I review my situation for 2018 and make adjustments to my withholding/estimated tax payments, will I have to do review it again in the future?
Unfortunately, yes. The IRS anticipates that additional changes will be made to Form W-4 in 2019.
With one quarter of 2018 already past, it is important that you estimate your income tax liability now. By doing so, you can make any necessary adjustments with ample time to spread any required increases to withholding over a longer period of time. If you have been over withholding, then the sooner you make the calculations the sooner you can start getting a bigger pay check.