Edward A. Zurndorfer
As federal employee and annuitants prepare their 2019 federal income tax returns, they should be aware of the possibility that they may be subject to an “under-withholding” penalty when filing their 2019 federal taxes. They should also be aware of what needs to be done during 2020 to avoid any under-withholding penalty when they file their 2020 federal income taxes in spring 2021. This column discusses the IRS’ under-withholding penalty and which individuals need to consider making federal estimated tax payments during 2020 in order to avoid this penalty in 2021.
For 2019, individual tax filers are subject to an underpayment penalty unless their total tax withholding (from salaries, pensions or other sources) and 2019 estimated tax payments equal the smaller of:
· 90 percent of their tax liability on the 2019 federal tax return, or
· 100 percent of the tax liability shown on the 2018 federal tax return (110 percent if the individual’s 2018 adjusted gross income (AGI) was over $150,000, $75,000 for individuals who file as married filing separately).
The underpayment penalty for 2019 does not apply if either of these conditions exist: (1) an individual’s federal income tax balance due after subtracting 2019 federal tax withholding is less than $1,000; or (2) the individual was a U.S. citizen or resident alien during 2019 and had no federal tax liability on a 2018 federal income tax return that covered 12 months.
The under-withholding penalty is calculated on IRS Form 2210 (Underpayment of Estimated Tax byIndividuals, Estates and Trusts) and reported on line 24 of Form 1040. Form 2210 is not filed with the return unless one of the exceptions discussed below applies. The underpayment penalty is not required to be calculated and reported on line 24. The IRS will calculate the penalty and bill the individual later. No interest is charged on the penalty if the return was filed by the due date and the penalty is paid by the date specified on the bill.
Form 2210 must be filed with an individual’s tax return in the following situations:
· Request for waiver. The IRS may waive an under-withholding penalty in the case of a casualty, disaster, or other unusual circumstance affecting the individual’s ability to pay the balance due;
· Annualized income installment method. Required quarterly payments can be calculated based on actual income and deductions in each quarter. If income was higher in later quarters of the year, then this method may reduce the penalty by lowering required quarterly payments at the beginning of the year; or
· Using actual payment dates for withholding. Withholding from wages and other payments is considered to have been paid in four equal installments. An individual can choose to apply withholding to the quarter it was actually paid. This can reduce the penalty if a large amount of tax was withheld early in the year.
Avoiding the Under-withholding Penalty for 2020
If a federal employee or annuitant wants to avoid an under-withholding penalty for 2020 due to a change in personal financial circumstances, now is the time for the employee annuitant to consider making quarterly estimated tax payments during 2020. In most cases, the required annual payment can be paid in four installments to avoid a penalty. If any installment is paid late, the penalty is charged beginning on the payment due date and ending on the date paid. The penalty is interest on the underpaid amount for the number of days the payment is late. Interest is charged at the federal rate for underpayments. The following table summarizes the due dates for 2020:
Estimated Tax Payments – 2020 Due Dates
|Installment Payment||Due Date|
|April 15, 2020 |
June 15, 2020
September 15, 2020
January 15, 2021
Why Would an Employee Have to Make an Estimated Tax Payment During 2020?
The main purpose of making estimated tax payments is to make sure that an individual has paid the minimum amount of federal taxes required at the time a significant event potentially increases his or her annual federal tax liability. Also, the individual does not know whether he or she has had a sufficient amount of federal income taxes being withheld from a paycheck or a pension plan distribution or withdrawal to cover the increased federal tax liability.
The following three examples will help illustrate:
Example 1. Sally retired from federal service on Dec. 31, 2019. She received her last two paychecks (for pay periods 25 and 26) and her lump-sum payment for unused annual leave hours in January 2020. Her first FERS annuity check was received on Feb. 3, 2020, and her second FERS check was received on March 2, 2020. Both checks had a minimum of federal income taxes withheld. Sally has taxable interest, dividend, and capital gain income. Sally should consider making an estimated tax payment for the first quarter of 2020 (the period January 1 – March 31, 2020) in order to meet her federal tax liability for the first quarter of 2020. She should total all of her gross income for the first quarter of 2020 – salary income including lump-sum payment for unused annual leave, FERS annuity payments, interest, dividends, and capital gains. If Sally was in a 22 percent federal marginal tax bracket during 2019, then as a “safe-harbor” Sally should use that “safe harbor” as a means for approximating her marginal tax bracket for 2020. She should multiply her approximate gross income for the first quarter of 2020 by 0.22 and the resulting amount is her first quarter estimated tax payment that is due April 15, 2020.
Example 2. In January 2020, Carl sold 100 shares of ABC stock for $30,000. The 100 shares of ABC stock were gifted to Carl three years ago from Carl’s father. Since Carl received the ABC stock as a gift, Carl’s cost basis in the stock is the same as the donor’s (the individual who made the gift) basis. Carl’s father’s basis in the stock was $10,000. Therefore, upon selling the stock, Carl incurred a $30,000 less $10,000, or $20,000 (long-term) capital gain. At Carl’s 22 percent federal marginal tax bracket, long-term capital gains are taxed at 15 percent. Therefore, Carl’s tax liability resulting from sale of the 100 shares of ABC stock is equal to:
15 percent of $20,000, or $3,000.
While Carl has until April 15, 2021, to pay the $3,000 tax due on the sale, he should pay at least 90 percent of $3,000, or $2,700, through an estimated tax payment due April 15, 2020. The capital gain occurred during the first quarter of 2020. Carl, therefore, needs to make sure he pays 90 percent of what he owes for the first quarter of 2020 by April 15, 2020.
Example 3. Jennifer decides to convert $50,000 of her traditional IRA to a Roth IRA on March 9, 2020. She elects not to have any federal income tax withheld at the time of conversion. Before the conversion, Jennifer was in a 22 percent federal marginal tax bracket. As a result of the conversion, the $50,000 of converted IRA monies will be added to Jennifer’s other 2020 taxable income. The result is that Jennifer will be pushed into a 24 percent tax bracket. Jennifer, therefore, owes 24 percent of $50,000, or $12,000 in federal income taxes. Jennifer should consider making a federal estimated tax payment for the first quarter of 2020. She should pay 90 percent of $12,000, or $10,800, in estimated taxes that are due April 15, 2020.
It needs to be emphasized that in the three examples presented, each of the three individuals incurred significant federal tax liabilities resulting from events that occurred during the first quarter of 2020. Each individual was encouraged to make a first-quarter 2020 estimated tax payment due April 15, 2020. The same recommendation would apply to individuals who, as a result of a significant taxable event, incurs a significant tax liability in:(1) the second quarter of 2020 (April 1 – May 31, 2020) (with the estimated tax payment due June 15, 2020);(2) the third quarter of 2020 (June 1 – August 31, 2020) (with the estimated tax payment due (September 15, 2020); and (3) the fourth quarter of 2020 (September 1 – December 31, 2020) (with the estimated tax payment due January 15, 2021). The purpose of making these estimated tax payments is that individuals cannot wait until they file their current year tax return in the spring of the following year and pay a significant federal tax balance due (more than $1,000). If they do wait, they run the risk of paying to the IRS an under-withholding penalty and interest charges. Additional information about federal estimated tax payments, including how to make federal estimated tax payments, may be found here.
Finally, those individuals who live in states with income taxes need to check with their state revenue departments or with their tax advisors about state estimated tax payment requirements in their respective states.
Edward A. Zurndorfer is a Certified Financial Planner, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While the employees of Serving Those Who Serve are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
The hypothetical examples throughout this material are for illustration purposes only and do not represent an actual investment. Please consult with your financial advisor if you have questions about these examples and how they relate to your own financial situation.