PricewaterhouseCoopers is supporting calls from the American Institute of CPAs and some lawmakers in Congress who are asking the Internal Revenue Service to lower the penalty threshold for taxpayers who didn’t withhold enough from their paychecks or make enough estimated tax payments in the wake of the new tax law.
Last month, the IRS announced that it would generally waive the tax penalty for any taxpayer who paid at least 85 percent of their total tax liability last year through federal income tax withholding, quarterly estimated tax payments or a combination of the two (see IRS to waive tax penalties for underwithholding and underpayment). The usual percentage threshold for avoiding a penalty is 90 percent. However, once tax season got underway at the end of January, many early filers complained about lower tax refunds or unexpectedly high tax bills, largely due to the extensive changes in the Tax Cuts and Jobs Act, and failure to adjust withholdings last year. On Friday, the IRS released filing season statistics for the week ending Feb. 15, 2019, indicating that the average refund amount had declined 16.7 percent, from $3,169 for the same week last year to $2,640 this year.
The AICPA sent a letter to the IRS late last month asking it to lower the threshold further to 80 percent (see AICPA wants more penalty relief for underpayments and late payments by taxpayers). A group of Democrats in the Senate and the House is also asking the IRS to lower the threshold (see Senate Democrats accuse Treasury of manipulating withholding tables to produce ‘phantom windfall’) . In the House, Rep. Judy Chu, D-Calif., has re-introduced a bill called the Taxpayer Penalty Protection Act that would shield taxpayers from taxpayers who unintentionally did not withhold enough from their paychecks. The bill has been endorsed by the AICPA.
“We were delighted to see the IRS take the action they did in January, but we didn’t think it went far enough,” said Mark Nash, a tax partner in PwC’s Private Company Services practice. “The AICPA submitted comments on behalf of the profession, and PwC sits on the committee that helped draft those comments. So the thing that was reflected in the AICPA letter at the end of January, where they asked the IRS to consider going even further, we certainly would agree with that, because it doesn’t quite apply to everybody.”
The Tax Cuts and Jobs Act eliminated or sharply limited many traditional tax deductions in exchange for doubling the size of the standard deduction. The tax overhaul also got rid of personal and dependent exemptions, but doubled the size of the Child Tax Credit. However, relatively few taxpayers adjusted their withholdings last year in response to the new tax law, even though the IRS urged taxpayers to do a “paycheck checkup” and use its online withholding calculator to try to figure out how to adjust their withholdings.
“There was massive confusion at the beginning of 2018 around the withholding matter,” said Nash. “The W-4 was not clear. If you look at the computation worksheet on the W-4, it still makes reference to things in terms as though you’re looking at personal dependency exemptions even though those no longer apply, so for your average taxpayer that didn’t have a PwC or a firm preparing their taxes and working through actual computations of what the liability was going to be, I think your average person really was winging it, so to speak, to wonder how much they should withhold. So it’s not a surprise to us that a number of people came up underwithheld, and that the IRS decided to issue the relief.”
The payroll giant ADP found that the number of taxpayers who changed their withholdings last year was roughly the same as in 2017, before the tax overhaul passed at the end of the year. “We did a comparison, essentially asking the question of given the tax reform act in 2017 was so comprehensive and fairly complex, did taxpayers generally respond appropriately by revising their Forms W-4 to perhaps reduce the number of withholding allowances, because among other things, they eliminated the personal exemptions,” said ADP Head of Government Relations Pete Isberg. “You might expect the taxpayers to learn about that and kind of turn around and go back to their employer and say, ‘I’d better go ahead and file a new Form W-4, removing my withholding allowances associated with the personal exemptions.’ What we found, though, is that they generally did not do that. There was virtually no change in the percentages of people who elected one or two or three withholding allowances. It was pretty much unchanged in September 2017 versus September 2018, which I thought was a surprise.”
The online withholding calculator was not so easy to use for the average taxpayer, requiring them to make assumptions about how much they would be earning in 2018.
“I think the withholding tables worked fine for someone who had a good grasp of what their taxable income was going to be, but the withholding tables kind of asked you to do a ballpark estimate of what your tax liability was going to be if you were going to itemize deductions,” said Nash. “A lot of taxpayers, if they didn’t have help, weren’t prepared to do that. I think the tables were accurate if you knew how to use them. I just think that they were not simple.”
PwC was able to help a number of clients make adjustments, but these were generally more sophisticated taxpayers who could employ a Big Four accounting firm. “We have had a number of clients ask us to review their W-4s and their withholdings with them,” said Nash. “We use our own projection software, not the IRS calculator that’s online, but we have had a number of clients that are raising the question. … Most of our clients make quarterly estimated payments. Once we figured out what the new withholding was going to be, they filled out their W-4, and we made adjustments to the estimated payments as necessary.”
However, PwC and the AICPA would like to see the IRS lower the penalty threshold as well as grant relief to business taxpayers who may have underwithheld or underpaid their estimated taxes. “One of the things that the AICPA did ask for in their January letter was they did point out that there was no relief given to businesses and they thought the IRS should consider extending relief to businesses and tax-exempt organizations,” said Nash.
He isn’t sure what the right threshold should be for the penalties. “Some folks said that 85 [percent] wasn’t enough and that 80 [percent] should be considered,” said Nash. “I don’t know how you quantify what’s a better number. Obviously, the more relief you give, the less people that are caught in the trap, so I think more relief is generally good, considering the amount of confusion that there was in the beginning of last year.”
He believes taxpayers should be sure to adjust their withholdings as soon as possible if they haven’t already done so. “The important thing now that the IRS is having to grant relief, now that folks are seeing that they’re getting smaller refunds, it’s a good reminder to people to start now to think about what 2019 is going to look like,” said Nash. “If you were surprised and you ended up in a position where you qualified for the relief, or you didn’t but you were underwithheld, now is the time to run those projections and make sure that you adjust the withholding or the quarterly estimated payments to make sure you’re not caught that way for 2019 because I think the IRS will probably be less sympathetic the second time around. … There are still a lot of folks that have not approached their extension calculation and don’t even know if they are in a situation where they’re underwithheld. It is time to start looking forward to think about 2019 so that they’re not caught again.”
PwC’s Private Company Services practice, where Nash works, recently released its annual Guide to Tax Wealth Planning. The report represents PCS’ expert guidance for strategic tax planning, portfolio management, charitable giving, and estate and gift planning. The annual guide also reflects the impact of tax reform and includes guidance surrounding the IRS waivers.
“It’s one of our favorite publications that we do at the firm,” said Nash. “It’s one of the most often downloaded from the website. We update it every year on a lot of different topics, a lot on income tax planning, retirement and family offices. It’s just a wealth of information at a very high level that any client can read and appreciate. And it’s free on the website.”