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Dodge an underpayment tax penalty

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in Small Business Tax

Are you in danger of owing a penalty for underpaying federal income taxes in 2018? You still have time to set things right.

Strategy: Increase your withholding between now and the end of the year or make an estimated tax payment. If you then meet one of the safe-harbor rules, the IRS can’t hit you with a penalty.

But figuring out how much to pay in tax this year is even more complicated than usual, thanks to the Tax Cuts and Jobs Act (TCJA).

Here’s the whole story: Generally, you’re required to pay income tax during the course of the year through payroll withholding. Similarly, you may pay tax in quarterly installments on your investment income or if you’re self-employed. The quarterly due dates are April 15, June 15, September 15 and January 15 of the following year (or the following business day if the due date falls on a weekend or holiday).

Thus, the final quarterly installment due date for 2018 is January 15, 2019.

However, the IRS won’t impose a penalty if you qualify under one of these three safe-harbor rules based on any combination of withholding or installment payments.

1. You pay at least 90% of the current year’s tax liability. This requires you to make a calculated “guesstimate” of your 2018 tax situation.

2. You pay at least 100% of the prior year’s tax liability. The figure increases to 110% if your adjusted gross income (AGI) for the prior year exceeded $150,000. This is often the easiest method to use because you know the exact amount of your previous year’s tax liability.

3. You pay at least 90% of the current year’s “annualized income.” The annualization method may work for certain taxpayers who receive most of their income on a seasonal basis. For instance, it might work well if you’re an independent contractor dependent on holiday sales.

Due to all the changes in the TCJA—including loss of personal exemptions and reductions and repeals of itemized deductions—you may be underwithheld for 2018.

Best approach: Analyze your 2018 liability right now. You can use the IRS’s calculator at www.irs.gov/individuals/irs-withholding-calculator for a quick determination. If you need to increase your withholding, notify your payroll department right away.

Tip: Remember that a January 2019 estimated tax payment can still bail you out.

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