CA Estimated Tax Underpayment Penalty Assessments
Many of our clients have been receiving notices from the FTB assessing a penalty for underpayment of estimated tax. Many of these notices are unwarranted, and it seems the FTB is taking the stance that it is the taxpayer’s responsibility to prove they don’t owe a penalty that should never have been assessed!
The assessments stem from the change in estimated tax requirements for taxpayers with AGI equal to or greater than $1 million. Beginning January 1, 2009, if you have AGI of $1 million or more, you can no longer use the prior year tax safe harbor rules. Under the old rules, taxpayers could avoid an estimated tax penalty as long as they paid in 100% (110% if your AGI was over $150,000) of the tax shown on the prior year return. California Revenue and Tax Code Section 19136.3 changed the estimated tax requirements so that the prior year tax safe harbor rules would not apply if your AGI was $1 million or more. Instead, those taxpayers are now required to pay estimates equal to 90% of the current year tax. For example, if your AGI was $100,000 in 2008 but jumped to $1.1 million in 2009, you were required to pay 90% of your 2009 tax liability in order to avoid an underpayment penalty.
There is, however, one exception. Under California Revenue and Tax Code Section 19136(c)(2), taxpayers will not be subject to an underpayment penalty on their current year return if the tax minus withholding for the prior year was $500 or less ($250 or less for married filing separately taxpayers.) This means if your prior year withholding covered your prior year tax liability (or was up to $500 less than your tax liability) and in the current year you have AGI over $1 million, have no withholding and made no estimates, you would not be subject to an underpayment penalty. The FTB appears to have issued underpayment penalty notices even if the taxpayer met the requirements of section 19136(c)(2).
If you received one of these notices talk to your LMGW advisor BEFORE you pay the penalty to make sure it was fairly assessed. We can assist you in responding to the FTB to have erroneous penalties removed. Also keep in mind this article refers to the California requirements only and your federal estimated tax requirements may be different.