Tax Liability and Safe Harbor

[gordda40]

We made a couple small Roth conversions in 2018 that will result in us owing $200.00 to the IRS total on our tax return once we take into account a retirement savings credit for my wife, an aotc for myself and and earned income credit for our last son at home.  We will also owe the State of Michigan just under $500.00, in part because of these conversions, once we take our state property tax credit into account  My question is regarding safe harbor based on the previous years tax liability if you have had 100% of your previous years tax liability covered by withholding or extimated payments.  What is considered tax liability?  Is it before any credits or does it include any credits?  I have seen it described on some forums as the amount from line 63 on the old 1040, or what will go on line 15 of the new form.   We had no tax due to the federal or state in 2017 because of credits, but want to make sure I understand how that differs from tax liability?

[MargaretL]

The tax liability is an amount AFTER subtracting your withholding and refundable credits. You won't pay the penalty for 2018 if:

• you had no tax liability for 2017 (which you did not), OR
• the total tax shown on your 20018 return minus the amount of your withholding is less than $1000

Please click here for more details.

[gordda40]

Thank you so much.  So looking ahead to 2019, we plan on doing a large Roth Conversion and we are thinking about waiting to pay the tax until we file our 2019 return rather than doing quarterly or drastically increasing payroll withholding.  As long as we have enough withheld to match our 100 percent of our 2018 tax liability, we would again be protected from penalty and interest if I am correct?  The State of Michigan states they also follow these same IRS guidelines for exclusion of penalties as well.

[MargaretL · Accepted solution]

You are welcome!

Please remember that IRS is a pay-as-you-go system - you must pay income tax as you earn or receive the income during the year. So for 2019...you will avoid the penalty if you either owe less than $1000 in tax or if you paid your withholding/estimated tax of at least 90% of the tax for the current year (which will be your 2019 year) or 100% of the tax shown on your 2018 tax year(whichever is smaller).

[gordda40]

Just to make sure for the State of Michigan, when they talk about 100% of your previous tax year's liability as your safe harbor, this also is what you actually owe minus credits and withholding?  It is not the actual total tax you owed for 2018 without taking into consideration what was withheld?  Sorry for the followup question, but trying to make sure we have our withholding correct on our new Michigan W-4.

[MargaretL]

Yes, for the State of Michigan, the rules are the same. Here what MI Dept of Treasury says: 

"The Michigan Department of Treasury follows the Internal Revenue Service (IRS) guidelines for estimated tax requirements. Based on the IRS estimated income tax requirements, to avoid penalties for failure to make estimated tax payments, your total tax paid through credits and withholding must be:

90% of your current year's tax liability,
or 100% of the previous year' liability, 
or 110% if your previous year's adjusted gross income is more than $150,000  ($75,000 or more for married filing separate)."

[rosanne125]

Have a similar situation with doing two Roth Conversions in 2019.  Since there will be a spike in the two quarters that I do the Roth conversions (June and December), am I still able to utilize the Safe Harbor Rule by paying at least 90% of what I will owe in taxes for 2019 in 4 equal quarterly installments in March, June, September and December? Or will I have to pay more in the two months where I am doing the Roth Conversions since there will be an income spike? I have no other income or withholding of taxes for 2019.