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Recent Claims Trend – Estimated Tax Requirements for California Taxpayers

Some tax practitioners who represent California taxpayers may not be aware of the rules for assessing penalties for underpayment of estimated tax for high income earners in California.

Generally, California taxpayers with an Adjusted Gross Income (“AGI”) of $1 million or more may no longer use the prior year tax safe harbor rules. Although this is not a new rule (i.e., effective date was January 1, 2009), some tax practitioners who represent California taxpayers may not be aware of its impact.

Under the old rules, high-net-income California taxpayers could avoid an estimated tax penalty as long as they paid in 100% (110% if the taxpayer’s AGI was over $150,000) of the tax shown on the prior year return. California Revenue and Tax Code (“CRTC”) §19136.3 changed the estimated tax requirements so that the prior year tax safe harbor rules no longer apply if taxpayer’s current year AGI is $1 million or more. Instead, those taxpayers are now required to pay estimates equal to 90% of the current year tax. For example, if taxpayer’s AGI was $250,000 in 2019 but jumped to $1.1 million in 2020, the taxpayer would be required to pay 90% of their 2020 tax liability to avoid an underpayment penalty. The Franchise Tax Board (“FTB”) is actively enforcing the law and sending penalty notices to high income taxpayers who have underpaid. This has resulted in several recent claims.

One exception under CRTC §19136(c)(2) is available for taxpayers who are subject to the underpayment penalty. The taxpayer would not be subject to an underpayment penalty if:

  • the calculated tax minus withholding for the prior year was $500 or less ($250 or less for married filing separately taxpayers),
  • the taxpayer’s prior year withholding covered their prior year tax liability (within $500 or less),
  • the taxpayer’s current year AGI is over $1 million, and
  • the taxpayer had no withholding and made no estimates.

Note that the FTB may issue the underpayment penalty notice even though the taxpayer has met §19136(c)(2)’s requirements.

Penalty Abatement/Waiver

The FTB does not provide an abatement or waiver of the underpayment of estimated tax penalties for reasonable cause. However, taxpayers may request a penalty waiver in the following limited situations:

  • Underpayment was due to a casualty, disaster, or other unusual circumstance; or
  • The taxpayer retired after age 62 or became disabled in the prior or current year, and the underpayment was due to reasonable cause.

Loss Prevention Tips

  • Stay current with state-specific safe harbor rules for estimated tax requirements.
  • DOCUMENT, DOCUMENT, DOCUMENT! Be sure to have written documentation from your client, or at the very least, memo(s) to file, regarding the income amounts that are provided to you for purposes of assessing your client’s estimated tax requirements.

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