Did you know your taxes can go down but you still might owe come tax time. This is why almost every tax professional is encouraging all taxpayers to check their withholding to make sure you have enough withheld for the year under the new tax law. In fact, the Governmental Accountability Office believes that up to 30 million taxpayers will owe money with their 2018 tax return when they file in 2019. [see the GAO report here]
One concern is that so many people always expect to get a tax refund that they stay in autopilot when it comes to tax matters. I think it’s happened so many times that they actually rely on the refund to pay off other bills. In one sense, they assume the amount withheld will completely cover their tax liability and leave them with a little extra that they can get back in their tax return refund.
In the past, getting a refund might have been a safe assumption because their income was fairly stable, their tax rates were fairly stable and their withholding was fairly stable. Put these pieces together and it was logical that if nothing big changed from year to year, they could rely on receiving a refund with their tax returns.
The above predictability of steady wages, steady tax rates and steady withholding has been turned on it’s head this year. The Tax Cuts and Jobs Act was passed in December of 2017 and generally goes into effect for tax years beginning after January 1, 2018. This tax reform is changing multiple pieces of the equation I mentioned above.
Amount of Tax Due:
There are a number of variables that changed for 2018 and this will impact the amount of tax due with your 2018 tax return. Here are a few of the big changes:
- Tax rates are changing. The tax rates for each income level have been reduced for 2018. This means that even if your taxable income doesn’t change, your taxes due should go down.
- Tax deductions are changing. The tax reform act made a lot of changes to deductions, but the main changes are that deductions have further limitations or have been eliminated in calculating taxable income. In addition, the standard deductions were increased which might make a lot more people to take the standard deduction rather than itemizing their deductions.
- Personal exemptions are gone. Personal exemptions used to be allowed on the tax return for the taxpayer (and spouse if married filing joint) and each dependent. Starting in 2018, taxpayers won’t get the extra amount to reduce their taxable income. In some respects, the removal of personal exemptions is offset by the increased amount for the standard deduction.
- Extra Credits! No, these aren’t like the extra credits you got in high-school for doing an extra amount of work, these are the credits that Congress is giving you for having children and taking care of other family members. Remember I just told you the personal exemptions for your dependents are gone? Well, these credits are intended to help lessen the sting of not having those exemptions any more. What’s even better about the credits are that they reduce your taxes dollar for dollar, which makes them go a lot farther if you’re in a lower tax bracket.
When you take all the changes into account, you should be able to see that your taxes are going to change for 2018. In general, it’s expected that most people will see lower taxes in 2018 compared to 2017. To be sure, it’s assumed that everyone’s taxes will go down, however, that’s not the case for each situation. Regardless of whether your taxes go up or go down, you’re going to owe money if you don’t have enough taxes withheld from your paycheck.
Withholding
This brings us to another part of the equation. If you receive a paycheck, your employer should be withholding a little (or a lot) from each paycheck and giving it to Uncle Sam on your behalf. This withholding is reported to you on your annual Form W-2 and you use this withholding to pay most or all of your taxes each year. You may not remember doing it, but when you started your job you filled out a Form W-4 and gave it to your employer. This Form W-4 is what your employer uses to determine how much to withhold from each paycheck.
The IRS updated both the Form W-4 and the way employers use the information on Form W-4 to calculate the withholding amounts. The changes are supposed to make sure your employer withholds enough taxes throughout the year so that you don’t owe taxes when you file your tax return. In a perfect world this would be an easy exercise where you tell your employer your filing status, marital status and number of dependents you have. Unfortunately, this isn’t a perfect world and the Tax Cuts and Jobs Acts is not a perfect law. Therefore, the IRS is really struggling to get the withholding calculations perfected based off the information from Form W-4.
The bottom line
The bottom line is that you really can’t assume that the IRS withholding tables will work for each taxpayer. While they might work for some taxpayers, what if you’re not in that group? What if you’re expecting a tax refund but end up owing money with your 2018 tax return when you file it on April 15, 2019?
Let’s look at a simple example. Suppose you get paid weekly and your employer withholds $20 less from each paycheck than you really need to be withheld to cover your taxes. Over a 52 week year, this would leave you with $1,040 less being withheld for the year. This would mean you have to pay $1,040 with your tax return. Going the other direction, if you employer over withholds $20 per paycheck, you would get a $1,040 refund.
This is why the IRS and tax professionals are encouraging everyone to do a “Paycheck Checkup” to make sure you have a sufficient amount of withholding for the year. There is still enough time left this year to make an adjustment so you don’t have a large tax payment due with your 2018 tax return. However, if it put if off, you’ll run out of time and, instead of paying a little more with each paycheck, you’ll have a large amount due at one time.
Resources
The first place you’re going to want to visit is the IRS’s website, www.irs.gov to do a paycheck checkup. You might also want to review the new version of Form W-4 and possibly fill one out and give it to your employer.
If you need some help filling out your W-4, check out this post to help you figure out how many allowances to claim.
For general information about how tax reform will impact your 2018 taxes, there are a ton of online tools. A good online calculator might be the best option. The Tax Policy Center has a calculator to see how it affects different taxpayers with different situations.
If you need professional assistance, please contact me using the Contact Me page on my blog. We can help you fine-tune your withholding calculation to make sure you aren’t surprised when you file your next tax return.