The Tax Jobs and Cuts Act (TCJA) was signed into law last year, with the promise that most taxpayers would get a tax break. However, the General Accounting Office (GAO) is warning that, unless taxpayers act to adjust their withholding, more than thirty million taxpayers will owe taxes next year, an increase from last year.
Why is this? In addition to the new tax rates, the TJCA made significant changes to itemized deductions normally claimed on a Schedule A. Those changes include limits on the deductions for state and local (SALT) taxes, a cap on the amount that you can borrow for purposes of the home mortgage interest, and exclusions for job-related expenses.
As a result, the Internal Revenue Service (IRS) has encouraged taxpayers who itemize to do a checkup on their taxes. By plugging your current tax data into the withholding calculator on the IRS website, you can do a “paycheck checkup” and avoid surprises at year end.
But just doing a checkup isn’t enough: You may need to take additional steps. Generally, employers are required to withhold income taxes on employee pay, but employees can exclude part of their pay from withholding. You typically do this by completing a form W-4 to help your employer determine how much federal tax to withhold from your paycheck. If you withhold too much, you are due a refund; if you withhold too little, you will owe at tax time. The key is to try and maintain a balance.
As a result of the new tax rates, the IRS published new withholding tables for employers, together with a new form W-4. To measure how the new tables might be working in connection with the updated rates, the GAO conducted a “performance audit” from February 2018 to July 2018. They found that taxpayers are likely not withholding the proper amounts from their paychecks.
Typically, most taxpayers over-withhold. That’s encouraged by the feds because it means that there is less likelihood of noncompliance; the IRS has estimated that 99% of income subject to withholding, like wages and salaries, is accurately reported.
Who is most at risk for missing the sweet spot? A GAO analysis of hypothetical taxpayers suggests that those most likely to over-withhold as compared to last year are married, single wage earning middle-class married taxpayers with two children, who claim the standard deduction. Those most likely to under-withhold are married, single wage earning upper-middle-class taxpayers with two children, who itemize their deductions and report additional non-wage income like dividends and interest.
To help address the issue, the Treasury Department intends to make additional changes to the withholding tables in 2019. The IRS is also updating the form W-4 (again):
Until that time, how can you avoid getting stuck with a big tax bill?
- Do a tax checkup (here).
- Consider revising your form W-4. Here’s your rule of thumb: The more allowances you claim, the less federal income tax your employer will withhold from your paycheck (the bigger your take-home pay). The fewer allowances you claim, the more federal income tax your employer will withhold from your paycheck (the smaller your take-home pay).
- Pay attention to income not subject to withholding, like dividends and interest – and that gig income.
- Stay up to date. It’s important to remain informed, so follow a trusted tax column (like this one) or other sources, so that you can make changes as necessary.