Our clients typically follow the pattern of taxpayers in general--they are split into two groups--people who are accustomed to receiving an income tax refund and file their taxes early, and people who wait until April (or later) to pay what they expect to owe. This year, however, those early filers are finding to their surprise that they actually owe money to the IRS.
Whether you get a refund or owe extra to the IRS at filing time is a function not just of your total taxes owed, but also of how much tax is withheld from your paycheck by your employer on paydays. And following the Tax Cuts and Jobs Act (TCJA) that was passed in December of 2017, the Treasury Department tweaked things so that on average taxpayers’ withholdings fell by more than the reduction in their expected tax savings.
It is true the TCJA was largely focused on reducing taxes for business owners. This included a big cut in the corporate income tax rate, as well as a similarly proportional cut in the amount of pass-through income by non-corporations (such as partnerships or sole proprietors) subject to personal income tax. But there were changes for all other individual taxpayers too. On the negative side, the TCJA either eliminated or curbed a whole bunch of popular tax deductions--including the personal exemption, the state and local tax deduction, and the miscellaneous deduction where things like home offices and financial advisory fees resided. On the positive side the Child Tax Credit got more generous, the standard deduction got much bigger, the threshold for the much despised Alternative Minimum Tax was significantly raised, and individual tax bracket percentages were reduced. In the aggregate, this meant lower taxes for the vast majority of Americans.
So everyone’s withholdings had to be calculated anew. But in July 2018 the government financial watchdog General Accounting Office (GAO) discovered that while both taxes owed and withholdings went down, withholdings went down too much. Under the old system, 75 percent of taxpayers were getting refunds — meaning that the withholding system was poorly targeted in the Treasury Department's view. By switching to a new system in which fewer people get refunds and more people owe extra money, the IRS believes it will be achieving a more balanced result.
This will be of little comfort for people hit with a surprise request to pay extra to the IRS. They will think that the TCJA raised their taxes. In most cases that’s not what’s happening. Rather, their take home pay was a little too high during 2018.
Worried about 2019 withholding? Clients should reach out to their assigned tax advisor at the firm. Potential clients should email us at email@example.com to get help.
This post was adapted from a story in Vox.