Lower Withholdings Under the New Tax Law May Cause an Unexpected Bill in April

The Tax Cuts and Jobs Act (TCJA), signed into law in late 2017, significantly changed tax brackets, deductions, and other facets of the tax code, as discussed in a prior post.  For most taxpayers, the law will be a net positive in the coming years, with lower tax brackets outweighing other changes and causing a decrease in their overall tax bill.*  However, even though most taxpayers will pay less in taxes in 2018, they still may receive an unwelcome surprise when they complete their tax returns in April.  Many will owe taxes or receive a smaller-than-expected tax refund because they have been withholding an insufficient (or barely enough) amount from their paychecks this year.

Changes to Withholdings.  In response to the new tax law, the IRS updated its withholding tables in January, changing the amount that employers had to set aside from employee paychecks for federal income tax.  According to some employment tax experts, this change, which employers were required to implement by mid-February, was undertaken quickly to ensure that American workers began to receive higher take-home pay soon after passage of the new law.  The withholding rates for most workers though are based on outdated W-4s (the forms that indicate the number of allowances for each worker), since the IRS only released a revised version of the W-4 in late February.  This is contributing to concerns that current withholdings are not accurate for many workers.  According to a recent report from the Government Accounting Office, 21 percent of taxpayers (about 30 million people) might not be withholding enough from their paychecks to cover their tax liability in 2018.  Even those who are withholding enough may be disappointed in April if they are expecting a significant tax refund and don’t get one.  The average refund in 2017 was just over $2,800, but that could also change depending on how taxpayers are impacted by the new tax law.

Action to Take Now.  To avoid unwelcome surprises at tax time, we suggest doing a “Paycheck Checkup” to determine whether your current withholdings are adequate to cover your expected tax liability.  The IRS has a Withholding Calculator available for this purpose—you just need last year’s tax return and a recent paystub to input the relevant data.  Those receiving pension and/or Social Security income can use this tool as well.  If you find that you are not withholding enough for taxes, you can update the amount being withheld from your paycheck by filling out a new W-4.  (Regardless of changes in the tax law, it is useful to complete a new W-4 if you have been in the same job for several years, since you may have had changes in income or life events—marriage, new baby, divorce, house purchase, etc.—that impact the number of allowances that you should claim.)  Alternatively, you can make an estimated tax payment to cover the expected liability.  If you are uncertain about using the IRS Withholding Calculator, you can always contact your CPA to do a tax projection for you—or, for our clients, we are happy to do a projection as part of our service to you.

*One exception that we have seen among our clients is taxpayers who benefited considerably from miscellaneous itemized deductions on their Schedule A.  These miscellaneous deductions—for unreimbursed job expenses, tax preparation and investment expenses, etc.—are no longer deductible, which may result in a higher tax liability for the affected individuals.  Similarly, taxpayers who have deducted significantly more than $10k for state and real estate taxes in the past may also be negatively impacted by the changes to itemized deductions.