Lately there has been a lot of mainstream and social media attention surrounding people who traditionally get a tax refund but are not this year. Some are finding they actually owe money. Understandably, these reports are causing anxiety and anger among a large portion of the taxpaying public who feel cheated after being promised a tax reduction. Much of this is based on a misunderstanding of how the 2017 Tax Act worked.
Many taxpayers believe that because their refund is smaller, they are actually paying more tax. This is not necessarily true—many individual taxpayers are benefitting from lower taxes as a result of the 2017 Tax Act. Instead, reduced refunds result from changes in the way the IRS has collected tax during the year. After the 2017 Tax Act was passed, the IRS adjusted tables employers use to determine how much income tax to withhold from their employees’ paychecks. For most (if not all), this resulted in less income tax being withheld.
Whether you receive a refund or owe on April 15 is a product of the total tax (based on income and deductions), less amounts paid throughout the year in the form of wage withholdings and Estimated Tax Payments. Hence, when less tax has been withheld or paid during the year, the amount of your refund will likewise go down. In effect, taxpayers have been receiving the “refunds” they were accustomed to in small increments in every paycheck (because less tax was withheld). While many taxpayers are frustrated by the result at the end of the year, this is actually the more beneficial scenario. In prior years, your tax refund was the Government repaying the interest-free loan you gave it during the year.
Nevertheless, the abrupt realization that anticipated refunds are not forthcoming this year has created a number of problems. Many counted on refunds to pay for large expenses delayed throughout the year, vacations, or paying down other debt. For others, they are finding that unlike past years they will actually owe a significant amount come April 15.
If you are in the latter position, there may be even larger consequences. If you are currently in an Installment Agreement with the IRS, filing your 2018 tax return with an additional amount due will cause it to default. Worse, if you received an Offer in Compromise from the IRS in the past five years, filing a return with a balance due may cause your Offer in Compromise to default, putting you back at square one.
For these reasons, it is important for all taxpayers to:
- Be proactive in having your tax returns prepared early. The sooner you know what to expect, the more time you have to develop a plan that will minimize the impact;
- Review and revise the W-4 you provided your employer, so you don’t have the same problem in 2019. While the 2017 Tax Act increased the amount of the standard deduction, it also eliminated personal exemptions, and limited other deductions that may have been considered in the amount of your withholdings; and
- To determine whether you have benefitted from the 2017 Tax Act, compare the amount of “tax” showing on each return (not the amount to be refunded or owed), and consult a qualified tax professional to determine whether you should adjust past tax reduction strategies.
If you have questions, contact Anderson & Jahde, PC. at (303) 782-0003.