The recent tax reform was supposedly aimed at letting average taxpayers keep more money in their pockets every paycheck.
A recent report by the U.S. Government Accountability Office says about 30 million taxpayers might actually be keeping too much cash throughout the year because their taxes are being under-withheld by their employers — which means they’ll owe the IRS come April 2019.
These taxpayers may not be withholding enough in taxes from their paychecks for multiple reasons, including:
- The Tax Cuts and Jobs Act, which passed last December, set the personal exemption to zero for tax years falling between Dec. 31, 2017, and Jan. 1, 2026. That had been key in calculating an individual’s federal income tax withholding.
- People who haven’t recalculated their withholdings and updated their W-4s accordingly could be underpaying their taxes throughout the year.
What does this mean for you?
Taxes are pay as you go. As you earn money throughout the year, you pay taxes. Pay more than you owe, and you’ll probably find you’re owed a refund when you file your tax return. Pay less than you owe and you will likely owe the IRS come Tax Day.
A simulation by the Treasury Department in the GAO report estimates that about 73% of wage-earning taxpayers will have more tax withheld throughout the year than they need to, so those U.S. taxpayers probably have nothing to worry about based on this report.
But if you’re among the roughly 21% of taxpayers that the Treasury Department’s simulation says could be having your taxes under-withheld by your employer, you may find yourself facing a bill in April 2019 when your taxes and tax return are due.
Why should you care?
The pain of a big tax bill is obvious. Having to come up with a large chunk of money to pay your taxes can cause stress and financial hardship. Plus, not being able to pay the full amount of taxes owed when due can subject you to penalties and interest on the amount you owe.
However, getting a huge refund isn’t necessarily a great thing either — especially if you’re living paycheck to paycheck. A large refund essentially means you gave the government an interest-free loan for the year. The average refund issued in the first five months of 2018 was $2,778, according to the GAO.
What can you do?
First, don’t assume your employer has automatically adjusted the amount it’s withholding from your paycheck to account for the changes in tax law. Tax law is complicated, and employers with the best of intentions could be confused by how tax reform has changed things.
Recalculate your withholdings
To get a better idea of what you should be withholding from your paycheck for your 2018 federal income taxes, head over to the IRS website. There you’ll find a free withholding calculator that helps you determine your tax withholdings to make sure you’re currently having the right amount of tax withheld from your paycheck.
Before you dive into the calculator, make sure you have your most recent pay stubs and your most recent income tax return. You’ll need to enter information from those documents into the calculator.
If the calculator shows you’re not having enough withheld, consider updating your W-4 accordingly — you can make changes to your W-4 at any time during the year.
Minimize your tax bill
You can take steps to minimize your tax bill all year long. Before Tax Day 2019 arrives, consider these actions:
- Maximize retirement plan contributions. Contributions you make to an employer-sponsored 401(k) can reduce your federal tax liability. For 2018, you can defer up to $18,500 of your wages into your employer-sponsored 401(k). If you’re 50 or older, you may be eligible to put an additional $6,000 into your traditional and safe harbor 401(k) plans. Keep in mind there’s an overall limit of 100% of your compensation or $55,000 (whichever is less) — up to $61,000, including catch-up contributions, if you’re 50 or older — for the total 2018 annual contributions into all your retirement accounts maintained by one employer and any related employer. You may also be able to deduct contributions to a traditional IRA.
- Contribute to a health savings account. If you’re eligible to participate in a health savings account, consider contributing the maximum allowable amount — $3,450 for self-only plans and $6,900 for family plans in 2018. Contributions to HSAs are tax deductible. You can use the money in your HSA to pay for qualified medical and health expenses.
- Keep track of charitable donations. Knowing how to properly deduct charitable donations can lower your taxable income. Depending on how you donate and how much, different rules apply. So it’s important to know how to do it properly and to keep records in case you get audited.