When the new tax law was enacted almost a year ago, the IRS had to scramble to put in place new rules, forms, and regulations. As a result, your take-home pay probably increased in February as employers introduced the new tax withholding guidelines. The idea was that most people will see a tax decrease as a result of the new law. It makes sense to reduce tax withholding so taxpayers can benefit from using their tax savings throughout the year.
It’s a great idea in theory, but my concern is that the automatic changes that affected our paychecks will result in millions of taxpayers owing in April, including many who are accustomed to receiving refunds. The Government Accounting Office (GAO) estimates that more than thirty million taxpayers will owe taxes next year. While the IRS endeavored to modify the tax withholding tables to keep taxpayers on track for the year, the effect of the new tax law on individual situations is hard to predict.
To summarize a few changes, the large majority will be taking the standard deduction, and will not be deducting state income and property tax, mortgage interest, and charitable contributions. Even if you itemize deductions, the deductible amount of property and income tax is limited. Offsetting these changes, tax rates have largely moved downwards. The GAO report said married (but single wage earning) upper-middle class taxpayers with children who itemize their deductions are more likely to not withhold enough in taxes.
To prevent a nasty April surprise, I recommend that you contact your tax preparer now or conduct your own tax planning exercise. If you will be owing thousands next year, it would be good to know now so you have a few months to save up for your tax bill.
Determine your tax withholdings. If you are working, consult your most recent paystub and look at the year to date numbers. It should say how much has been withheld for federal and state income taxes. Write down those numbers, and then determine how much more you will be withholding in your remaining paychecks for 2018. If you’re receiving retirement benefits through Social Security, a pension, or IRA distributions then you may have additional taxes withheld. Also, those making estimated tax payments should document those including the final 2018 payment due in January.
Calculate your income. Your paystub will help you with this task as well. Look at your work income earned year to date and add the amount you’ll earn in your remaining pay periods for 2018. We only need to focus on taxable income, so we can subtract 401(k) and other pre-tax retirement plan contributions, health insurance premiums, and other deductible expenses. Also make a note if you have income from other sources such as IRA distributions, rental property, Social Security, interest and dividends, business, and other sources.
Understand your bigger deductions. Estimate how much in state income and property tax you have paid in 2018. Also approximate mortgage interest (interest rate multiplied by mortgage balance will get you close) and charitable contributions for the year. If you’re making HSA or IRA contributions, those are good to note.
Estimate your tax bill. With the information you’ve collected, you’re now ready to get some answers about whether you’ll owe or get a refund in April. Intuit, the publisher of TurboTax, has a free app available for IOS and Android called TaxCaster. While the app isn’t designed to address more complex tax situations, it does a good job of estimating your tax bill. Another internet resource is the free 1040 Tax Calculator for 2018 on dinkytown.net. You don’t need to enter any personally identifiable information to use the tools.
While none of us likes a big tax bill, by checking in with your tax preparer or with a little do-it-yourselfer grit you can come pretty close to understanding your April situation now. If you’re going to owe next year, wouldn’t you like some time to save for it? It sure beats paying interest and penalties to the IRS that can come with an underpayment of taxes.