Many Americans who have already prepared their tax returns are complaining that they are getting a smaller refund than last year, so they assume the new tax laws are hurting them. The size of a refund, however, may have nothing to do with a taxpayer’s actual tax liability. Remember, a tax refund isn’t a gift from your benevolent old Uncle Sam. It is merely a return of your own money because you already paid in too much during the year.
The new tax law came out in December of 2017. It lowered tax rates, eliminated personal exemptions, increased the child tax credit, increased the standard deduction, and limited or eliminated many itemized deductions. There are a lot of moving parts in the preceding sentence. No two taxpayers have identical situations, so all these changes affect people in different ways. Although the withholding tables changed in February of 2018, very few people took the time to review the W-4 already on file with their employer and make any necessary changes. This means the taxes taken out of every paycheck for the last ten months of the year may have had incorrect withholding. If you pay in less tax every week, you will have less tax paid in for the year as a whole, and there will be less of your money on account with the government to come back as a refund.
That’s one of the things that makes this so hard. The withholding tables only consider your filing status, the number of withholding allowances on your Form W-4 and the amount of wages you are earning at that job. Calculating the correct number of allowances is tricky business. It certainly isn’t as easy as adding up how many kids you have and putting that on the form. To do it properly, you must have a good idea about what your total income on the tax returns will be when the year is over. This means you need to know your wages, the wages of your spouse, and also have a pretty good idea about what your deductions will be. You also need to know the dollar amounts of any credits you will get as well as any unearned income like interest or dividends.
Well, in theory, your withholding would be for the exact amount of income tax liability you will show on your tax return and you would neither owe nor get a refund. This is pretty hard to do, however. To test it out, I used the advantage of hindsight to fill out a W-4 for a married couple that had already completed their tax return for 2018. I knew their exact amount of wages, child tax credit, education credits, and deductions. I pretended I knew all of this on January 1, 2018 so that I could fill out the “perfect” W-4 and they could turn it in to their employers and have the “correct” withholding for the year. I completed the Personal Allowances Worksheet from the W-4 instructions, then I completed Worksheet 1-6 form Publication 505 to convert tax credits to withholding allowances, and then I completed the Two-Earners Worksheet from the W-4 instructions.
Guess what? It didn’t work. They would end up owing $2,600 on their tax return because there wouldn’t have been enough withholding from their wages during the year. And filling out three separate worksheets is pretty time-consuming, even for a CPA that understands all the terminology on the forms.
First of all, realize that what happened in 2018 is water under the bridge at this point. If your refund turns out to be smaller than it was before, rejoice in the fact that your interest-free loan to the government was smaller, also. If you owe money on your 2018 return, go to your employer now and correct your W-4 so the same thing won’t happen in 2019. Exactly how much to change your W-4 depends upon how much you owe. For example, if my sample couple was claiming 10 withholding allowances in 2018, but they owed $2,600, they need approximately $50 more in federal withholding each week. One of them could ask for just that – keep the same withholding allowances but ask for an additional $50 to be withheld each week. Or they could both ask for an extra $25 each week. Or they could figure out how many withholding allowances to remove in order to get to the right amount.
All of this has focused on the withholding. Before you get too upset, look at the total tax calculated on your return. If this number is smaller than last year, then the tax law helped you. Whether you paid the tax in over the course of the year or you owe part of it at the end or you paid in too much and got a refund doesn’t matter. Paying less tax in total is better, right?
If you miss your gigantic refund, ask your employer to deposit part of your pay into a savings account each week. Next April you can give yourself a refund by withdrawing the cash. And if your total tax is higher this year? Well, then you can do all the complaining you want. I’m just not sure if Congress will listen.
Contact an Alloy Silverstein tax advisor at 856.667.4100.
Associate Partner
Julie has over 20 years of experience in public and private accounting, representing varied clientele including the medical, legal, and real estate industries and trusts.
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