So, you survived your first tax season under the new tax law. Do you need to make changes now?
Tax Cut and Jobs Act of 2017
This was the first tax season filing tax returns under the tax law changes passed at the end of 2017. How did you make out?
The tax code is incredibly complex. So, in spite of nearly endless coverage in the news of tax law changes, many people still had little or no idea how the changes would affect them. Whether you prepare your own taxes with a software package or have someone else prepare your tax returns for you, it is difficult to predict which provisions and changes of the tax law will affect your situation.
For instance, on your federal income tax return, you might deduct the amount you pay for state and local taxes. However, with the new tax act, the amount you can deduct is now limited to $10,000. The $10,000 cap on state and local tax (SALT) deductions affected many people in the northeast and on the west coast. In states that have both an income tax and high property taxes it can be easy to meet or exceed the cap quickly. For some families, the new cap on the deduction for state and local taxes meant that it didn’t make sense to itemize deductions even if they had in the past. In other words, the amount of the new, increased standard deduction was greater than the total of all of their other deductions when accounting for the limited state and local tax deduction. Since you choose the method that results in lower taxable income, you would choose the standard deduction. Even though the standard deduction nearly doubled, if the amount of the deduction that you lost due to the SALT cap was more than the increase in the standard deduction, you may have been surprised at your tax bill.
No more exemptions
If you have children, you may have assumed that you would still get exemptions for your children. In the past, you may have taken exemptions for each of the dependents in your household. Exemptions worked much like the standard deduction in that they reduced your taxable income. In 2017, the amount of the reduction was $4050 for each exemption claimed.
However, exemptions were eliminated in the tax law changes. If the value of all of the exemptions that you used to claim (but no longer can) was greater than the increase in the standard deduction, you may have ended up with higher taxable income.
Another area that caused confusion for taxpayers was the change in withholding tables. Because of changes like the elimination of exemptions as well as changes in the tax brackets and rates themselves, it was necessary to make changes to withholding tables. These tables provide employers or payroll companies with guidance as to how much tax should be withheld from paychecks. These calculations are based on information that the employee provides on a form W-4 which accounts for “allowances” and things like the child tax credit. However, the tables weren’t ready at the start of 2018. And, many employees did not complete new W-4 forms. In addition, the form asks the taxpayer to complete the information based on whether or not they itemize deductions, whether they will have qualified business income (another area of the tax code that wasn’t completed until late in the year), or will qualify for certain tax credits. Even if an employee did complete a new W-4, it is quite likely that they couldn’t really make a good prediction which areas would affect their tax situation.
In addition, if they did suspect that they needed to make changes to their withholding, they were often given misinformation by their human resources departments. Many folks who had their advisors project their tax liability attempted to change their withholding by completing new W-4 forms. In some cases, they were told that their payroll companies had recently implemented the new withholding tables and that everything would balance out by the end of the year. Unfortunately, things did not balance out by the end of the year for many people. In most years, there is actually a penalty for not withholding enough from your paycheck or in quarterly payments that you send in. Although, for 2018, the IRS gave many people a pass on the withholding penalty. That does not mean that the taxpayer wasn’t stuck writing a large check for their actual tax liability though.
It’s on you
It’s important to remember that the employer is not responsible for determining if the employee will no longer qualify for tax credits. And the employer won’t know that the reason the employee had low withholding in past years because their property tax deduction was really high, or their state income tax deduction was really high due to a spouse’s income. Ultimately, the taxpayer is responsible for paying the tax bill and for withholding or paying an appropriate amount during the year with estimated payments.
Now is the time
Time flies and it seems like New Year’s day was just yesterday. But we’re already a third of the way through the year. Companies who pay bonuses at the beginning of the year or in the spring will likely have made those payments by now. This is a good time to pull together your 2018 tax return and your recent paystubs and do some tax planning for 2019 and future years rather than leaving things to chance. Are you withholding enough? Will you itemize or take the standard deduction this year? Should you change the timing of income, payments or donations? Are you close to qualifying for tax credits? Does it make sense to increase contributions to retirement plans for tax reasons as well as retirement savings? How about college savings? Does your state offer tax credits and would you qualify for them?
Tax planning gives you some control rather than relying on luck. You have the opportunity now to affect not only on the size of the check that you write or receive next April, but also on the total amount that you pay for this year and in future years. Many people focus only on the refund or payment in April. At that point, you are only reporting on what has already happened. Right now, you can take steps to affect what you will be reporting in the future. Will you rely on chance or will you make conscious changes?
Take a look at line 15 on your 1040 tax form. That’s the line that shows your total income tax. Are you surprised at that number? Were there steps you could have taken during 2018 that would have reduced your tax bill? That’s where tax planning comes in. The important thing to remember is that the whole point of generating an income is to move you closer to your financial goals.
You take the steps necessary to generate that income. Now, take the next steps to use as much of that income as you can towards your goals.