Unanticipated Consequences of the Tax Cuts and Jobs Act

Late last year and early this year, I wrote a series of blogs about the new tax law changes and what their potential impact could be on a wide spectrum of taxpayers. Those blogs generated quite a bit of interest but naturally, as time passed, people moved on to other interests and topics.

However, as the end of tax season draws near, we are seeing some issues emerge from the new Tax Cuts and Jobs Act (TCJA) which were unanticipated at the time of its passage, and also because this is the first full year of its implementation.

Of course, there was much in the new tax law to commend but for some taxpayers, there have been unexpected and negative consequences related to the issue of under-withholding payment of their taxes.

Pay As You Go

As most people know, the U.S. tax system operates on a “pay-as-you-go” basis, meaning employers are required to withhold taxes from their employees’ paychecks throughout the year, based on IRS calculations. However, an employee can reduce the amount that is being withheld by claiming personal  allowances. But if, at the end of the year, the taxpayer didn’t pay at least 90% of their owed taxes throughout the year – if their taxes have been underwithheld due to unwarranted personal exemptions – then the IRS has historically levied penalties against those taxpayers.

In years past, as many as 27 million Americans a year underwithheld their taxes. But according to the government’s own General Accounting Office, it is estimated that in tax year 2018, 30 million Americans could be affected.

The reason for this increase? It mainly has to do with changes in the TCJA. First, all personal exemptions have been eliminated in the new tax law, and replaced with an increase in the standard deduction. Second, the TCJA also initiated changes to the previous IRS withholding tables. Finally, taxpayers were not required to update their W-4 form.

The consequence of all these changes is that millions of people are discovering that they unknowingly underwithheld their taxes and, as a result, they are receiving smaller than expected tax refunds, and there is a possibility they could be penalized as well.

IRS Relief

As I mentioned above, the usual threshold for avoiding a tax penalty is 90%, but when the underwithholding issue first came to light, The Treasury Department immediately agreed to lower that number to 85%. However, for many lawmakers, that was insufficient. They demanded that the Treasury and the IRS either rescind the tax penalty for underwithholding entirely for 2018 or reduce the rate to 80%, and that’s what has been done. The underwithholding payment threshold for 2018 is 80%.

This new rate applies to taxpayers whose estimated tax payments and total withholding for 2018 are, equal to or greater than, 80% of what they owe in taxes. Hopefully, for millions of Americans, this reduced guideline will help them to avoid any tax penalties due to underwithholding.

Going Forward

Last year, the IRS urged taxpayers to employ an online calculator to help them determine the correct amount to withhold from their paychecks, but the online calculator was confusing and complicated, and relied too heavily on assumptions, so very few taxpayers actually used it. It also encouraged taxpayers to update their W-4 form but since it wasn’t mandatory, most tax payers simply ignored that advice.

Going forward, the IRS is still advising taxpayers to assess their withholding at IRS.gov/withholding to make sure that next year, they are withholding the correct amount. They also advise taxpayers to update their W-4 form and if they are in need of help, to seek assistance from their employer’s Human Resource department.  

Whenever new tax legislation is enacted, it is common for the IRS and the Treasury Department to provide additional clarification, guidance, and announcements to tax professionals and the public as the legislation is being implemented.

For example, we just received further clarification from the IRS surrounding Section 199-A, which describes and cements the final rules regarding business deductions. As a result, we will continue to generate blogs that address these kinds of topics to keep you informed, and to help you to measure the impact on your personal financial life and business. 

United Capital does not provide personalized tax advice.  Please consult your tax advisor regarding your individual situation.