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Get ready for an unhappy tax surprise

Rick Newman
Senior Columnist

For many workers, income taxes are on autopilot. Your employer withholds a fixed amount from each paycheck, and when you file your return the following year, it generally works out. About 75% of filers get a refund each year, and it’s usually around the same amount, as long as you don’t change jobs or undergo other big changes.

But big changes hit most taxpayers in 2018, because President Trump signed the Tax Cuts and Jobs Act into law at the end of 2017. The TCJA lowered the overall tax burden for about two-thirds of workers, leaving a majority with slightly larger paychecks. But a quirk could leave some taxpayers with an unhappy surprise as they file their 2018 returns this year, and find that the refund they were expecting is smaller than before. Some people accustomed to a refund could even end up owing money, instead.

Jonathan Smoke, chief economist for Cox Automotive, which owns Kelley Blue Book and other auto-industry services, believes many taxpayers had too little money withheld from their paychecks in 2018, because of a mismatch between changes in taxes owed and taxes withheld. “We think tax withholding tables were too aggressively adjusted,” Smoke told reporters recently at the Detroit auto show. “Withholdings are down close to 4%, even though the tax changes imply they should only be down 1%. That could mean several million people are going to get a smaller refund. And it could snowball.”

The IRS updated its withholding calculator last year, to account for changes in the tax law. But few taxpayers seem to have used the tool or updated their withholdings to account for the changes. Cox Automotive checked on its own 30,000 employees, and found that the portion changing their withholdings was essentially the same as the year before, indicating no bump in updates related to the new tax rates. Cox also found that taxes paid by its employees fell by more than the tax-rate changes imply they should have, suggesting those workers will end up with smaller returns than expected when they file—or taxes owed instead of a return.

Fewer, smaller refunds

The Trump tax cuts, which passed with only Republican votes, turned out to be unpopular because many voters felt they favored businesses and the wealthy over the middle class. The law slashed the corporate tax rate from 35% to 21%, with corporate profits soaring and corporate tax receipts plunging in 2018. Taxes paid by individuals actually rose, leaving workers bearing a higher portion of the nation’s overall tax burden. And while Trump and his fellow Republicans predicted the federal deficit would fall because of the tax cuts’ stimulative effect, it is surging instead.

Disdain for the Trump tax cuts helped Democrats regain control of the House of Representatives in last year’s midterm elections. Fewer, smaller refunds this tax season could ding Trump’s popularity even more. And it would come as the economy is slowing, producing a double whammy because tax refunds are usually a meaningful contribution to consumer spending in the first and second quarters.

Before the Trump tax cuts, the average refund was about $2,800, and consumers used some of that money to finance big purchases, such as a car. Smoke cautions car dealers hoping for a similar bump this year to prepare for disappointment.

Others see it differently. Morgan Stanley last year found that workers were having too much tax withheld, and predicted the typical return would be 26% higher this year. The varying estimates come from the IRS’s one-time change, following the Trump tax cuts, in the way it sets guidance for how much employers should withhold from workers’ paychecks. Employers are required to withhold a minimum amount, but workers have some input too, when they fill out their W-4 forms. Most taxpayers want their employers to withhold the full amount of the taxes they owe or a little more, so they don’t have to write a check to Uncle Sam when filing their returns the following year.

With no real-world data on accurate withholdings under the new tax rates, the IRS ran simulations to help update its guidance. A Government Accountability Office report from last July found that in the IRS modeling, the portion of taxpayers who underpaid their taxes and therefore owed money rose by 3 percentage points, while the portion who overpaid and got a refund fell by 3 points. Democratic Sen. Ron Wyden of Oregon called the GAO report “an alarm bell for the nearly 30 million households that are expected to owe more money come tax time” in 2019.

For those who do owe more, the IRS is easing up on a penalty for serious underpayers. Filers used to owe a penalty fee if they paid less than 90% of the tax they owe prior to filing a return. The IRS recently lowered that to 85%, to allow more leeway for taxpayers who haven’t fully adjusted to the new tax rules. But that won’t sound like much of a deal to taxpayers who owe the IRS more in 2019.

Confidential tip line: rickjnewman@yahoo.com. Click here to get Rick’s stories by email.

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Rick Newman is the author of four books, including “Rebounders: How Winners Pivot from Setback to Success.” Follow him on Twitter: @rickjnewman