Plan now to avoid paying tax penalties
Under new tax laws, you might need to adjust your paycheck withholding
Time is running out to adjust your paycheck so that you’re paying enough in taxes this year – a calculation complicated by recent changes to federal tax laws. ❚ If you’re too far behind to make up the shortfall before year-end, you might need to send in extra payments to avoid a costly penalty. ❚ Either solution means less money in your pocket before the holiday season and underscores the importance of re-evaluating your tax withholdings early every year.
Last year, nearly 10 million taxpayers faced penalties for underpayment, according to the IRS, a figure that has been rising for the last decade. Taxpayers most at risk are two-earner households, workers with multiple jobs, the self-employed and those with income sources outside their jobs.
This year, the math of getting your withholdings just right got even harder. That’s because sweeping changes to the tax code increased some credits and deductions while eliminating or capping others.
Mark Wilson, president of MILE Wealth Management in Irvine, California, runs tax projections for his clients every year to make sure enough taxes are withheld from their paychecks. Most of his clients overall will pay less in taxes this year versus 2017, but too little was being taken out of their paychecks before adjustments to cover their 2018 tax liability that will come due in April.
“What’s frustrating is they’re paying less taxes but they’ll get a big tax bill next year,” Wilson said. “I think everyone was off, some by thousands of dollars.”
Why are my taxes off?
How much is withheld from your
“A taxpayer’s life is fluid. A kid’s gone to college, you get another job, retirement, these are the kinds of variables that affect not just the withholding but the tax liability itself.” Gil Charney, director of The Tax Institute at H&R Block
paycheck is determined by the number of allowances you claim on your W-4, a tax form you fill out when you start a new job. The more allowances you select, the less money is taken from each paycheck for taxes.
The federal government determines how much one allowance is worth. The Treasury Department’s goal this year was to choose an allowance value that increased withholding accuracy, so what you pay out in taxes from your paycheck over the year matches your ultimate tax liability.
That should mean fewer large tax bills and fewer big refunds come April.
“The refund that would have come out of the tax cuts is instead being doled out to you every pay period,” said Gil Charney, director of The Tax Institute at H&R Block.
But the allowance value can be less accurate for those with more complex taxes, especially this year when major tax law changes makes it difficult to estimate your tax bill.
Playing catch up
If you find you’re paying way too little, it’s time to make some big moves. To avoid a huge payment and tax penalty in April, Wilson helped his clients adjust their paycheck withholdings so they are taking home less each paycheck, but sending more to Uncle Sam until the end of the year.
The later you do this, the bigger chunk you must pay out per payday. “The most recent one I did, he had to change his withholding by $500 per paycheck, or $1,000 a month,” Wilson said. “That’s a lot for year-end.”
To do this, request a new W-4 from your employer’s human resources department and reduce the number of allowances you claim. Alternatively, you can input a specific amount to be withheld from each paycheck. (Remember to reset this in the new year.)
If there simply aren’t enough paychecks left in the year to satisfy your tax shortfall, you can send estimated tax payments to the IRS before the end of the year. You can do this in a lump sum or over multiple payments on the IRS website at www.irs.gov/payments/direct-pay.
You also can increase your withholding rates on traditional IRA withdrawals, if you take them, to close a tax gap, Stillman said. Typically, 10 percent of IRA distributions are withheld for federal taxes.
Prepare for next year
To prevent an end-of-year tax scramble, promise to analyze your tax situation shortly after filing your taxes. Aim for May through July to revisit your paycheck withholdings. Remember that major life events can significantly alter your tax liability from one year to the next.
“A taxpayer’s life is fluid,” Charney said. “A kid’s gone to college, you get another job, retirement, these are the kinds of variables that affect not just the withholding but the tax liability itself.”