Underwithholding Epidemic 2018: 21% of Taxpayers Owe IRS
Underwithholding Epidemic 2018: 21% of Taxpayers Owe IRS
The General Accounting Office (“GAO”) issued a July report that 21% of taxpayers are underwithholding on their employment taxes under the new tax laws and will owe significant amounts come tax-day (April 17th, 2018). This is about a 1/6th increase from 2017 levels if the current tax laws had been in effect last year, and this jump is attributable to the fact people haven’t adjusted their withholding and have experienced a slight jump in raises, in combination with lower individual income tax rates.
How Payroll Withholding Works
Employers are required to withhold income taxes on employee pay each time they pay their employees—that is, for each payroll period. 26 U.S.C. § 3402; 26 C.F.R. §§ 31.3402(a)-1, 31.3401(b)-1. Your withholding allowance on your W-4 is an amount which can be excluded from personal withholding based on your individual circumstances.
While about three-fourths of taxpayers overwithhold to the point that they are going to get a refund, an unprecedented number have moved from the former category into the “underwithholding zone.” This works out to 102 million of the 135 million taxpayers getting a refund every year. This is going to go up to over 110 million more underwithholders in 2018 for a total of about 30 million people who will be affected and will end up with pesky new tax debts they have to work out with the IRS.
Penalties For Underwithholding
The failure to file and failure to pay penalties are the big penalties under the U.S. tax code, and we go over them regularly in this newsletter. But, for payroll withholding purposes we need to look at 26 U.S.C. §§ 6651 (failure to file/pay) and 6654 (estimated taxes). Under 26 U.S.C. § 6654(c), estimated tax payments are due on April 15th, June 15th, Sept. 15th (*coming up soon—call us if you need to plan ahead for this), and Dec. 15th.
However, under Sec. 6654(d) there is a “safe harbor” where if you make the “required annual payment” of 90% of the tax shown on the return from the prior year (*25% per estimated payment) or 100% of the actual tax due (which applies if you are an extension filer), you won’t incur the failure to pay penalty.
How Do People Get Into Trouble?
If you have income from sources not subject to withholding there is a fair chance you’ll end up owing at the end of the year. If you generate interest on loans or other investments, have dividends from stocks, alimony, self-employment income, or partnership income you should be making estimated tax payments. Commissions can be a big problem as well, because employers often don’t tax the receipt of commissions like regular pay.
People most at risk are those who are primarily wage-earners but have some other income from some of the categories mentioned above as well. If you get a big spike from a commission or some other one-time event, you need to account for this change.
Other events that change your total tax picture are when a dependent child enters the workforce, the limitation on personal exemptions (notably the SALT deduction) to $10,000—meaning that mortgage interest payments are no longer going to reduce your taxable income. If you have significant mortgage interest that had traditionally been generating big deductions, in combination with other income sources (rent, interest, dividends, etc.) you could be crossing the line on the spectrum from underwithholding and getting a refund to overwithholding and getting a big tax bill.
Incomes have been fairly stagnant for wage earners, but 2017 saw significant raises for many who have historically not received a bump in pay. If you just increased your income, you might want to check whether you have jumped to a new tax bracket.
Household income jumping over the $78K threshhold causes a whopping 10% increase in your tax rate under the new tax brackets. Jumping over the $165K threshhold causes a 2% increase in your tax rate which would mean additional tax of $3,300 on the low end and additional tax of $6,300 on the high end. If you are fortunate enough to break into the bracket where you are jumping over the $315,000 threshhold you are going to experience an 8% increase in your tax rate which will cost you between $25,200 to $32,000. You want to be extra cautious when you experience an increase of taxable income, especially when it comes to timing capital gains and/or other one-time payments and when to recognize certain taxable events.
For reference, here are the new income tax brackets for married couples.
Rate Taxable Income Bracket
10% 0 to $19,050
12% $19,050 to $77,400
22% $77,400 to $165,000
24% $165,000 to $315,000
32% $315,000 to $400,000
35% $400,000 to $600,000
37% $600,000 and up
Scope of the Problem
Right up there with unplanned 401(k) withdrawals, underwithholding is one of the primary reasons taxpayers get into trouble and end up owing large balances to the IRS. We see it every day.
Total U.S. Tax Revenue for 2017 was $3.32 trillion. Total tax receipts from income taxes were $2.3 trillion in the United States, with an additional $1.4 trillion of Social Insurance Taxes ($905 bn for Social Security, $285 bn for Medicare, and $57 bn for Unemployment Insurance). Of the $2.3 trillion of income taxes, nearly half, or about $1 trillion come from payroll tax withholding.
The Council for Electronic Revenue Communication Advancement, the American Payroll Association, and the American Institute of Certified Public Accountants have all provided feedback to the General Accounting Office on what taxpayers should do to ensure their withholding is correct.
U.S. Government revenue from all sources in 2018 is expected to reach $6.21 trillion.
Income Taxes $2.3 trillion
Social Insurance Taxes + $1.4 trillion
Ad valorem Taxes + $1.5 trillion
Fees and Charges + $0.5 trillion
Business and Other Revenue + $0.5 trillion
Total Direct Revenue $6.2 trillion
A few weeks back we encouraged wage earners to take a look at their withholding to make sure you don’t get jammed up come April.
If you have any questions about this topic or your individual situation, we’d love to go over your tax withholding and help to make sure you don’t have a problem in April.
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