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If your tax refund was smaller this tax season—or you're shocked at how much you owe—you're not alone.
Data from the Internal Revenue Service for the week ending April 5—the latest available week for filing statistics—show cumulative federal tax refunds down 2.6 percent vs. the same time period in 2018. So far this tax season, the average refund has been $2,833, slightly smaller than the average 2018 refund of $2,864.
And about 1.2 million fewer people are getting a refund than did last tax season, the April 5 statistics show.
Individuals paid about $1,600 less in federal income tax, on average, than they paid in 2017, says the nonpartisan Urban-Brookings Tax Policy Center (TPC), a nonprofit based in Washington, D.C. That's due to changes in the Tax Cuts and Jobs Act, passed at the end of 2017.
But many people faced smaller-than-expected refunds this tax season, in large part due to their withholding level: the amount of tax they chose to have taken out of their paychecks in 2018.
When the Tax Cuts and Jobs Act took effect last year, most Americans didn’t take the IRS’ advice and make sure their employer was adjusting their withholding correctly, according to Pete Isberg, head of government affairs for payroll processor ADP. “I would have expected taxpayers to adjust their withholding, but they generally didn’t do it,” Isberg says.
That explains why so many taxpayers are getting back less money or owe more than they anticipated for the 2018 tax year.
To avoid errors or unpleasant surprises next tax season, consider this advice for fixing your withholding, along with tips for those who work for an employer, the self-employed, and retirees who rely on investment income.
Assess Your Current Tax Bill
Whatever your employment situation, if you’re a getting a smaller refund or are just about square with the IRS, you’re right on track. It means you paid the right amount of federal tax for 2018.
“If you’re getting a big refund, you’re giving the government an interest-free loan,” Isberg says. “You could have been earning that interest yourself.”
If it turns out you owe Uncle Sam, that’s another story. That rude tax awakening can throw your budget out of whack. In a worst-case scenario, if your tax bill hits $1,000 or more after subtracting withholding and refundable credits, the IRS will charge you penalties.
“It’s about the time value of money,” says Eric Bronnenkant, head of tax at Betterment, an online financial adviser. That is, the IRS charges you the interest it would have made on your taxes if you’d paid on time.
You also may have triggered a penalty if your employer withheld less than 80 percent of your expected 2018 tax bill—or 100 percent of what you owed for 2017, whichever was greater. (For 2018 only, the IRS dropped the underpayment threshold to 80 percent from 90 percent to accommodate taxpayers who underwithheld.)
If you don’t have an employer, you're supposed to pay those amounts in quarterly installments.
(This “safe harbor” percentage rule is a little more strict for taxpayers with adjusted gross income above $150,000; refer to IRS Publication 505, “Tax Withholding and Estimated Tax,” for more information.)
Employees: Adjust Your Withholding Now
If at least one member of your household gets a paycheck, make sure the employer withholds enough in federal tax each pay period.
Many taxpayers can use the IRS’ free Withholding Calculator to make that determination. The calculator will tell you how many personal allowances to enter on your W-4 withholding form. To use the tool, you’ll need information from your 2018 tax return, plus recent pay stubs.
You don’t have to input your Social Security number or bank or investment account information in the tool. And the IRS says it doesn’t save your input.
Keep in mind that the IRS says its Withholding Calculator is mainly useful for households with two working spouses, two or more jobs, or nonwage income, such as cash tips.
If you and your spouse file jointly, and you both earn about the same amount, you may be better off not using the calculator. The IRS recommends reading the instructions for Form IRS W-4 for how to proceed.
Those with complex situations—such as being subject to the alternative minimum tax—should talk to a tax professional or use the worksheets in IRS Publication 505.
Here’s how to use the withholding calculator results:
• You’re married filing jointly. Input the calculated number of personal allowances on the W-4 of the partner who earns more. The other person should input “0” personal allowances on his or her W-4.
• You still owe even with zero personal allowances. The calculator will tell you how much more tax you’ll need to pay by year-end. If you’re filing jointly, you can have that amount taken entirely from one partner’s paycheck or split it between you. Divide the amount you owe by the number of pay periods remaining in 2019 to find out how much you’ll need to have withheld. You can also pay in one sum or installments, using IRS Form 1040-ES for estimated taxes.
• You earn a paycheck but also get Social Security benefits. The IRS says its withholding calculator won’t tell you which portion of your benefits are taxable. But, it says: “If you estimate the taxable amount (e.g., using the worksheet in the Form 1040 instructions [PDF]), you can enter that into the calculator as other nonwage income so that the calculator can take it into account.”
The Self-Employed: Figure Your Estimated Quarterly Taxes
You’ll need to use IRS Form 1040-ES to pay your estimated quarterly taxes. Because the IRS withholding calculator isn’t designed for self-employed people, you can opt for do-it-yourself tax software, which will make those calculations for you based on your 2018 taxes.
TurboTax, for instance, produces prefilled IRS Form 1040-ES forms for you to send to the IRS with your payment four times to cover tax-year 2019. The first deadline, April 15, just passed. The other deadlines are June 17 and Sept. 16 in 2019, and Jan. 15 in 2020.
Alternatively, talk to a tax professional or use the worksheets in IRS Publication 505.
As a rule of thumb to avoid an underpayment penalty for tax-year 2019, self-employed people can pay estimated taxes equal to 110 percent of their 2018 federal tax.
Retirees: Pay Taxes With Your RMD
Retired taxpayers with taxable income from nonwage sources, such as Social Security and investment portfolios, will also need to determine how much to pay the IRS on a quarterly basis. One option is to follow the same steps as self-employed people, noted above.
But if you have substantial retirement savings in IRA or 401(k) portfolios and don’t want the hassle of quarterly payments, you can consider another strategy: Pay your taxes with all or a portion of your annual required minimum distributions from your retirement accounts. By using this method, you can pay your tax annually and close to the end of the year, rather than in quarterly increments.
“The IRS considers this payment as if you made it evenly throughout the year,” says Bronnenkant at Betterment. “So it can help you avoid penalties that you might otherwise have to pay if you made a late estimated quarterly payment.”
This strategy works best for individuals who expect to withdraw enough from their retirement accounts to pay their entire tax liability, Bronnenkant says. If you can’t cover all of your federal taxes this way, you still may have to make some estimated quarterly payments for the balance to avoid an underpayment penalty, he adds.
Most retirees wait until the end of the year to take their RMDs so that they can allow their retirement earnings to grow. If they make a one-time tax payment with their RMD, they should make it no later than Dec. 31, Bronnenkant says.
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