Do Your Taxes Early, avert a Financial Emergency.
I always recommend that people do their taxes early, but
this year it is even more important, and it ties into my last article. With all the tax changes in the past year I
am certain a large number of people severely under withheld and are going to
owe a lot more than they are expecting at tax time. Considering over 60% of Americans have less
than $1,000 in their savings account this will cause some financial emergencies.
If you do your taxes now you still don’t have to pay until April 15th
which gives you two months to figure out how to come up with the money. If you wait until April 14th to figure
out what you owe and learn of an unpleasant surprise you may be in trouble.
This could complicate the problem by adding penalties and interest to your unexpected
situation.
In the rest of this article I will explain who is at the greatest
risk for this surprise and why. But even if you are not at risk it is always
wise to do your taxes early. If you have money coming back you can put it to work
for you sooner. If pay for tax software the cost go up as the deadline
approaches. (Credit Karma fixed their error from last year and is total free if
you’re willing to make the switch). When you file early, If you over or under withheld
you will have more time to adjust for next year’s taxes so you are not in the
same situation next year.
As you probably heard Congress passed something called the
Tax Cut and Jobs Act (TCJA). I will try to leave the political discussion out
of this while explaining what this may mean for you.
Some of this will be a bit technical so let me start out by pointing
out the people I think are at the greatest risk of under withholding. If you claimed multiple dependent
exemptions (you have a lot of kids) on your taxes last year, or if you itemized
your deductions you are at risk. If both these things apply to you the risk is
that much greater.
The TCJA will lead to a reduction of annual taxes paid by
the majority of Americans (estimated at 75%) but will actually mean an increase
in the annual tax bill for millions of Americans, with others seeing little
change in the taxes they paid. It is
important to note that whether your taxes go up, down or remain about the same
have little to do with whether or not you had the correct amount of taxes withheld
from you paychecks. The TCJA made adjustments to withholding calculations
your employer was supposed to withhold, but there is no guarantee they did it
correctly. It also appears they may have been a bit too generous in reducing
the amount of withholding in their efforts to show the immediate effect the tax
reductions. In addition, those rates are based on assumptions that you will
file the standard deduction. They also do not account for the fact that there
are no longer personal exemptions available. Many people do not realize or
understand this and never changed their withholding allowances or if they did
fill out a new withholding slip, they listed the same number of allowances, as
they always have, i.e. one for each Child.
So why is this important? Each personal exemptions was worth
$4,050 last year. So a married couple
with three children was able to exempt $20,250 (5X $4,050) of their income from
taxes last year. That perk is gone. If
they are still having taxes withheld on that basis, they have under withheld by
$4,400 (assuming a 22% tax bracket and none of the exemptions are eligible
for a child tax credit, for children under 17). Part of that difference in
taxes owed will be made up in the higher standard deduction, but since the
standard deduction is assumed in the withholding tables it does not help you if
you did not lower your allowances on your withholding forms. Of course if you
itemize your deductions the increase in the standard deduction does not help
you offset that amount at all.
Further adding insult to injury is the fact that many of the things you used to be able to
deduct in your itemized deductions are gone or limited, so your itemized
deductions may be lower this year. The
biggest limitation is on the State and local taxes (SALT) deduction. It is
limited to $10,000.00. So if you wrote off $6,000 in state income tax last
year and $6,500 in property taxes, your itemized deductions will be reduced by
$2,500 on that basis alone. The means another $2,500 of your income, which was
not taxed last year, will be taxed. Based again on the 22% rate that is another
$550 in taxes you may not have counted on.
I have only highlighted the major changes that are most
likely to affect under withholding but there are others. Suffice it to say is
that with all the changes you should not
feel safe assuming your will get the same tax refund you did last year, and
there is a chance you may even owe a significant amount of money. It is better
to know this as soon as possible so do your taxes as soon as you can.
There are winners on under or over withholding front if
family taxes are handled the right way. The winners are adult children that had
jobs but were previously claimed as dependents on their parent’s returns. With
few exceptions (such as single parents needing to claim at least one child for
head of household status, or adult children with income less than $4,050) there
is no reason for parents to claim children over the age of 16 as dependents on their
tax returns anymore. If they are not claimed as dependents on anyone else’s
return they now essentially get the first $12,000 they make free of federal
income tax since as they can take the standard deduction for themselves.
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