Be aware of tax code impact and IRS penalty reduction
On Jan. 28, the tax season officially kicked off and, with it, the most significant tax code changes in the last 30 years. While the federal tax overhaul was signed in December 2017, it applied to 2018, the year we are now filing for.
Many Americans are aware of the sweeping changes, yet many of these same taxpayers may be unsure of how it will impact them personally. The U.S. income tax system is “pay as you go,” meaning the tax burden occurs as you earn your income throughout the tax year. With the massive tax code changes, some taxpayers may have unknowingly under withheld tax payments. Normally underpayments can result in financial penalties owed to the Internal Revenue Service.
The IRS recognizes that some taxpayers may be making an inadvertent error with regard to withholding the proper tax amount. Unfortunately, much of the news surrounding this topic has been a bit misleading, so let’s iron out the details and bring some clarity to the matter.
For most taxpayers in West Michigan, overall taxes will be lower compared to the same income from the previous year with certain exceptions. The exceptions may very well apply to those who have significant SALT (state and local tax) deductions. Historically, the taxpayer would add up all property tax paid, state and local income tax paid then deduct this total along with any other itemized deductions from taxable income (if higher than the standard deduction).
Who will be hit the hardest? Those who live in high property tax areas (think New York City, San Francisco), those with the most expensive homes and those with vacation homes. While most tax filers still are expected to see lower overall tax rates, due to changes in the tax law, withholding tables may not properly represent each taxpayer's unique situation. Withholding tables are designed to approximate tax due based on your income and few other data points, yet it’s impossible to account for other deductions limited by the SALT cap. Remember, your tax refund or taxes due is simply the tax liability for the year minus what you have paid so far.
Considering the numerous changes in a very complex tax arena, taxpayers need to be leery of guidance that may not provide a complete picture for their unique circumstance. One such example of this can be found in a recent article in a major Michigan newspaper that states, “Didn’t withhold enough for taxes? IRS drops penalties on 2018 returns.” In short, yes, some may find the underpayment penalty waived, but when you look at the details not addressed in this article, this isn’t such a sweeping change as it may seem.
According to the IRS’s Jan. 16 news release, to waive the penalty, the taxpayer must have paid at least 85 percent of their total liability during the year through federal income tax withholding, estimated payments, etc. The usual threshold is 90 percent. To be clear, if the taxpayer paid less than 85 percent of the current year tax liability, then he or she is not eligible for the waiver and the penalty will be calculated normally and applied. So yes, the IRS is dropping penalties on 2018 returns — by lowering the threshold by 5 percent.
Alternatively, taxpayers can avoid underpayment penalty if they paid 100 percent of their previous year’s tax liability or 110 percent of the previous year’s tax liability for those taxpayers with adjusted gross income of more than $150,000 for those filing married ($75,000 for those filing single). In this case, as with all tax law changes, the details matter.
Remember, the tax return has many moving pieces that may make you a tax winner or a tax loser, especially considering these new changes. If you normally file taxes yourself, take some extra time to make sure you understand how the new laws impact your personal situation. If you work with a professional to get your taxes done, be sure to ask them how these new changes are going to affect your filing this year and into the future. Lastly, a lower tax refund versus last year does not necessarily mean your tax liability is higher. It simply means your withholding level may have been too low and may need to be adjusted.
Phil Mitchell, CPA, CFA, CTP, is president at Kroon & Mitchell, Integrated Tax and Investments, in Grand Rapids.