Your updated paycheck in February probably looked pretty good. With federal income taxes reduced by the Tax Cuts and Jobs Act, the take-home pay for you and most other taxpayers increased.
The conservative Heritage Foundation says a single taxpayer will save an average of $1,400 this year and a married couple with two children could save $2,917, although this varies across congressional districts.
Consumers have been spending that money, too.
Household spending rose 0.4 percent in July, according to the Commerce Department, after months of strong growth. Several factors are credited with the spending increase. For one thing, businesses have begun to charge more for their products. In addition, consumers are optimistic about the economy and willing to spend the windfall.
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What’s not to like about this scenario?
In my office, we’re starting to see a crack in the increased income euphoria. As we review clients’ income and probable 2018 federal tax liability, we’ve noticed that many people are having too little withheld from their paychecks. That means they’re likely to owe taxes for the 2018 income tax filing year.
How can that happen, you might wonder, if income taxes were reduced and are automatically withheld from paychecks?
The problem seems to spring from directives issued by the Internal Revenue Service earlier this year. It appears that when the IRS adjusted withholding tables, it didn’t recommend that employers withhold enough to meet their employees’ income tax liability. When workers’ tax brackets dropped, their federal income tax withholding fell, too.
This will result in many American workers owing federal income taxes for 2018, which leads to yet another problem. There’s a penalty if you don’t pay income taxes equal to either 100 percent of the prior year or 90 percent of the current year’s liability.
Our experience is that this could affect almost anyone who gets a paycheck and has income taxes withheld. However, people who have a percentage of income withheld for taxes are probably OK. This would include those who have income taxes withheld from pensions, Social Security or IRA distributions.
IRS directives show that the taxpayers affected will vary greatly depending on their situation and based on such factors as how many children they have.
To make sure you don’t fall into this trap, we recommend that you review how much money you’ll earn by the end of the year, how much federal income tax you will have withheld and your actual tax liability.
As an alternative, ask your tax preparer to do some calculations now to avoid an unpleasant surprise as April 15, 2019 approaches. Tax preparers are being flooded with IRS notices urging them to reach out and explain this potential pitfall, so they should be well-prepared to help you.
If this review shows you’ll owe more federal income taxes, there are a couple of ways you can avoid paying a tax liability and related penalties next year when your 2018 income taxes are calculated — but you need you move quickly.
▪ You can have more money withheld from your paycheck immediately.
▪ If you pay income taxes quarterly, you can make a larger payment in January. If you don’t pay income taxes quarterly you might want to consider doing so.
It’s time to heed the warnings being issued by the IRS and take action on your own now to avoid the problem.
Barbara McMahon is a Certified Financial Planning professional, member of the Financial Planning Association of Greater Kansas City and president of Innovest Financial Partners, located in the Brookside East neighborhood of Kansas City. Janine Bell, EA, assisted in the preparation of this article. Securities and Advisory Services offered through an Investment Advisor Representative of Cetera Advisors LLC, Member FINRA/SIPC. Innovest Financial Partners, Inc. is independent of Cetera Advisors LLC, 601 E 63rd St., Ste. 220, Kansas City.