Problem Discovered in Tax Bill Will Leave Many Owing the IRS Big Next Year

It’s going to be a cold winter next tax season if people don’t prepare for the antics of Congress and the IRS.

A major tax bill late in the year followed by a bill of extenders February 9th and we have the perfect recipe for problems.

My initial reaction to the tax bill in December was that most of my clients would see some benefit since my clients tend towards the upper end of the income scale. I also have lower income and older clients who are not benefiting as I expected. Certain taxpayers are even seeing a tax increase, most notably, those with large unreimbursed employee business expenses like on-the-road sales people and rock band members.

The tax software used in my office estimates what the new tax rules will mean for clients if the rules applied to their 2017 return. This has been a powerful planning tool early in the tax season. But as an accountant I always look under the hood and when I did found a disturbing problem.




From Joy to Tears

Taxes cause pain in two ways. First, the actual tax dings the household budget. Second, if not properly prepared for the changes, the timing of when the remaining taxes are paid can cause exquisite pain.

Adding to the mess, the IRS didn’t have time to update withholding tables until the end of January. Most clients didn’t see a change in their paycheck reflecting the new tax law until their first paycheck in February.

Also problematic is the issue of exemptions. For this calendar year personal exemptions are eliminated while the standard deduction is increased. As expected, this change was a big yawn for most clients. A few were able to capitalize on this particular change.

Without exemptions it is harder for the IRS to estimate the tax liability of household size. Yes, the child tax credit has been increased and the phase-out level pushed higher, but the age of the child and if they attend college now plays a bigger role than in the past.

Late January and early February tax returns delivered in my office presented our estimate of how the tax change will affect the client. A few people saw a tax increase, but most had either a small change or a larger refund.

One thing bothered me as we shared the news. I worried how the updated withholding tables would affect my results. I warned clients my estimate assumed everything was exactly the same as their 2017 return when we know the updated withholding tables would mess with my estimate.

Now that we are on the backside of February and most clients picking up in the last week have seen a paycheck with the new withholding, I can ask an additional question: How much did your paycheck change with the new withholding?

I expected a modest adjustment to my software’s estimate. What I got made me light-headed.

Every single client I met in the last week or so with a new withholding amount is under withholding by a large margin! People expecting a $3,000 reduction in their tax bill are seeing a $4,000 or more reduction in withholding. Clients who already owe money or like to keep it close to breakeven are in for a rude surprise if I don’t intervene.




An Imperfect Solution

I have a solution to fix the problem, but it entails a lot of screwing around. You can either reduce your exemptions on your W-4 or fill in an extra amount to be withheld each pay period above the withholding table amounts.

Unfortunately, most people don’t have a clue what is about to hit them. If their accountant doesn’t figure this out fast they will be steamrolled next tax season when the miscalculation bites. DIYers are at greatest risk as they tend to believe what the computer tells them. Computers are great for grunt level computing in preparing a tax return, but ill equipped to fix this new problem.

Here is what I consider the only appropriate option. When tax season is over you need to speak with a tax professional that is willing to crunch the numbers by hand to adjust for the tax and withholding changes. There is no other way.

My guess is online programs will become available as the year goes on. It still requires taxpayers to understand they even have a problem.

A Busy Off Tax Season

Tax professionals will be busy this year. I can’t imagine 140 million people are going to show up at the tax office this summer. First, many tax offices close or have reduced staff over the summer, and second, tax offices will focus on their regular clients if they address the issue at all. About half of taxpayers prepare their own return. Next spring, after the mid-term elections, taxpayer will have a hangover from the antics of Congress and the IRS. The reduced refunds and increased balance dues could chill the economy. (At least the guys who created the mess got re-elected. Man, if they lost their cushy government jobs they’d be unemployable, except as lobbyists.)

Prepare your own taxes and support your favorite blog at the same time. What could be better?

Your favorite accountant already has a plan. Originally I planned on reviewing all returns in my office with a business or income property. If we find an issue we’d give the client call to set up a meeting. This has been expanded to all clients! I estimate I’ll communicate with 600-700 clients over the summer out of a book approaching 1,000.

Readers of this blog will also feel uneasy as my discovery is copied by other news outlets. (Note to news outlets: Let your readers know where you learned this nugget of information as a gift to a wayward accountant from Backwoods, Wisconsin.) My regular clients have preference. Openings in my schedule are available to non-clients. That means most of you, kind readers.

It’s nothing personal. I have to focus my time as it will be at a premium this year. The amount of tax planning necessary this year will trump (pun intended) anything I’ve experienced in my 36 year career. The business income deduction alone would be enough for a comfortably busy summer. All these extra issues will overwhelm any tax office brave enough to remain open after April 17th.

I’m not bailing on you guys! Normally I block one day per week for consulting. This year I will open two days per week with the option some weeks for a third day. Keep in mind consulting takes prep work before we speak. I need to see your 2017 return and any expected changes.

To make this work will require specialized training in my office so I’m not a lone soldier. As a lone wolf I’d never make it through my client list, not even considering even one non-client from my list of awesome readers.

Late April will be a recovery period as I train and take some time with family. Clients reading this can set a summer appointment already. Some have. Clients picking up from now to the end of tax season will be reviewed for a summer appointment.

From May 1st on it will be full speed forward with consulting and tax planning. Clients with a business and landlords really need to make it a priority to see me this summer or fall.




How Much of My Tax Savings are Going to You, Mister Accountant?

And then we get to fees. In my office I will charge a flat $50 for clients to have their withholding reviewed. Before you pay me a cent (or I do a stitch of work) I’ll pull up your file to determine if a review is warranted. If it makes sense for me to review your records I will. If it is obvious you don’t have a tax issue I’ll inform you so you can save fifty bucks. Retired persons and those with low income generally fall into this group.

Businesses and landlords all require a review this year no matter what! There are too many additional moving parts to abscond a detailed review. My hourly fee will apply. I doubt anyone will lose on the deal as the advantages this year will far exceed anything you pay me (or most other accountants).

All non-client reviews are based on my hourly rate of $275 per hour. Regular clients have an advantage since I already know their tax situation and have their return on file. I need more review time with non-clients to acquaint myself with their tax situation.

I encourage you to begin a dialog with a tax professional early this year due to higher demand on their services. Your withholding is almost certainly wrong and to the government’s benefit. If you never consulted with a tax pro this is the one year you might want to consider it anyway.

I can see all your hands up. Yes, I will handle as many as humanly possible. However, I have a strong feeling my larger public presence will crimp the percentage of non-clients I can accept compared to demand.

The forum on this blog and Mr. Money Mustache are a great resource if you don’t have a tax professional on speed dial. I also expect many local accounting firms to add hours to handle the extra consulting this year.

Finally, you are welcome to contact me for consulting, a review and/or to prepare your return. I recommend you read the Working with the Wealthy Accountant page before hitting the Contact button.



Keith Taxguy

27 Comments

  1. Christine on February 26, 2018 at 7:51 am

    Ha, I actually have the opposite problem! I can’t get the witholdings low enough! Due to the new child tax credits, having my third child this year and having a lower than normal income due to the maternity leave, I anticipate that the amount of tax due on my income will be covered by the child tax credits. I have my witholdings set to 11 and they are still taking out money. And of course I get two bonuses a year, so I’ve already have $1500 withheld, even though I don’t expect to have a tax liability after credits. Somewhat frustrating, but I guess its a good problem to have compared to what your clients will be dealing with.

    • Keith Taxguy on February 26, 2018 at 9:08 am

      That still requires some consulting, Christine. However, most of my clients (higher income taxpayers) are in for a more rude surprise.

      • Christine Patane on February 26, 2018 at 10:07 am

        I wish I was higher income. 🙂 For this year, it’s mainly because the maternity leave is going to lower my income (even with a generous paid maternity leave policy, I miss out on OT and bonuses.) Next year will likely be much different. I did the math a few times and ran it by my (non-professional) tax guy, but I think you are right. I may want to run it by a professional just for peace of mind.

  2. Holly on February 26, 2018 at 8:00 am

    Thanks Keith! I was curious about this myself.

    My husband’s company limits the number of withholdings and makes it difficult to have HR change the W4. Should be easy but they just don’t. We always get a refund which I prefer not to. He did show a decrease in taxes paid with the new tables put in place.

    Will be talking to my CPA about this. Thanks!

  3. Andy on February 26, 2018 at 8:15 am

    Keith,

    My wife and I have no kids, we’re debt free including mortgage. She is getting back $3,000 this year so we decided to change her withholding from 0 to 2 in January. We saw the paycheck increase in January and then we saw the Trump increase the first paycheck in February. I was concerned about the exact same thing you’re describing in this article so our plan is to not dollar cost average into our Roth IRA’s this year but she will continue to max her 401(k) at $18,500. Instead we will lump sum our 2018 Roth contributions after we do our taxes April 2019. In case we have to pay in next year I want to make sure we have the cash available to do that and lump sum our Roth accounts. This will work out better for us psychology because we do not know how much we will owe in case we have to pay in.

  4. Kenneth on February 26, 2018 at 8:24 am

    Turbotax TaxCaster (free) does a pretty decent job of estimating your 2018 taxes. https://turbotax.intuit.com/tax-tools/calculators/taxcaster/

    Or, you can pay your accountant or Keith to do it for you.

    • Keith Taxguy on February 26, 2018 at 9:12 am

      The TurboTax estimator is as wrong as mine. It can’t take into account the nuances, Kenneth. You don’t need a tax pro if you can annualized your withholding and compare it to the new tax rules. Be careful of the estimators! I trusted the computer at first, too and discovered the error when I asked more questions. All estimators will have a disclaimer on the bottom for this reason. The biggest unaddressed problem is QBI. The IRS hasn’t issues regs on this new animal and I bet the regs they do issue end up in Tax Court.

      • Dave on February 27, 2018 at 4:05 pm

        QBI is the big one, though I would suspect that the change in the itemized limitations/increase of standard deduction is also going to negatively impact a number of people. Thoguh it appears that this past weekend, the AICPA did send a letter to the IRS asking for guidance on a number of section 199A issues. Though, the IRS has enough on their plate, due to the form changes resulting from the early February extenders bill passing, the repatriation issues for 2017, and all of the other tax law changes from the 2017 tax act.

        I’ll continue to be curious as to what all you do for consulting this year, as I’m more than a little bit tempted to copy you and attempt to pitch similar services to our clients (and I’m a few states away from you).

  5. Nick on February 26, 2018 at 8:30 am

    Hi Christine, you just need to contact your payroll/HR department and ask them to withhold nothing. They should be able to change it on their end to withhold no federal taxes for you without much difficulty.

  6. Susan @ FI Ideas on February 26, 2018 at 9:12 am

    An advantage of being already FI is that we no longer have withholding. But since I’m a finance hobbyist, I help family with their taxes and I will get the word out. I have several relatives who unfortunately live paycheck to paycheck and cannot afford to find this out next spring. Thank you for all you do!

  7. Mick on February 26, 2018 at 11:31 am

    My January paychecks had normal (2017 law) withholding
    First paycheck in Februrary was VERY low withholding (which would have drastically under-withheld). I think that was to compensate for the overage in January.
    Second paycheck in February was closer to what I expected–witheld amount was reduced by about 15%.
    If I extrapolate to end of year my total withholding will be a little over my expeced tax liability.

  8. Jason on February 26, 2018 at 11:49 am

    Thanks for the find. I will definitely be reviewing this within a short period of time.

  9. Full Time Finance on February 26, 2018 at 11:51 am

    My big problem is my largest withholding each year tends to come from my RSUs. Historically they’ve withheld 40% of my RSUs regardless of my withholding elections. That has offset my wife’s self employment income after solo 401 k removal. I’m now unsure what withholding will occur on those end of year RSUs. That makes it extremely difficult to estimate taxes in 19.

    In 18 I came in at near 0 tax owed. I knew how much that was going to be within 100 dollars 7 months ago.

  10. Claudia on February 26, 2018 at 12:55 pm

    Hi Keith,
    Thank you for this post but I have to admit that I do not totally understand the issue you are describing. Clearly it is my lack of knowledge.

    Do you have suggestions for additional reading we could do to become more informed?

    Thank you!

    • Keith Taxguy on February 26, 2018 at 1:45 pm

      I haven’t seen anyone talk about this yet, Claudia. The short version is that the IRS withholding tables are overestimating the tax reduction for many taxpayers which will cause problems next tax season.

  11. Mimoza on February 26, 2018 at 1:31 pm

    Keith,

    I don’t understand what the problem would be for people who have simple situations. Perhaps you deal with complicated clients. The IRS has already released formulas how to calculate 2018 taxes. People with W-2 just need to prepare a simple tax return (I do in Excel that mimics 1040 though it can be done by hand) and find out their tax liability for the whole year and then by month or whatever pay period. Then see if that amount is close to the amount withheld on their current pay-stub. Of course if one has passive income tax withholding should be account for that as well.

    Am I missing something?

    You made it sound like a major hurricane coming like an insurance salesman trying to sell a whole life insurance LOL.

    • Keith Taxguy on February 26, 2018 at 1:48 pm

      Simple has nothing to do with it, Mimoza. Businesses and landlords have issues QBI and wage earners have an issue with the new withholding tables. “Simple” isn’t what will hit you; income level will. A client with a W-2 and nothing else is a simple return, but the withholding could radically change his outcome next year. Household incomes under $50,000 and families are less affected.

  12. MB on February 26, 2018 at 2:30 pm

    Great article. Thank you for pointing out the withholding issues this far in advance!

    Just as a sidenote. There is an ad on this article 1040.com that keeps moving the entire text of the page up and down as it moves through its gif. I am assuming the gif is made of two different size pictures. This viewing issue is on a desktop.

    • Keith Taxguy on February 26, 2018 at 3:10 pm

      I’m not having the issue on my desktop. Anyone else? Is it in the text or a sidebar?

      • Edward on February 27, 2018 at 11:19 am

        Keith, yes. This has happened on your last couple of posts. It is the ad under the section “A Bust Off Tax Season.” Very annoying issue on my end.

        Still love reading what you have to say. Obviously, just one of those lovely technical issues/glitches.

        • Keith Taxguy on February 27, 2018 at 11:51 am

          Thanks for pointing out the issue, Edward. If anyone else is experiencing a similar issue let me know. I can’t get it to happen on my end.

          The ad in question isn’t exactly an ad. It’s a link to do your own return with my software. I made a change to see if that helps you, Edward. Also, try cleaning the cache on your computer as that can sometimes cause problems. Let me know if the problem persists.

  13. Blastmaster on February 27, 2018 at 4:59 pm

    Keith, as many of your readers are FI enthusiasts, could they not use the lower withholding to their advantage by contributing more to their 401K or deductible IRA’s? Many of us, especially with 1040 income and a side hustle are utilizing every possible avenue to sock away as much pretax as possible, including Solo 401K for the side hustle/business income. If my taxable income is greatly reduced due to tax sheltering resulting in even less being withheld, how is this a negative?

    • Keith Taxguy on February 27, 2018 at 6:11 pm

      Blastmaster, utilizing retirement plans to reduce taxes still works. However, increasing 401(k) or similar contributions will not solve the underwithholding problem as the withholding tables adjust to the lower includable income after contributions to the retirement plan. The result is still underwithholding and a potential balance due with penalties.

      Side hustles and business owners already calculate their taxes based on actual income when figuring their estimated tax payments so they are less affected here.

      A deductible IRA is a good idea for those who can use it. Many readers and clients have a retirement plan at work and earn over the limit where a deduction is allowed.

      The reason this is a negative is that underwithholding will generate a balance due for many and an interest penalty. It also requires a budget item to handle the extra tax expense in spring. I’d rather see consistent investing by clients (and readers). The smoother the ride the more likely my client will remain vigilant in their investing program.

  14. Rachel on March 1, 2018 at 10:54 am

    I just text my accountant the link to this post to ask him if I should do anything differently, but I want to summarize what you’re saying to make sure I understand:

    The withholding tables are wrong, I’m going to probably owe the IRS some massively unexpected sum of money next year unless I calculate it myself now and make adjustments.

    I have a W2 job but also several rental properties and an outside consulting business. When I text my accountant I asked if I should adjust my work withholding or just send in more in estimated taxes in my case. It’s easier for me to just do the latter because making changes where I work can sometimes be complicated, so I’d rather not touch anything there unless it’s like a hair-on-fire level tax emergency 🙂

    • Keith Taxguy on March 1, 2018 at 12:08 pm

      It’s not so much the withholding tables are wrong, Rachel; it’s that it is hard to adjust now that we don’t have exemptions. My very small sampling size showed problems. I’ll update with a new post if I discover the extent of the withholding issue is worse or better than my initial pool of clients I reviewed.

      • Scott on March 15, 2018 at 4:31 pm

        Keith, what about for someone like my brother. Single with income around $100k, rents an apartment and doesn’t have kids. Would the IRS withholding calculator be sufficient for him?

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