The Planner's Perspective: New Year Withholding Checkup

Paul Morrone |

By Paul Morrone CFP®, CPA/PFS, MSA

With the Tax Cuts and Jobs act in effect for a full year, we are just now beginning to see the fallout of many of the changes that took effect only a short year ago. With the benefit of hindsight, it may be wise to review your 2019 income tax withholding as you look to prepare your 2018 tax returns. The new law came with lower marginal tax brackets nearly across the board (i.e. the 15% bracket was reduced to 12%, etc.), which was a welcomed change for many. In response, the IRS released updated withholding tables which required that income tax be withheld at a lower percentage rate based upon your salary.  This is why you may have noticed an increase in your take home paycheck or pension payment in February or March of last year (no, you didn’t get an unsolicited raise!). However, with this positive change we need to be careful of some potentially negative side effects.

While many have enjoyed their higher take home pay during the year, the downside to this universal change is that each individual taxpayer’s situation is different. Some may find that the reduced amount of tax being withheld is still sufficient (or more than sufficient) to meet their annual tax obligation at the end of the year. Other taxpayers, and many ordinarily accustomed to a refund, may find themselves owing a balance to the IRS after they calculate their final year-end tax liability.

Those living in high-tax states (NY, CT, NJ, MA, CA, OR, etc.) have the most exposure and will have the toughest time coping with the changes to their withholding this year. The cap on the state and local tax deduction was one of the most hotly contested provisions of the new law and will significantly impact the taxable income, and thus the tax liability, of residents of these states. If you ordinarily pay a large sum in state and local taxes and your plan going into 2018 was ‘ignorance is bliss,’ your tax return may yield some ugly and costly surprises. If the result is a large balance due and you haven’t paid in enough tax to meet the IRS safe harbor requirements, you may also be faced with underpayment penalties and interest charges due on the amounts underpaid.

The simultaneous combination of these two items could be a double whammy for the unsuspecting taxpayer. Those accustomed to large overpayments may suddenly have much smaller refund checks coming their way. Even worse, many may find themselves with large unanticipated balances due, a nightmare scenario for a household that is not financially sound and relies on getting a tax refund each year. Remember, a good planner will always remind you that tax refunds are not a saving strategy and should never be relied on to supplement your income.

If you fear that you may be in this type of situation in 2018, there is still a saving grace, at least for 2019. Updating withholding elections earlier in the year will prevent you from having to play catch-up later in the year, meaning you can more prudently managing your after-tax cash flow. With your 2018 numbers now final, it may be best to do some proactive tax planning for this year even though you can’t yet file your tax return.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. US Wealth Management and LPL Financial do not provide tax advice.

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