Why this year’s personal taxes could hold a painful surprise

Accountants are bracing for unusual confusion in this year's federal income tax season, with millions more people than last year learning they have underpaid — or way overpaid —  before the April 15 deadline.

The Government Accountability Office and the Internal Revenue Service issued warnings last week that Americans need to update their tax withholding forms — W-4s — by the end of this year, because of changes in President Trump's tax law.  As passed by Congress, the law cut taxes significantly for corporations and wealthy people, but also reduced some familiar deductions used by millions of Americans.

The GAO estimates that this year's guidelines have resulted in 73 percent of the 138 million Americans who pay federal income taxes now overpaying, enduring a kind of forced no-interest savings until they get refund checks — up from 70 percent last year.

At the other end, 21 percent are likely underpaying and will end up owing the government a check — up from 18 percent. Add it up, and that works out to more than 10 million more Americans this year whose withholding doesn't reflect what they will owe at the end of the year, on top of tens of millions who were out of synch in previous years.

"This year end is going to be so painful – everyone needs to get looked at," said Paul Adelizzi, CPA, director at Citrin Cooperman in Center City. "There was an adjustment in the beginning of the year on all wage earners' withholding. The issue this year is that for the first time, all tax projections need to be done on a case by case basis, because of the little quirks in the new law. "

For example: According to the GAO, a family claiming the Child Tax Credit, with two children and two parents, one of them earning $75,000, the other at home, and using this year's government withholding guidelines with last year's personal income data, is likely to be withholding nearly double their actual tax obligation and may be due for a big refund when filing next spring.

But the same sized family, with a parent earning $180,000, and claiming $20,000 in tax deductions, will likely be underpaying its taxes over the year by nearly 20 percent, and may be socked with a large tax bill next spring.

The changes happen to be timed so that many taxpayers won't realize they owe until after November's midterm congressional elections, notes David L. Zalles, a veteran tax practitioner in Blue Bell.

In his practice, Zalles said he's finding that "taxpayers with two or more children don't realize that the well-publicized doubling of the Standard Deduction has been more than offset by the elimination of the personal exemptions."

"Consider a family with three kids," he added. "The five personal exemptions with a $20,250 deduction [in 2016] has been replaced by a $11,300 increase in the Standard Deduction. That is an increase of $ 8,950 in their taxable income. At a 22 percent tax rate, this is an increase in their taxes of $2,000."

The family could offset part of that tax increase with the new $2,000 child tax credit, but only for kids under 17. For older kids, including costly college students, the credit is just $500, Zalles adds.

Due to the Trump tax law, this is the first year the Treasury and IRS, rather than Congress, set withholding targets. The GAO says Treasury, headed by Secretary Steve Mnuchin, failed to document how it came up with the withholding guidelines it imposed earlier this year, so it's been tough to figure out why withholding projections are less accurate than last year.

Treasury for its part complained it was unable to tell the difference between workers with multiple jobs at the same time, and those who change employers during the year, which can change the impact of dependents on the tax bill at each employer. So Treasury's "lack of data" meant "its withholding estimates were subject to considerable uncertainty," GAO concluded.

An IRS advisory warning last week said it "urges taxpayers who haven't yet done a 'Paycheck Checkup' to take a few minutes to see if they are having the right amount of tax withholding following major changes in the tax law."

It plans to add advice on its Web site and YouTube channel, and to hold "special sessions" with tax professionals to warn what to watch for. The IRS offers a withholding calculator here:

There are 68,000 professional tax preparers in the U.S., according to the Bureau of Labor Statistics, and 138 million taxpayers, according to federal tax data. The IRS YouTube channel has 25,000 subscribers.

The tax law's changes include an increased standard deduction, the elimination of personal exemptions, a higher child tax credit and limits on deductions, along with new rates and brackets. "The changes are extra likely to affect two-income families, workers with more than one job, Child Tax Credit claims, families with college-aged dependents, and high-income people, among other groups," the IRS said.

Zalles said "the IRS is doing its best to get the word out on this."

"For many taxpayers who were used to getting average refunds of $ 2,800 when they filed their tax returns, they will be in for a rude awakening when they do not get much." Paychecks rose starting in February, when withholdings were cut due to the new tax law.

"On the other hand, high-income taxpayers, especially those who file estimates, may find a significant increase in their overpayments, because their taxes will be reduced greatly in 2018," Zalles adds.

"Employees living or working in Philadelphia will be hurt" if their state and local income and real estate taxes total $10,000 or more [or $5,000 for married people filing separately.] I have a high income client whose total of these taxes is $70,000, which will be limited to a $10,000 deduction. However, because of the reduction in the tax rates, their taxes will be reduced by $ 25,000. Therefore, I had them reduce their withholdings by $3,000 per month for the remaining 8 months of the year."

"Most professional tax practitioners are doing these projections for clients," Zalles told me. "But taxpayers who do their own taxes, or who use 'retail preparers', will have significant difficulty in making these determinations themselves."