jhoward@seacureadvisors.com

13
May

1040 Postmortem: Making Sense of Your Taxes and Withholding

An estimated 65% of U.S. households paid less in federal income taxes in 2018, whereas 29% paid about the same and 6% paid more.

Source: Tax Policy Center, 2019

The Tax Cuts and Jobs Act (TCJA), which passed in December 2017, made fundamental changes to the U.S. tax code, and 2018 returns were the first time most taxpayers could see the practical impact of these changes.

In an April 2019 Gallup poll, 43% of Americans said they were unsure how the new tax law affected them personally. Surprisingly, 21% thought their federal income taxes went up in 2018, and 21% said they were about the same. Only 14% of respondents reported that their taxes went down, even though independent analyses and preliminary tax filing data suggested that about two-thirds of Americans would owe less in federal taxes in 2018.1-2

One reason for this apparent confusion might be because taxpayers tend to pay little attention to employer withholding, and any potential increase in take-home pay may have been less noticeable when divided into weekly (or biweekly) paychecks. It’s also possible that many respondents didn’t take the time to compare their tax burdens to the previous year and/or may not know how to do so. Despite a stated effort to simplify the federal withholding and tax filing process, the tax code is still complex, and many taxpayers don’t understand the details and terminology.

Stay on top of withholding

About 73% of 2018 tax returns showed a refund, averaging $2,725.3 The amount of your refund or the amount you owe with your return has little to do with your overall tax burden. These numbers reflect whether your withholding and/or estimated tax payments during the year were more or less than your final tax bill.

In theory, your withholding should equal your tax liability; otherwise you are loaning your money interest-free to the government. But IRS formulas tend to err on the high side, partly because people usually dislike owing a balance and are often happy to receive a tax refund.

Employers estimate your federal tax bill based on the number of exemptions claimed on your W-4 Form and on IRS calculation tables. The IRS rather quickly released 2018 calculation tables reflecting the new rates and rules. However, the agency did not replace the W-4 Form and worksheet, which are based on exemptions, deductions, and credits that were reduced or eliminated under the new tax law.

This resulted in smaller refunds or higher tax bills than expected for some taxpayers, especially dual-income households with more complicated situations. The Treasury estimated that 21% of taxpayers would be subject to underwithholding because of the TCJA, compared with 18% if the tax law provisions had not changed.4

If you owed a large amount of money for 2018, bumping up your withholding now could help avoid a similar fate next April. You might also reevaluate your withholding If you received a large refund. You could make larger retirement contributions instead or take home more of your pay and put it to better use.

It’s also a good idea to review your withholding whenever something changes in your life — such as a marriage, divorce, birth of a child, new job, or other significant change in your financial situation.

The IRS (irs.gov) has an up-to-date, online calculator that can help you determine the appropriate amount of withholding. You still need to complete and submit a current W-4 to your employer to make any adjustments. An all-new W-4 Form for the 2020 tax year is in the works but isn’t expected to be available to employers until later in 2019.

Measuring the impact

How you fared under the TCJA depends on a variety of factors, such as how much you earned, your filing status, the ages of your dependents, and where you live. Undertaking a thorough side-by side comparison of your 2017 and 2018 returns could help you identify changes that affected your bottom line. Be sure to note differences in your allowed deductions, taxable income, and total tax liability.

New marginal tax brackets are likely to mean that much of your income is taxed at lower rates. But other provisions may add to or reduce that benefit.

Standard deduction amounts for 2018 roughly doubled to $12,000 for single filers and $24,000 for married taxpayers filing jointly. However, personal exemptions ($4,050 in 2017) for yourself, your spouse, and your dependents are no longer available. The expanded child tax credit may offset the loss of exemptions for many taxpayers, but the math may not work out in your favor if you’re a family of four or more.

A number of tax deductions commonly used by high earners have also been modified, capped, or eliminated. For example, the itemized deduction for state and local taxes (SALT) is now limited to $10,000 ($5,000 if married filing separately). This provision caused tax increases for some taxpayers in high-tax states. On the other hand, the overall limit on itemized deductions that applied to higher-income taxpayers (commonly known as the “Pease limitation”) was repealed, and fewer taxpayers are subject to the alternative minimum tax.

You might also consult a tax professional who can explain the relevant changes and recommend potential strategies to help reduce your tax liability for 2019.

What if you owe money and can’t pay?

If you didn’t file your 2018 federal income tax return because it’s going to show a balance due, you should file your return immediately and pay as much as you can afford. This can help limit penalties and interest, and being up-to-date on filing is generally required to pursue a payment agreement with the IRS.

If you owe $50,000 or less, you may even be able to apply for a short-term extension (up to 120 days) or a longer payment agreement online. Interest and penalties continue to accrue on unpaid amounts.

1) Gallup, April 12, 2019

2) The New York Times, April 14, 2019

3) Internal Revenue Service, April 12, 2019

4) U.S. Government Accountability Office, 2018

6
May

The Future of Social Security and Medicare: What Trustees Project

Based on the “intermediate” assumptions in this year’s report, the Social Security Administration is projecting that the cost-of-living adjustment (COLA), announced in the fall of 2019, will be 1.8%. This COLA would apply to benefits starting in January 2020.

Most Americans will eventually receive Social Security and Medicare benefits. Each year, the Trustees of the Social Security and Medicare Trust Funds release lengthy reports to Congress that assess the health of these important programs. The newest reports, released on April 22, 2019, discuss the current financial condition and ongoing financial challenges that both programs face, and project a Social Security cost-of-living adjustment (COLA) for 2020.

What are the Social Security and Medicare Trust Funds?

Social Security: The Social Security program consists of two parts. Retired workers, their families, and survivors of workers receive monthly benefits under the Old-Age and Survivors Insurance (OASI) program; disabled workers and their families receive monthly benefits under the Disability Insurance (DI) program. The combined programs are referred to as OASDI. Each program has a financial account (a trust fund) that holds the Social Security payroll taxes that are collected to pay Social Security benefits. Other income (reimbursements from the General Fund of the U.S. Treasury and income tax revenue from benefit taxation) is also deposited in these accounts. Money that is not needed in the current year to pay benefits and administrative costs is invested (by law) in special Treasury bonds that are guaranteed by the U.S. government and earn interest. As a result, the Social Security Trust Funds have built up reserves that can be used to cover benefit obligations if payroll tax income is insufficient to pay full benefits.

Note that the Trustees provide certain projections based on the combined OASI and DI (OASDI) Trust Funds. However, these projections are theoretical, because the trusts are separate, and generally one program’s taxes and reserves cannot be used to fund the other program.

Medicare: There are two Medicare trust funds. The Hospital Insurance (HI) Trust Fund helps pay for hospital care (Medicare Part A costs). The Supplementary Medical Insurance (SMI) Trust Fund comprises two separate accounts, one covering Medicare Part B (which helps pay for physician and outpatient costs) and one covering Medicare Part D (which helps cover the prescription drug benefit).

Highlights of Social Security Trustees Report

  • Social Security’s total cost is projected to exceed its total income (including interest) in 2020 and remain higher for the next 75 years. The U.S. Treasury will need to withdraw from trust fund reserves to help pay benefits. The Trustees project that the combined trust fund reserves (OASDI) will be depleted in 2035, one year later than projected in last year’s report, unless Congress acts.
  • Once the combined trust fund reserves are depleted, payroll tax revenue alone should still be sufficient to pay about 80% of scheduled benefits for 2035, with the percentage falling gradually to 75% by 2093.
  • The OASI Trust Fund, when considered separately, is projected to be depleted in 2034. Payroll tax revenue alone would then be sufficient to pay 77% of scheduled benefits. These figures are unchanged from last year’s report.
  • The DI Trust Fund is expected to be depleted in 2052, 20 years later than projected in last year’s report. The significant depletion date change reflects the fact that both benefit applications and the total number of disabled workers currently receiving benefits have been declining over the past few years. Once the DI Trust Fund is depleted, payroll tax revenue alone would be sufficient to pay 91% of scheduled benefits.
  • Based on the “intermediate” assumptions in this year’s report, the Social Security Administration is projecting that the cost-of-living adjustment (COLA), announced in the fall of 2019, will be 1.8%. This COLA would apply to benefits starting in January 2020.

Highlights of Medicare Trustees Report

  • Annual costs for the Medicare program exceeded tax income each year from 2008 to 2015. There were fund surpluses in 2016 and 2017. In 2018, expenditures exceeded income, and this year’s report projects that costs will exceed income by increasing amounts (excluding interest income). The report notes that in 2007, assets represented 150% of expenditures, but by the beginning of 2019, the ratio of trust fund assets to expenditures had fallen to 66%.
  • The HI Trust Fund is projected to be depleted in 2026, the same year as projected in last year’s report. Once the HI Trust Fund is depleted, tax and premium income would still cover 89% of estimated program costs, declining to 78% by 2043 and then gradually increasing to 83% by 2092. The Trustees note that long-range projections of Medicare costs are highly uncertain.

Why are Social Security and Medicare facing financial challenges?

Social Security and Medicare are funded primarily through the collection of payroll taxes. Because of demographic and economic factors, including higher retirement rates and lower birth rates, there will be fewer workers per beneficiary over the long term, worsening the strain on the trust funds.

What is being done to address these challenges?

Currently, not much, but both reports urge Congress to address the financial challenges facing these programs soon, so that solutions will be less drastic and may be implemented gradually, lessening the impact on the public. Combining some of these solutions may also lessen the impact of any one solution.

Some Social Security reform proposals on the table are:

  • Raising the current Social Security payroll tax rate. According to this year’s report, an immediate and permanent payroll tax increase of 2.7 percentage points to 15.1% would be necessary to address the long-range revenue shortfall (3.65 percentage points to 16.05% if the increase started in 2035).
  • Raising or eliminating the ceiling on wages currently subject to Social Security payroll taxes ($132,900 in 2019).
  • Raising the full retirement age beyond the currently scheduled age of 67 (for anyone born in 1960 or later).
  • Reducing future benefits. According to this year’s report, to address the long-term revenue shortfall, scheduled benefits would have to be immediately and permanently reduced by about 17% for all current and future beneficiaries, or by about 20% if reductions were applied only to those who initially become eligible for benefits in 2019 or later.
  • Changing the benefit formula that is used to calculate benefits.
  • Calculating the annual cost-of-living adjustment for benefits differently.

You can view a combined summary of the 2019 Social Security and Medicare Trustees Reports and a full copy of the Social Security report at ssa.gov. You can find the full Medicare report at cms.gov.

29
Apr

Teaching Your College-Age Child about Money

When your child first started school, you doled out the change for milk and a snack on a daily basis. But now that your kindergartner has grown up, it’s time for you to make sure that your child has enough financial knowledge to manage money at college.

Lesson 1: Budgeting 101

Perhaps your child already understands the basics of budgeting from having to handle an allowance or wages from a part-time job during high school. But now that your child is in college, he or she may need to draft a “real world” budget, especially if he or she lives off-campus and is responsible for paying for rent and utilities. Here are some ways you can help your child plan and stick to a realistic budget:

  • Help your child figure out what income there will be (money from home, financial aid, a part-time job) and when it will be coming in (at the beginning of each semester, once a month, or every week).
  • Make sure your child understands the difference between needs and wants. For instance, when considering expenses, point out that buying groceries is a need and eating out is a want. Your child should understand how important it is to cover the needs first.
  • Determine together how you and your child will split responsibility for expenses. For instance, you may decide that you’ll pay for your child’s trips home, but that your child will need to pay for art supplies or other miscellaneous expenses.
  • Warn your child not to spend too much too soon, particularly when money that has to last all semester arrives at the beginning of a term. Too many evenings out in September eating surf and turf could lead to a December of too many evenings in eating cold cereal.
  • Acknowledge that college isn’t all about studying, but explain that splurging this week will mean scrimping next week. While you should include entertainment expenses in the budget, encourage your child to stick closely to the limit you agree upon.
  • Show your child how to track expenses by saving receipts and keeping an expense log. Knowing where the money is going will help your child stay on track. Reallocation of resources may sometimes be necessary, but help your child understand that spending more in one area means spending less in another.
  • Encourage your child to plan ahead for big expenses (the annual auto insurance bill or the trip over spring break) by instead setting aside money for them on a regular basis.
  • Caution your child to monitor spending patterns to avoid excessive spending, and ask him or her to come to you for advice at the first sign of financial trouble.

You should also help your child understand that a budget should remain flexible; as financial goals change, a budget must change to accommodate them. Still, your child’s ultimate goal is to make sure that what goes out is always less than what comes in.

Lesson 2: Opening a bank account

For the sake of convenience, your child may want to open a checking account near the college; doing so may also reduce transaction fees (e.g. automated teller machine (ATM) fees). Ideally, a checking account should require no minimum balance and allow unlimited free checking; short of that, look for an account with these features:

  • A simple fee structure
  • ATM or debit card access to the account
  • Online or telephone access to account information
  • Overdraft protection

To avoid bouncing checks, it’s essential to keep accurate records, especially of ATM or debit card usage. Show your child how to balance a checkbook on a regular (monthly) basis. Most checking account statements provide instructions on how to do this.

Encourage your child to open a savings account too, especially if he or she has a part-time job during the school year or summer. Your child should save any income that doesn’t have to be put towards college expenses. After all, there is life after college, and while it may seem inconceivable to a college freshman, he or she may one day want to buy a new car or a home.

Lesson 3: Getting credit

If your child is age 21 or older, he or she may be able to independently obtain a credit card. But if your child is younger, the credit card company will require you, or another adult, to cosign the credit card application, unless your child can prove that he or she has the financial resources to repay the credit card debt. A credit card can provide security in a financial emergency and, if used properly, can help your child build a good credit history. But the temptation to use a credit card can be seductive, and it’s not uncommon for students to find themselves over their heads in debt before they’ve declared their majors. Unfortunately, a poor credit history can make it difficult for your child to rent an apartment, get a car loan, or even find a job for years after earning a degree. And if you’ve cosigned your child’s credit card application, you’ll be on the hook for your child’s unpaid credit card debt, and your own credit history could suffer.

Here are some tips to help your child learn to use credit responsibly:

  • Advise your child to get a credit card with a low credit limit to keep credit card balances down.
  • Explain to your child that a credit card isn’t an income supplement; what gets charged is what’s owed (and then some, given the high interest rates). If your child continually has trouble meeting expenses, he or she should review and revise the budget instead of pulling out the plastic.
  • Teach your child to review each credit card bill and make the payment by the due date. Otherwise, late fees may be charged, the interest rate may go up if the account falls 60 days past due, and your child’s credit history (or yours, if you’ve cosigned) may be damaged.
  • If your child can’t pay the bill in full each month, encourage him or her to pay as much as possible. An undergraduate student making only the minimum payments due each month on a credit card could finish a post-doctorate program before paying off the balance.
  • Make sure your child notifies the card issuer of any address changes so that he or she will continue to receive statements.
  • Tell your child that when it comes to creditors, students don’t get summers off! Your child will need to continue to make payments every month, and if there’s a credit card balance carried over from the school year, your child may want to use summer earnings to pay it off in order to start the next school year with a clean slate.

Finally, remind your child that life after college often involves student loan payments and maybe even car or mortgage payments. The less debt your child graduates with, the better off he or she will be. When it comes to the plastic variety, extra credit is the last thing a college student wants to accumulate!