Financial News

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.

15
Apr

IRS Issues Annual List of Tax Scams

While tax scams are especially prevalent during tax season, they can take place at any time during the year. Remember to keep your personal and financial information private and be vigilant so you don’t end up becoming the victim of a tax scam. For more information on tax scams visit irs.gov.

The IRS recently issued its annual list of tax scams. The list highlights various scams that taxpayers may encounter, many of which occur during tax filing season. Here are some of the scams that are highlighted on the list.

Phishing

Phishing scams usually involve unsolicited emails or fake websites that pose as legitimate IRS sites to convince you to provide personal or financial information. Once scam artists obtain this information, they use it to commit identity or financial theft. The IRS will never initiate contact with you by email to request personal or financial information. This includes any type of electronic communication, such as text messages and social media.

Phone scams

Phone scams typically involve a phone call from someone claiming you owe money to the IRS or that you’re entitled to a large refund. The calls may show up as coming from the IRS on your Caller ID, be accompanied by fake emails that appear to be from the IRS, or involve follow-up calls from individuals saying they are from law enforcement. Sometimes these callers may even threaten you with arrest, license revocation, or deportation.

Identity theft

Tax-related identity theft occurs when someone uses your Social Security number to claim a fraudulent tax refund. You may not even realize you’ve been the victim of identity theft until you file your tax return and discover that a return has already been filed using your Social Security number. Or the IRS may send you a letter indicating it has identified a suspicious return using your Social Security number.

Return preparer fraud

Sometimes scam artists pose as legitimate tax preparers and try to take advantage of unsuspecting taxpayers by committing refund fraud or identity theft. It’s important to choose a tax preparer carefully since you are legally responsible for what’s on your return, even if it’s prepared by someone else.

Inflated refund claims

Taxpayers should be wary of anyone promising an unreasonably large or inflated refund. These scam artists may ask you to sign a blank return and promise a big refund without looking at your tax records or charge fees based on a percentage of the refund.

Fake charities

Groups sometimes pose as charitable organizations in order to solicit donations from unsuspecting donors. Be wary of charities with names that are similar to more familiar or nationally-known organizations. Before donating to a charity, make sure that it is legitimate. The IRS website has tools to assist you in checking out the status of a charitable organization.