Bamboozled February 13, 2019: Will you get a smaller refund? Probably. But are you really paying more in tax?

Many taxpayers will get ugly surprises when they file their tax returns.

Many taxpayers will get ugly surprises when they file their tax returns.  (pixabay.com)

The IRS reported that tax refunds were down an average of 8.4 percent for the week ending Feb. 1 compared to the same week the year before. On average, refunds decreased from $2,035 to $1,865.

Keep in mind it’s early in the tax filing season, plus the government shutdown caused some delays in processing returns.

But what about the new tax plan? Wasn’t it supposed to give taxpayers a tax cut?

Smaller refunds don’t necessarily mean you’re paying more in taxes, but those who usually get a large refund check may be in for a rude awakening.

In addition to smaller refunds, the tax preparers we spoke to found some other surprises for taxpayers who were expecting to pay less in tax overall.

But first, why the smaller refunds?


Refund surprises

One of the biggest impacts on your tax situation has nothing to do with changes to deductions and credits.

Updated IRS withholding tables are the biggest culprit leading to smaller refunds.

The tables are used by employers to calculate the tax withheld from an employee’s paycheck, said Lynn Ebel, director of The Tax Institute at H&R Block.

“These changes generally resulted in bigger paychecks and less tax withheld starting in February or March, even if you took no action,” Ebel said.

With less tax withheld throughout the year, it means shrinking refunds because there’s less to refund taxpayers when returns are filed.

Ebel said anyone who updated their withholding after the IRS made its adjustments can expect the withholding outcome they planned for when completing their W-4. But those who didn’t update their W-4 are “most at risk of significant changes to their refund or balance due,” Ebel said.

If you usually get a large refund and you planned to use the money to pay down debt or make a down payment on a new car, you could be disappointed. Instead, you’ve been seeing that money all along.

Of course, that doesn’t alleviate the gut punch of a smaller refund if you were expecting one.

In some instances, taxpayers accustomed to modest refunds now have balances due on their 2018 income tax returns, said Neil Becourtney, a certified public accountant and tax partner with CohnReznick in Eatontown.

“It appears that the average working stiff with 2018 income about the same for 2017 is in for a decrease in their refund historically received,” he said. “If someone’s net pay went up last winter, they likely equated that to the tax benefit they were reaping from The Tax Cuts and Jobs Act but now they may have ‘buyer’s remorse.'”

The IRS and the Government Accountability Office previously estimated that nearly five million fewer taxpayers would receive refunds, while another five million would probably owe money when they file their returns.


Case studies

Overall, the tax preparers we spoke to said they haven’t completed many returns yet. Some are still waiting for 1099s from brokerage houses and other paperwork to come through.

But the returns they have completed show some interesting findings.

Michael Karu, a certified public accountant with Levine, Jacobs & Co. in Livingston, said for the two returns he completed so far, both had smaller refunds even though their income was roughly the same.

“It has nothing to do with the law changes and everything to do with the government reducing the withholding tax requirements and people getting a little more each week in their paychecks,” Karu said.

Karu, who personally prepares about 400 returns a year while his firm prepares 2,500 each season, shared one of his client’s profiles as an example.

It was a single parent with two children filing as Head of Household. Gross income was $95 higher than the year before and taxable income was $4,195 higher, but the parent also had higher credits. Overall, the refund was $773 lower than the year before, but the parent had been receiving more in each paycheck throughout the year, Karu said.

The tax professionals we surveyed said they haven’t seen any real trends yet, but they are seeing surprises.

“Employees had more take-home pay because this was sold as a middle income tax cut, but it doesn’t seem to be working out that way,” said Cynthia Fusillo, certified public accountant with Lassus Wherley, a subsidiary of Peapack-Gladstone Bank, in New Providence.

She said she’s only completed two returns so far this season.

One was for a 64-year-old single filer who lost $15,862 in itemized deductions and $4,050 of an exemption. The taxpayer had a lower adjusted gross income (AGI), but taxable income was higher, and he ended up with a $656 higher tax bill.

Patricia Daquila, also a certified public accountant and certified financial planner with Lassus Wherley, which prepares 500 personal returns a year, said changes in the law, beyond the withholding changes, aren’t all working out for her clients.

“In general, it seems that the middle income taxpayers are getting hit harder due to the loss of miscellaneous deductions and [deductions for] state and local taxes over $10,000,” Daquila said.

She offered this example: An 88-year-old widow with identical income in 2017 and 2018. In both years, his gross income was $99,708 and his taxable income was $86,108. But his actual tax for 2018 was $12,075, up $1,117 from 2017’s $10,958. That’s a 10.2 percent increase.

“The tax increase was due to the elimination of miscellaneous itemized deductions in 2018,” she said.

Daquila said tax rates may also lead to surprises for some taxpayers. While the rates generally went down, the income ranges for those rates start at a much lower income level, she said.

For example, for 2017, the single tax rate of 33 percent was for those with income of $191,651 to $416,700. But for 2018, the 32 percent tax rate starts from $157,501 through $200,000, and it’s 35 percent for those earning $200,001 to $500,000.

Retired people who take distributions from retirement accounts could also be in for negative surprises.

When you take a distribution from a retirement account, typically, the brokerage house will withhold estimated taxes on the distribution.

“[Retired people] are having less withholding taken out of their retirement distributions and they didn’t realize this would happen,” said Gail Rosen, a certified public accountant in Martinsville. “Many just considered the impact of the new tax rate tables on wages and didn’t consider their retirement income.”

Rosen, who prepares nearly 1,000 returns each year, called it “disheartening” when upon completion of their tax return, seniors “owe money or have a significantly smaller refund which they depend on.”

“We warned our clients but now they are realizing the reality of the impact on the reduced tax rate tables,” she said.

Some taxpayers – those with higher incomes – can expect good news when they file their returns.

“From tax planning that we did and my own personal income tax returns that are substantially completed, many of our clients where income is relatively the same as 2017 will reap an overall tax reduction due to escaping the Alternative Minimum Tax and use of the Section 199A Qualified Business Income (QBI) deduction,” Becourtney said.

The QBI deduction is a 20 percent deduction on certain kinds of income – big savings for taxpayers who qualify.

Becourtney notes that each 1040 filer’s situation stands on its own based on many variables, including filing status, whether both spouses in a joint filing work, whether they have a business that’s eligible for QBI, whether they own or rent and more.

Also, because the standard deduction is nearly doubled, many who itemized in the past will now get a bigger benefit from the standard deduction, said Ebel of H&R Block.

“But those who will continue itemizing could be impacted by the $10,000 cap on state and local tax deductions and will be more likely to have a balance due when they file in 2019,” Ebel said. “Homeowners in high-tax states will also be more at risk of owing next tax season because of that cap on state and local tax deductions.”


What can you do?

If you don’t like what happened with your refund this year, you can take action to help make sure it doesn’t happen again by updating your withholding with your employer.

The IRS warned taxpayers throughout 2018 to expect these changes. It even offers a withholding calculator so you can see the optimal withholding for you.

Now is the time to make the changes. Don’t wait.

“Updating a W-4 at the start of the year stretches out the changes over a longer period, so tax season is an opportune time to update a W-4,” Ebel said.

And if you’re taking distributions from retirement accounts, be sure that enough is being withheld for your tax bill.

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