Most Americans got a tax cut thanks to the new Republican tax law, but it’s possible that millions of households will get a surprise bill from the IRS in the coming weeks.
Ben Williams, a lawyer in New York City, said he earned the same amount of money last year as he had the year before, but wound up with a totally different tax situation.
“Last year I got a $750 refund,” Williams said. “And this year I owe $4,600.”
There are two reasons for Williams’ predicament. The 35-year-old lost his refund both because Republicans targeted wealthy (and heavily Democratic) metropolitan areas for tax hikes and also because of how President Donald Trump’s administration implemented the law.
The Tax Cuts and Jobs Act cut rates for taxpayers at every income level and simplified the tax code for most filers. Part of that simplification meant getting rid of a lot of deductions, which people use to reduce the amount of their taxable earnings.
One of the most controversial changes limited the amount of state and local tax payments that could be deducted. Previously, a tax filer could reduce their taxable income by subtracting the income taxes they paid to their state and local governments. The law capped such deductions at $10,000. Williams said he usually pays more than three times that amount in state and local levies.
While preparing to file his taxes through the H&R Block website this week, Williams said the blood drained from his face when he realized how much he would owe. He had anticipated getting another refund that he would put toward a vacation.
“I guess that my assumption was that the IRS withholding tables would have been updated to some degree or my company would have done something,” he said.
There is no way Williams could have avoided paying higher taxes, given his circumstances. But if the government had administered the tax law more carefully, he could have been spared the February surprise. Employers are supposed to withhold federal income tax from their workers’ paychecks, and the vast majority of taxpayers typically withhold more than necessary, resulting in a refund in the early part of the year. The average refund is worth nearly $3,000.
But Republicans rushed their tax cuts through Congress at the end of 2017, making huge changes to the tax code without so much as a hearing, and gave the IRS hardly any time to implement the law, which took effect less than two weeks after Trump signed it.
The IRS had to scramble to figure how it should change the way tax would be withheld from paychecks for 2018. Officials with the Treasury Department told the Government Accountability Office, a congressional watchdog, that they felt they had to work with the same basic W-4 forms that employers were already using to determine withholding amounts. A trade group for payroll providers told the GAO that substantially different forms would necessitate changes to withholding software that would have taken at least half a year.
The IRS knew from its simulations ― which assumed that people would not adjust their withholding amounts ― that just plugging new numbers into its old withholding tables would probably reduce the number of tax filers getting a refund from 76 percent to 73 percent, according to the July GAO report.
That means millions more households getting a bill from the IRS. In Treasury’s simulations, households that itemized deductions, such as New Yorkers with higher local taxes, were likelier to withhold less tax as a percentage of their total liability.
“That is the group that ends up paying more tax under the new law,” said Nathan Rigney, lead tax research analyst at The Tax Institute at H&R Block. “It’s the people in New York who are losing such a large amount of the [state and local tax] deduction they can end up owing more tax because their taxable income goes up by so much.”
Tax filing season opened at the end of January, and the government shutdown may have hampered the IRS’ ability to process returns as quickly as in previous years. Around this time in 2018, the IRS said it had processed 30 million returns and dished out 13 million refunds. (The total for the year was 150 million returns and 111 million refunds.) Similar data is not yet available for this year.
The new law cut taxes for 80 percent of households, with the biggest benefit accruing to the wealthier ones, according to the Tax Policy Center, while roughly 5 percent saw a tax increase. The changes should have been evident in paychecks last year, though incorrect withholding may have obscured the policy until now.
Republicans knew in advance that the households negatively affected by their tax changes just so happen to be clustered in states where people tend to vote for Democrats. And according to the GAO, the Trump administration may have been more worried about people withholding too much instead of too little, even though the latter can stick people with surprise tax bills and penalties, and reduces overall compliance. Withholding too little, on the other hand, makes people’s paychecks bigger immediately ― and the Trump administration wanted to make sure to help the people it intended to help.
“Treasury officials stated that withholding more from paychecks than in past years for taxpayers whose tax liability is expected to decrease would be inconsistent with the intent of the law as they understood it,” the GAO said.