Typically, when a tax law is passed that changes the marginal tax rates, the IRS issues new tax withholding tables (for payroll and pensions) to reflect these changes. The logic behind doing this is simple. Rather than waiting to see the change at the end of the year when you file your taxes, Congress wants to collect more revenue throughout the year if marginal rates are going up, and get more money into people’s pockets sooner when marginal rates are being lowered.
This change can play funny tricks on people’s expectations. When a tax cut is announced most people expect a larger refund. But, if the tax tables are changed so the amount of tax withheld is less and the take-home pay is more, there may not be much of a change in the refund, since the tax cut has been realized over the course of one’s pay or pension each period.
This is true for the recently passed Tax Cuts and Jobs Act (TCJA). The IRS adjusted the tax withholding tables to reflect the cut in taxes. However, due to the many changes the TCJA made to the way taxable income is derived, it is likely that people may be more under-withheld than normal.
The IRS realized this and has suggested people use the IRS tax withholding calculator to see if the right amount of tax is being withheld.
It’s worth noting that the calculator has limited use for taxpayers with sources of taxable income other than earnings and pensions.
Last month, the IRS Information Reporting Advisory Committee issued a report stating that due to the premature withholding adjustments made by the IRS, a “significant number of taxpayers may be underwithheld when they file their 2018 personal income tax returns.” The Committee is recommending the IRS waive any underpayment penalties that taxpayers may have because of this.
So far, the IRS has not responded to this recommendation.
Regardless of whether the above applies to you or not, the amount of changes made this year warrants a discussion with your tax preparer prior to year- end. This should avoid any big surprises in the way of a larger than normal tax bill when your 2018 taxes are prepared.
January 18, 2019: An update about this problem has been posted here.