Ever since the Tax Cuts and Jobs Act went into effect last year, there's been much speculation about how it would change taxpayers' take-home pay and tax refunds. Now that tax season is here, we're beginning to see the effects of tax reform on paychecks, refund checks, and tax liabilities.
Bringing More Money Home Throughout the Year
Under tax reform, the income tax rates have been lowered in five of the seven income tax brackets, which is why an estimated 80 percent of taxpayers have paid less in taxes over the course of 2018 than in 2017. For example, a single individual who made $50,000 in taxable income in 2017 owed $7,399 in federal taxes. In 2018, this same individual making $50,000 owed $6,081. That is an annual savings of $1,318.
With tax reform being new last year, employers used estimated withholding tables from the IRS to adjust their employees' withholdings in their paychecks. In 2018, most taxpayers saw their paychecks increase each pay period due to the estimated tax savings. So considering our example above where the taxpayer saved $1,318 in federal taxes, a portion of that savings likely would have been added to each paycheck in 2018 beginning last February.
Refund Checks Are Smaller
So far in the 2018 tax season, the average tax refund from the IRS is $1,865 compared with $2,035 for tax year 2017. That's a decrease of 8.4 percent. Since a tax refund check is one of the largest payments a taxpayer receives annually, this smaller refund payment can be quite a shock at first. But to understand why the typical taxpayer is paying less in taxes this year while also getting a smaller refund on average, let's take a look at the bigger picture of tax reform.
It's All About Withholdings
Just because you're receiving a smaller refund doesn't always mean you paid more in taxes. In fact, the opposite is most likely true. As discussed earlier, the majority (80%) of American taxpayers paid less in taxes in 2018 versus 2017, even if they are getting a smaller refund this year.
Also as mentioned above, employers adjusted how much tax they withheld from their employees' paychecks to reflect the lower tax rates. Additionally early last year, taxpayers were encouraged to double-check the withholdings on their W-4 and make adjustments based on whether they wanted a larger refund or more in their paychecks. The problem is that few taxpayers actually adjusted their withholdings. For example, the Home Depot reported that only about 1 percent of their employees had changed their withholding rate.
Bigger Paycheck or Refund: It's Up to You
The point of all this is that every taxpayer should consult with a tax professional to determine if you're paying more or less in taxes after tax reform and how you want to handle it. Find out for sure how the combination of the higher child tax credit, no personal exemption, new family credit, and whether you itemize or take the new, larger standard deduction affects your tax liability. Do you prefer to adjust your withholdings so that you get a bigger paycheck, a bigger refund, or a smaller tax bill? With the help of a tax expert, that decision is up to you. But don't wait. Adjust your withholdings now so you know what to expect next year.
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