6 tips to avoid another tax surprise in 2020
Whether you received a smaller refund or a larger tax bill than expected, now’s the time to help prevent a repeat result in 2020, say Wells Fargo wealth planners.
A $9,673 federal tax bill wasn’t exactly the way John Fitzgerald wanted to start his retirement from the Montgomery County Police Department in Maryland.
But that’s what he owes the Internal Revenue Service in federal taxes by April 15, 2019, just 17 days after his retirement. Last year, Fitzgerald got a $1,400 refund.
“I guess it is sort of like grieving over a loss,” Fitzgerald said of the shocking departure from his typical tax-filing experience — paying a small tax bill one year and getting a small refund the next.
“I’ve experienced denial, anger, and certainly depression,” he said. “I was certain I’d made a significant error in preparing my taxes.”
Not so, said James Hoffman Jr., a wealth planner in Houston for Wells Fargo Private Bank.
While the Tax Cuts and Jobs Act President Trump signed into law in late 2017 did lower the overall tax burden for about two-thirds of workers, he said, for those like Fitzgerald, there was a hitch: Paychecks were even larger than they should have been.
The result: More people are owing money or receiving smaller refunds because the IRS changed the withholding table numbers to reflect the new tax law. “They just didn’t have enough taken out of every paycheck,” Hoffman said.
Many employees, he added, didn’t know they had to change their W-4 form (PDF) to make up for lost deductions or changes to such standbys as the property tax deduction.
“Personal exemptions were eliminated, and many people will no longer benefit by itemizing deductions,” Hoffman said. “This resulted in too little being withheld from paychecks by employers during 2018 because the withholding amount chosen by employees was based on a larger deduction from income.”
To help avoid the same scenario in 2020, Hoffman recommends using the IRS withholding calculator or following the guidance of your accountant or tax preparer to update your W-4 form and change withholding “as soon as possible after filing your 2018 tax return and paying any 2018 taxes and penalties owed.”
There is some good news for those who make estimated tax payments throughout the year, Hoffman said. Because so many taxpayers have had Fitzgerald’s experience, the IRS lowered the threshold to qualify for relief of underpayment penalties.
Taxpayers won’t face a penalty if they have paid — through withholding or estimated taxes paid quarterly throughout the year — at least 80% of their 2018 tax liability. It had been 90%.
Tax surprises are common whenever tax law changes. The more complicated the return, the more likely it is to have noticeable impacts. — Lisa Featherngill
“Form 2210 (PDF) is used to calculate the penalty,” Hoffman said. “The penalty will vary from taxpayer to taxpayer, based on the factors on the form (the number of months owed) and the amount owed.”
He said emergency funds, personal loans, or cash payments from other sources are among the variety of ways people paying more than expected are dealing with their 2018 tax bill surprise.
Fitzgerald didn’t have to take out a loan.
“We are dipping into an investment account that is being managed by a financial advisor,” he said. “We had hoped to save this money for our ‘golden years,’ but I guess we can consider it a rainy day fund now.”
In addition to a loan, Hoffman said the IRS accepts credit card payments (the payment processor charges a fee for the service).
The IRS also allows installment payments, he said, and payment plans can be set up online on the IRS website. Interest and some penalty charges continue to accrue until the balance is paid.
Tax surprises are common whenever tax law changes, said Lisa Featherngill, head of wealth planning for Abbot Downing, Wells Fargo’s business serving ultra-high-net-worth clients. The more complicated the return, she said, the more likely it is to have noticeable impacts.
“Many of those affected the most are in states with high state income and property taxes, because the deductions for these taxes are now limited to $10,000 — resulting in potentially higher taxes and less pay withheld to cover the higher tax.
“You don’t really see these effects of the new tax law until it is time to pay up,” she said. “This happens every time there is a tax law change. I believe this year’s experience will encourage even more people to plan ahead for tax time in 2020. The best time to plan is now.”
Wells Fargo Private Bank and Abbot Downing, a Wells Fargo business, offers products and services through Wells Fargo Bank, N.A. and its various affiliates and subsidiaries. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.
Wells Fargo & Company and its affiliates do not provide legal or tax advice. Please consult your tax and legal advisors to determine how this general information may apply to your own specific situation.