By April 15 you should have filed your taxes.
Now, that's not the same as saying that you will have paid your taxes. In fact you pay taxes all the time - provided you make the minimum amount required to file a tax return. That will vary depending on your filing status (single, married filing jointly, married filing separately or head of household).
Most Americans pay their income taxes every two weeks through automatic federal and state withholding from each paycheck. And while many taxpayers will get some of that money back, everyone who earns an income pays the FICA tax that funds Social Security, Medicare and Medicaid.
Then there are sales taxes, property taxes and import taxes, which Americans pay all the time. In the end, although we think of April 15 as Tax Day, paying taxes is a day-to-day feature of life in a modern economy.
That doesn't make April 15 any less complicated, and that's particularly true this year.
Most Americans get a refund when they file their taxes. The system is designed that way. This year, though, tax refunds are down… way down. By the beginning of April 2019 the IRS had issued about 1.64 million fewer refunds than it had by that same period in 2018. Individual refunds have only gone down by an average of $20 per taxpayer, but a lot fewer people are getting them. In fact, many Americans actually owe money on April 15 for the first time in their working lives.
What Is Withholding Tax?
To understand why millions of Americans will not receive their annual refund, we first need to understand withholding.
America uses what is known as a self-reporting income tax system. This means that every year, each citizen has the duty of figuring out how much they owe the government and making those payments themselves.
Self-reported taxation means far less overhead for the federal government, but also creates problems. For one thing, it puts the average citizen's tax burden front and center. Every year we all see just how much we owe, making taxes harder to sustain politically. This was particularly true in 1943, when the first permanent income tax was signed into law.
Self-reported taxes also force the government to wait for an entire year to collect its primary source of revenue. From the perspective of the U.S. Treasury, this would essentially mean giving each American an interest-free loan for 11 months and 29 days.
To solve these problems, the IRS collects "withholding."
Withholding is the amount of money taken out of every W-2 worker's paycheck as an estimated payment for the taxes they will eventually owe. Then, at the end of the year, that worker calculates their taxes and compares the amount withheld to the amount they owe. If the IRS withheld more than that worker's tax burden, as is the case for more than 70% of all taxpayers in an average year, the Treasury sends a refund check.
If the I.R.S. withheld too little, then the tax payer owes the difference.
Why Does the IRS Overestimate Withholding?
Ordinarily the IRS writes its withholding tables to overestimate the amount an average taxpayer will owe. This makes economists and personal finance experts unhappy because, as they accurately point out, paying too much in taxes amounts to giving the government an interest-free loan for an entire year.
But most Americans actually love it. The too-high withholding system acts as a sort of forced savings account for most people, one that nets them a check for hundreds, if not thousands, of dollars every year.
This, too, was by design. Instead of making Tax Day the time when everyone cuts the government an enormous check, Congress made April 15 a day when the government pays them. From a political perspective, it really doesn't matter that the IRS is paying people with their own money. Tax refunds are popular.
How Has Tax Reform Impacted Withholding?
However, in 2018 the IRS systematically under-estimated the withholding for millions of taxpayers.
In December of 2017 Congress passed the Tax Cuts and Jobs Act. This bill took effect for the first time for the 2018 tax year, those due on April 15 of this year. Although called "tax reform," the TCJA focused on a trillion dollar tax cut. Among other changes this bill significantly lowered taxes for corporations and high-earners, doubled the standard deduction for all tax payers, and changed the rates and income cutoffs for all tax brackets.
To reflect these changes the IRS adjusted its withholding tables for 2018. In doing so, the agency reduced the amount it withheld from the average worker's paycheck. This caused people to keep slightly more of their money on a per-paycheck basis. Media reports have indicated that the IRS was directed to make this adjustment for political reasons during the 2018 election year.
However, the IRS cut its withholding further than it has in the past. As a result, the Government Accounting Office has estimated that up to 30 million taxpayers had too little taken out of their paycheck. By the end of the year they hadn't yet paid all of their taxes through biweekly withholding.
If you owe a surprise tax bill in 2019, this is why. Your taxes have probably not gone up, the IRS simply took less money from you over the course of the year.
2017 Tax Cut
The 2017 tax cut did increase the after-tax income of most Americans by about 1%, even among those who owe thousands of dollars this April. The trouble is that distributing those savings over the course of a year caused most people to miss it. Few people noticed the small boost to each paycheck, and many likely spent that money on small personal indulgences if they did notice an extra $20 in their checking account.
A $1,000 tax bill, however, does not go unnoticed, nor does the absence of an expected check. For anyone who didn't realize they should have been saving up for a tax bill in April, this can all come as a nasty shock.
What Can You Do if You Owe Money on Your Taxes?
The IRS offers several options when you owe money and can't pay right away. If that's you, start with the following steps:
- File On Time: Don't delay your taxes, and don't confuse filing for an extension with permission not to pay. You won't do yourself any favors by putting this off. File your taxes on time.
- Pay Something If Possible: Pay as much of the bill as you can without incurring hardship. Your tax bill will accumulate some fees and interest until it's paid off, so the more you can get out of the way up front the better.
- File For A Short-Term Payment Plan: The I.R.S. offers several payment plans for taxpayers who owe less than $50,000. (If you owe more than that, seek advice from a tax attorney.) The easiest option is the short-term payment plans. This is a 120-day extension to pay your taxes in installments. For most taxpayers acceptance is automatic. The payment plan will charge some fees and interest, but it's unlikely those will amount to much over four months.
- File For A Long-Term Payment Plan: If your bill is too large to pay off quickly a long-term payment plan is likely your best option. The I.R.S. allows taxpayers to create installment plans that can last for years. Setting up this plan will cost a small flat rate and the government will charge you fees and interest over time, but it's better than going broke up front.
For more information, see the I.R.S. payment options website here.