Did you or your employees receive a surprising tax bill last year? The new W-4 that was released in December 2019 could be the cause. Additional factors this year could exacerbate the problem.
Only about 1 in 4 American taxpayers updated their withholding when the IRS released the new W-4 in 2019. Going back another year, reports the American Institute of Certified Professional Accountants (AICPA), only 16% made changes to their form after withholding tables changed due to the Tax Cuts & Jobs Act (TCJA). In fact, nearly half of taxpayers have no idea when they last updated their withholding.
The result? In the last three years, nearly three in 10 tax-filing Americans received an unusually large tax bill or tax refund. The pre-2020 W-4s and the TCJA changes are a volatile combination—exemptions and deductions between the two don’t match up.
Then came the pandemic. Millions of returns from last tax season still await review (which means the taxpayers don’t know if they overpaid or underpaid). According to the IRS, many of these returns were suspended during processing due to discrepancies between amounts claimed on the returns and amounts reflected on IRS records, most commonly involving Recovery Rebate Credit (RRC) claims.
A similar problem is expected this tax season due to two advance tax credits, a third round of Economic Impact Payments, and monthly payments of the Advance Child Tax Credit for the second half of 2021. As a result, millions of discrepancies—and math error notices—remain likely, says the IRS.
We’ve all been told that life changes including marriage, divorce, births, and grown children leaving the nest are vital reasons to update withholding amounts. The form changes and credits above provide more reasons. But that doesn’t mean we remember to update W-4s as a result.
What’s the problem with overpaying or underpaying taxes in this context? Those who love their refunds overlook a basic right that even the IRS asserts: The right to pay no more than the correct amount of taxes. In short, overpaying the IRS comes with a price. You’re essentially “loaning” money to the IRS to hold onto temporarily—money that could be used or invested in other ways. Employees who overpay may also have an unfair perception of their take-home pay and, therefore, it can affect your retention and employee satisfaction. And let’s not forget the delays: Those who count on their refund every year are finding themselves waiting longer than expected. Underpaying, on the other hand, holds more obvious consequences: A surprising and sometimes devastating tax bill that may include interest and penalties.
You’re required to remind employees to update their W-4s every year, but that doesn’t mean everyone’s getting the hint—and the avoidable surprises that ensue can be overwhelming to them. And what about you? When was the last time you updated your own W-4? If you’re the business owner, your tax obligations are likely more complex than your employees’. Talk to your tax advisor about any changes you may want to make so that your tax payments better line up with what’s actually due. Feel free to contact us with questions.