WASHINGTON — The Trump administration is pushing American businesses to withhold fewer taxes from paychecks by February, aiming to quickly deliver the boost in take-home pay that Republicans promised their tax law would bring.
But the rush could expose millions of workers to the risk of underpaying taxes to the government now, which means they might owe more than they are expecting when they file taxes in April 2019.
Business and taxpayers looking for clarity will be appealing to an Internal Revenue Service that, according to an internal watchdog report Wednesday, is underfunded and ill-prepared to answer basic questions. The national taxpayer advocate, an independent official within the IRS, told Congress that the agency would need at least $495 million in 2018 and 2019 to meet the new obligations created by the GOP tax law.
Funding for the IRS has fallen by about 20 percent, accounting for inflation, since 2010. Before the law’s passage, the IRS expected to be able to answer only 60 percent of the 100 million telephone calls it receives annually from taxpayers — a burden expected to increase under the new law.
“The IRS will have its hands full in implementing the new law,” said Nina E. Olson, the taxpayer advocate. “The IRS will have a lot of issues to work through, and taxpayers will have a lot of questions.”
The IRS is urging employers to immediately change their tax withholding arrangements, even though doing so will require them to use outdated forms as they figure out how much to set aside for tax payments. The forms, known as W-4s, were tailored to measure tax payments under the old tax code, which was largely rewritten in the new tax law.
In the next few days, the IRS plans to issue guidelines to companies and payroll processors on how to use the old forms to calculate tax payments under the law. But there’s no simple switch-over calculation, and the uncertainty could mean workers severely underpaying or overpaying their taxes by thousands of dollars in 2018 — something that will likely remain unknown until they file their tax returns next year.
The potential discrepancies are a side effect of the expedited overhaul that the Treasury Department and IRS are seeking to implement, prioritizing speed over accuracy as the Trump administration hopes tax cuts will bolster the economy before the midterm elections.
The rapid turnaround puts companies on a squeeze as they attempt to get employees the information they need to file their 2017 taxes — they are legally mandated to finish that process by the end of the month — while also preparing for the year ahead.
“Our view is that would be an extremely tight time frame,” said Eira Jones, leader of Deloitte’s national employment tax practice. “It’s likely there would need to be a greater testing period.”
Jones said March would have been a more practical goal for the paychecks to be adjusted.
The White House and IRS faced several options for implementing the new income tax regime. They could have required all working Americans to fill out new tax forms and provide information that would have allowed employers to more accurately decide how much to withhold. But that process could have taken months, likely delaying any benefit from the tax cuts until much later in 2018.
The law cuts income tax rates at all levels for the next several years, meaning most taxpayers will see at least modest decreases in their federal bills.
But the law also changes the tax code’s complex system of deductions. It expanded a “standard” deduction taken by many in the middle class and a Child Tax Credit, but the law also put new caps on how much people can deduct for state and local tax payments or for interest paid on a new home mortgage.
The deduction changes mean the tax cuts will vary widely between workers with similar wages, with the size of the relief depending on location, family size, and situation.
It is not immediately clear what type of household is at the greatest risk of having a new paycheck that does not match what their tax obligations really are. This will depend on how the IRS and Treasury Department design the new withholding tables.
But a household that earns $150,000 and has several children could end up temporarily overpaying their taxes under the new system because they would qualify for the Child Tax Credit in a way that likely won’t be captured by the old W-4 forms.
A household earning the same amount in New York or California, who bought an expensive house this year and has no children, could find they did not pay enough taxes in their paychecks and get hit with a bigger tax bill in 2019.
As they pushed their bill into law, Trump and congressional Republicans repeatedly promised the new tax regime would substantively improve working- and middle-class Americans’ financial outlook — even as Democrats hammered the plan as a giveaway to corporations and the wealthy with little in tax relief left over for anyone else.
How voters feel about the new tax law is expected to play a large role in the November midterms, when Republicans hope to hold on to their majorities in the House and Senate. But while the new paychecks arrive well before election days, many workers won’t get final answers on whether those bills are accurate until well after.
The process of withholding taxes from paychecks “will be less precise, but it’s really hard to quantify how much less and how bad it will be,” said Mark Mazur, a former senior IRS official who is now executive director of the Tax Policy Center.
For years, companies took some basic information from their employees into account before determining how much money to withhold from their paychecks, and this information was collected on the two-page W-4 form. But the new tax system is different, and some of the questions from the W-4 are no longer relevant.
For example, question “G” on the W-4 asks whether someone is in a household that earns less than $100,000 to determine whether they qualify for the Child Tax Credit. But the new tax law changed the Child Tax Credit, as it now applies to married couples that earn up to $400,000.
“It’s hard to know what information is going to be provided to payroll processors and human resources departments that can take care of that,” said Michael Mundaca, codirector of the national tax office at Ernst & Young.
In several months, the IRS is expected to follow up by asking employers to have all U.S. employees fill out new forms that will make the tax-withholding process more precise.
They will no longer be relying on a system that tabulated the number of “personal allowances” each taxpayer had, such as the size of their family, to determine the tax withholding for paychecks.
“With the elimination of those personal allowances, we are anxiously awaiting guidance from IRS which is scheduled to be released this month,” said Shelly Abril, head of payroll compliance at Gusto, a company that provides payroll and other services to 40,000 small businesses.
“The difficulty will really be owned by the employees and their tax professionals to determine the implications of their 2018 tax liability,” Abril said.
If companies don’t withhold enough income tax, taxpayers could experience short-term euphoria when they receive larger paychecks but then face a stunning tax bill in April 2019.
Similarly, if Americans underpay their taxes in February and March, the government could run up a huge budget deficit, creating a cash crunch at a time when it is under immense pressure to raise the debt ceiling.
It could not be learned whether the IRS plans to give any guidance that would direct employers to withhold taxes at a different level based on where someone lives, even though the tax cuts will have different impacts on Americans in different states.
For example, a middle-income taxpayer who owns a home in New York or California will likely need to withhold more money than a middle-income taxpayer in Florida because of a new limit that prohibits Americans from deducting more than $10,000 in state and local taxes from their federal income. But the W-4 does not include any questions about homeownership or the amount of state and local taxes paid.
For the tax cuts to be factored into paychecks quickly, the IRS is not expected to direct companies to review individual W-4s and see if they can glean new information that might make the adjustments more accurate.
For example, it would not be difficult for employers to check payroll records to determine each employee’s salary as a way to predict whether they would qualify for an expanded Child Tax Credit. But this process would have limited benefit, because the employer would not know whether a spouse’s income pushes them over the new $400,000 threshold.
Olson warned that other changes will probably need to be made before Americans file their 2018 tax returns by April 2019. The new tax law, for example, lowers the amount of mortgage interest that can be deducted from income, but it grandfathers in all mortgages made before Dec. 15, 2017.
“At present, the IRS generally does not know the date of a mortgage closing, the terms of a refinancing, or the date or terms of a purchase contract,” Olson said.
The Treasury Department and IRS have given little information about how they are designing the new tax-withholding system under the outdated W-4 forms, leading to complaints from Democrats that the Trump administration could try to make the tax cuts seem even rosier than they are before the midterms only to hit Americans with big tax bills next year.
“We oppose any attempts by the Administration to systematically under-withhold income taxes during the 2018 tax year, knowing that in 2019 taxpayers may find they owe taxes when they were expecting a refund,” Sen. Ron Wyden (D., Ore.) and Rep. Richard Neal (D., Mass.) wrote in a letter to acting IRS Commissioner David Kautter on Monday.
The letter included questions seeking information about what political influence, if any, Treasury officials had in deciding how much money should be withheld in the paychecks.
It comes at a unique time for the IRS, as the acting IRS commissioner — Kautter — is also serving as a senior Treasury Department official simultaneously, an unusual arrangement. Kautter is both a politically confirmed Treasury official and leading a large staff of tax experts at the IRS making decisions about technicalities in tax policy.
In 1992, the George H.W. Bush administration unilaterally changed the withholding tables to allow Americans to temporarily keep more of their income, even though they would owe the money when they filed their tax returns the following April.
This infuriated millions of Americans who didn’t like the idea of being hit with a big tax bill all at once, and many people asked to be exempt from the changes.
A person involved in the process of reworking withholding tables said the IRS and Treasury dismissed the concerns raised by Wyden and Neal, saying the process is being handled with care and without political interference.
The IRS reported in April that Americans filed 135.6 million tax returns for income earned in 2016. Almost 100 million of those filers received a tax refund, which averaged $2,763.