Many federal employees and retirees had an unhappy surprise when they filed their 2018 income tax returns this past filing season. Large and unexpected income tax balances owed to the IRS or much smaller than expected federal tax refunds were common among employees and retirees.
For many employees and retirees, the shock of lower than expected refunds or larger balances due was largely a result of their not monitoring their federal income tax withholding from their paychecks or their annuity checks throughout 2018. This column discusses some ways these same individuals can avoid a rerun of these tax surprises during 2019.
According to the IRS, as of April 12, 2019 1.2 million fewer filers were receiving refunds compared to this same time during April 2018. Total refunds are down by about $5.8 billion, or 2.6 percent.
The average refund is $2,833, down $31 from this time last year. But this data does not measure the number of filers who have gotten unwelcome surprises during this tax filing season, such as a lower refund or a larger balance due.
The IRS approved broad waivers of penalties on 2018 underpayments when 2018 federal income tax returns were filed. These waivers will likely not be extended for 2019. This means that most filers in 2019 need to pay in via payroll tax withholding and/or estimated tax payments at least 90 percent of their 2019 federal income tax liability in order to avoid any underwithholding penalty.
The following are some suggestions for employees and retirees to make sure they pay enough federal and state income taxes during 2019 in order to avoid any withholding penalty when they file their 2019 taxes in spring 2020:
Make estimated tax payments
If one’s taxable income is expected to be the same during 2019 as it was during 2018, and there was insufficient payroll tax withholding during 2018, then estimated tax payments during 2019 may be necessary. A previous column discussed estimated tax payments and who should make them. Federal estimated payments are due April 15, June 15, September 15, and January 15.
Make full use of payroll withholding
This is especially recommended if one has significant investment and passive income in the form of interest, dividends, or capital gains, and/or rental income not subject to withholding taxes. It often makes sense to increase paycheck withholding instead of paying quarterly estimated taxes in order to cover the potential tax liability resulting from such income. This is because paycheck withholding is not subject to the same timing requirements as quarterly payments. For example, if an individual had received significant portfolio income (dividends, capital gains) during January, February and March 2019, then a quarterly estimated tax payment should have been paid by April 15, 2019. It is now past April 15, 2019.
While a payment can still be made, the IRS will charge a late payment penalty. But if the same taxes are paid through increased withholding via payroll deductions starting in May, the IRS often does not impose any penalties as federal income tax withholding payments are considered spread “evenly” throughout the year.
Federal retirees and annuitants need to check withholding
CSRS and FERS annuities, and TSP withdrawals need to be checked for withholding. During 2018, withholding was lowered for pension payments as well as for salaries. Those annuitants who want to increase their Federal income tax withholding need to complete and submit to OPM’s Retirement Office Form W-4P or go online at www.servicesonline.opm.gov and change the amount of their federal income tax withholding.
Beware of bonuses
The 2017 tax overhaul reduced the withholding on bonuses from 25 to 22 percent. The result is that the lower amount of withholding can contribute to lower refunds or larger balances due. But employers will withhold more federal income taxes – if requested.
Do not forget about state and local income taxes
Those employees who live in states with income taxes have to make sure a sufficient amount of state and local income taxes are withheld from their paychecks. With an insufficient amount of state income taxes withheld during 2018, some employees paid penalties to their states. Federal annuitants who live in states with income taxes and who tax CSRS and FERS annuities have to make sure a sufficient amount of state income taxes is withheld from their annuities. OPM will withhold state income taxes from CSRS and FERS annuities upon request at www.servicesonline.opm.gov .
Thrift Savings Plan (TSP) participants who withdraw money from their traditional TSP accounts will have federal income taxes withheld from their TSP withdrawals. If the withholding is insufficient, the TSP participant can complete and submit a W-4P to the TSP Service Office to request additional federal income tax withholding.
But the TSP does not withhold state income taxes. For those TSP participants living in states with incomes taxes and who tax traditional TSP withdrawals, paying state income taxes on traditional TSP withdrawals must be done in another manner. This includes having additional state and local income taxes withheld from another source such as from CSRS and FERS annuities via OPM, or through making estimated tax payments to the state in which the TSP participant is a legal resident.