With the government shutdown resolved for now, taxpayers can start gearing up for the first filing season since the passage of the Tax Cuts and Jobs Act in December 2017. There has been speculation over whether the law will affect the size of taxpayers’ refunds and whether that might change how the law is perceived.
The new law cut taxes for the vast majority of Americans — but a smaller tax refund doesn’t mean Americans didn’t get a tax cut. That’s because early in 2018 the IRS adjusted tax withholdings to reflect the overhaul of the tax code.
For example, using the Tax Foundation’s 2018 Tax Reform Calculator, a married couple with two children and making $85,000, taking the standard deduction and contributing $5,500 to their 401(k), would see a $2,250 tax cut thanks to tax reform. But depending on their withholding, their tax cut could show up throughout the year in their paychecks or in the current tax filing season.
How about a single mother of two children making $52,000, taking the standard deduction and contributing $4,000 to a 401(k)? According to our tax reform calculator, this taxpayer would receive a $1,892 tax cut — but again, how that tax cut shows up depends on withholding.
That the method of realizing a tax cut can be a surprise to filers should not really be all that surprising. A survey from H&R Block shows that only 19 percent of Americans updated their withholding after tax reform, which is likely why the IRS has announced a waiver of certain underpayment penalties this year.
A Treasury Department simulation showed that without the new tax law, 18 percent of taxpayers would have under-withheld their taxes. But under the new law, 21 percent are estimated to under-withhold. If a taxpayer doesn’t have enough withheld from their paycheck throughout the year, they will owe the IRS at tax time and potentially face a penalty.
On the other hand, the government estimates that 73 percent of taxpayers will still over-withhold under the new law. Those who pay too much throughout the year will receive that back as a refund when they file.
Meanwhile, some private estimates show that perhaps the Treasury Department has withheld too much and that the IRS will pay out even more refunds this year than last.
While the recent shutdown may affect the timing of tax refunds, it will be important for taxpayers not to conflate the size of their refund with the size of their tax cut. Refund sizes simply depend on the accuracy of withholding over the course of the year, not on whether a person got a tax cut because of the new law.
Erica York is an analyst with the Center for Federal Tax Policy at the Tax Foundation in Washington, D.C.
