Ep.73- Filing Standard Deduction and Owing Taxes? It's Because of Personal Exemption and Bad HR (Part 1/2)
Read Time: 5 Minutes.
There are two type of tax filers in the U.S: those who file standard deduction and those who file itemized deductions. This blog post, Part 1, explains why those who file standard deductions are screwed this year. If this does not apply to you, as you are filing itemized deductions, read the next blog post, Part 2, instead.
According to a White House study in 2017, 92% of all U.S tax filers are expected to file standard deduction in 2018, because standard deduction is almost doubled, to $12,000 for an individual and $24,000 for a married couple, while the most common itemized deductions, such as mortgage interest and local taxes are severely capped.
Knowing this, with the larger standard deduction, it seems like most people will receive a large tax refund around this time. But… in reality, if you have already started your taxes, you are probably receiving a much smaller refund, or even pondering why you owe taxes.
There are two reasons : personal exemption and poorly educated HR.
STANDARD DEDUCTION HAS A MUCH SMALLER IMPACT THAN YOU THINK… MOSTLY OFFSET BY PERSONAL EXEMPTION
Think about personal exemption is the bonus deduction everyone gets for showing up and filing taxes.
TAXABLE INCOME BEFORE THE TAX CODE
Before the tax change (let’s say 2017), if we go with the standard deduction route, everyone’s taxable income = adjusted gross income - standard deduction - personal exemption. In 2017, the standard deduction was $6,350 for an individual, $12,700 for a married couple. The personal exemption was $4,050 for an individual and $8,100 for a couple. Remember, we only pay taxes on the taxable income, not gross income.
As an individual that makes $50,000 adjusted gross income, the taxable income is $39,600. ($50,000 - standard deduction of $6,350 - personal exemption of $4,050)
As a couple that makes $100,000 adjusted gross income, the taxable income is $79,200. ($100,000 - standard deduction of $12,700 - personal exemption of $8,100)
TAXABLE INCOME NOW
The tax code in 2018 increased standard deduction to $12,000 for an individual, and $24,000 for a couple, but eliminated personal exemption, which would have been $4,050 for an individual, and $8,100 for a couple.
As an individual that makes $50,000 adjusted gross income, the taxable income is now $38,000. ($50,000 - standard deduction of $12,000)
As a couple that makes $100,000 adjusted gross income, the taxable income is now $78,000. ($100,000 - standard deduction of $24,000)
HOW MUCH DID YOU SAVE?
If you compare the two “before and after” numbers. It’s a not a large difference, at least not as large as what the government preached.
If you are filing an an individual making $50,000, your taxable income is lowered by only $1,800 ($38,000 - $39,600). At the 22% marginal bracket , you would’ve saved $352 ( $1,600 x 22%). So yes, it’s definitely not nearly as large you you had thought.
If you are filing as a married couple making $100,000, your taxable income is lowered by only $3,600 ($76,000 - $79,200). Also at the at 22% marginal tax bracket, you would’ve saved only $704 ($1,200 * 22%).
POORLY EDUCATED HR
YOUR HR TEAM SHOULD’VE ASKED YOU TO LOWER YOUR TAX WITHHOLDING TO 0 … BUT THEY DIDN’T
Your tax allowance (W-4) is most likely the bigger reason you owe taxes this year. Let me explain.
You probably claimed at least 1, or maybe even 2 on your W-4 form, which is the form that helps calculate personal allowances.
This is how it used to work: each point you claim is worth the same amount as the personal exemption, which was $4,050 in 2017. It is subtracted from your gross income and not taxed during your regular paycheck. For example, if you make $50,000 a year, and claimed 1 as your tax allowance, your company would’ve withheld enough taxes for $45,950 ($50,000 - $4,050). It would’ve been the correct amount in 2017, because everyone could claim the personal exemption.
Wait a minute, the government eliminated personal exemption in 2018… What does that mean? It means, if we did not revised tax allowances from 1 or 2 down to 0, we have been paying too little taxes. In other words, the more you claimed during the year, the more you need to make up during tax return season.
For example, if you are an individual who claimed 1, you did not pay taxes on $4,050 during your regular pay periods. Now you need to pay for that. If you are a married couple that claimed 2, you will need to pay taxes on an income of $8,100 ($4,050 x 2). It goes on and on. The only way to avoid this, if you went to your HR to actively revise your tax allowances to 0.
Well… I did not. I don’t expect you did. It is really the company HR’s responsibility to active reset every employee’s tax allowances to 0. I doubt most companies truly understood the implication of the tax reform when it came out… Now we are all screwed.
In spite of the hypes on the promised tax breaks from the 2018 tax reform, if you are filing with standard deduction, you are likely getting a tiny refund, or owing taxes.
You are not alone. We have been screwed for two reasons.
First, the increased standard deduction is almost entirely offset by the elimination of personal exemption, making the saving very small.
Second and more importantly, your company’s HR department should’ve reset everyone’s tax allowance to 0, because personal exemption is completely eliminated. But more likely than not, they did not. The direct implication is that most Americans did not pay enough taxes during the regular pay periods. Now we have to make it up in a lump sum…