New Jobless Law Will Complicate Tax Filings
Paying taxes is about to get more complex for millions of Americans thanks to a little-known provision in the Unemployment Compensation bill that became law Nov. 15.
The bill extended unemployment benefits to millions of workers who have been unable to find jobs for more than 26 weeks when such benefits traditionally run out. It was a badly needed measure in light of the current recession that has put millions out of work and has made it more difficult for Americans to find new jobs.
The problem with the measure, according to several experts, is in the Byzantine way it is being partially funded. Congress proposes to pay for some of the new benefits by making certain Americans pay their tax bills a bit more quickly. Those who fail to comply, either purposely or accidentally, will be subject to huge underpayment penalties.
Who is affected? “High-income” taxpayers, according to Congress. However, accountants maintain that middle-class, two-income families will hardest hit.
Here’s how the new system works: Couples who earn more than $75,000 annually and have a $40,000 increase in income in one year must make sure their estimated tax payments are at least equal to 90% of the tax owed during that year or face severe underpayment penalties. The previous rule said individuals could pay 90% of the current year’s tax, or 100% of the previous year’s tax, to avoid underpayment penalties.
The new rule does not increase anyone’s total tax. But it does eliminate the “safe harbor” that said if you paid in an amount equal to last year’s tax, you would not trigger underpayment penalties in the current tax year regardless of how much more you earned.
Seems like a mild change? Not necessarily.
The advantage of the old system was its predictability, said Donald H. Skadden, vice president of taxation at the American Institute of Certified Public Accountants. People who wanted to pay in their fair share, but who had unpredictable income, would be able to pay in what they paid the previous year and rest assured that they never got on the wrong side of the IRS--at least not for underpayment.
Now these individuals must essentially estimate their tax liability, which is almost as difficult and time consuming as filing a return, four times a year. And many people will probably find that they cannot pull together the appropriate information in the 15 days between the end of the quarter and when the estimated payment is due.
The change introduces “an unacceptable level of complexity and uncertainty for millions of taxpayers” who would often be forced to make quarterly tax payments based on “incomplete and inaccurate data,” complained Leonard Podolin, chairman of the tax executive committee at the American Institute of Certified Public Accountants.
Congress has estimated that fewer than 500,000 individuals will have to alter their tax payments. But accountants maintain that literally millions of individuals will need to do all the calculations each year to determine whether they fall into that group.
There’s no throwing up your hands and saying it’s too difficult to comply, either. Those who are affected but don’t act will face tremendous penalties. Underpayment of your federal taxes will land you with a non-deductible fine that’s now equal to 10% interest on the underpaid amount, said Robert Giannangeli, an IRS spokesman. Someone who paid $1,000 too little for 12 months, for example, would pay a $100 fee.
Those at greatest risk for such penalties under the new rules are doctors, dentists, accountants, realtors, commissioned salespeople and anyone else who has self-employment income that is not subject to withholding. Additionally, those who have substantial investments in well-performing mutual funds, those who exercise stock options or get substantial bonuses may also be affected.
Salaried employees of large firms generally would not be affected because employers deduct taxes from each check, and they are therefore not required to make quarterly estimated tax payments.
How might a middle-class family come into conflict with this rule?
Consider a two-income household. One partner earns $40,000 annually; the other was laid off in early 1991 and was not able to find work until nearly a year later--not terribly unusual today. The previously unemployed partner goes into business as a realtor in 1992 and earns $40,000 in commissions. If this couple paid the IRS only what they paid in 1991, they would face a penalty that could exceed $1,000, depending on their total taxable income and how many months the underpayment lasted.
Another possibility is someone who gets stock options at work and decides to cash them in one day. If they earn substantial profits on the stock, they might also trigger penalties for underpayment.
The AICPA, a trade group for the nation’s accountants, is considering fighting this new rule as part of its larger effort to reduce the complexity of the tax system.
However, it is important to note that the accountants don’t argue with forcing some people to pay their taxes more quickly. Their solution is to make everyone who earns more than a threshold amount, say $75,000, pay in at least 105% or 110% of last year’s tax (or 90% of the current year’s tax) to avoid penalties. That gets the extra revenue in the door, but it eliminates the uncertainty.
