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NC tricking taxpayers?

Frustrated man
Frustrated by Zach Klein, CC-BY, on Flickr

This year NC taxpayers filed for the first time under the tax changes made by the Legislature in 2013 but mostly effective in 2014. Many lower-income people, those making less than about $80,000, paid the same, a little less or a little more income tax as under the 2013 rules. But because the withholding tables resulted in much lower withholding in 2014 than in 2013, many taxpayers owed for the first time. Others received much lower refunds than they did the prior year.

Complaints abound

Complaints were loud and intense for a while. Politicians being politicians, they figured they needed to fix this problem and help most people receive a refund in the future. After all, 2016 is an election year. Instead of cutting tax rates or allowing more deductions the Legislature decided it could fool most of the people most of the time.

The “fix” or tricking taxpayers

Maybe I am a cynic but this is sure what it looks like. The Legislature passed House Bill 117, also known as Session Law 2015-259 (PDF). Starting in 2016, the law requires employers to withhold at a higher rate than the actual NC tax rate. This should cause more people to get a refund or get a larger refund. Voila, problem fixed.

Of course one could argue the Legislature is helping taxpayers who were confused by the more complex new NC-4 (PDF of withholding allowance form) and had less tax withheld than was proper. The fix to that would seem to be to make the law simpler and not cause smaller take home pay for almost everyone, even those who got the NC-4 right.

Example of the “fix”

Lets look at a simple example. Taxpayer Tom owed $2,000 for 2014 and had $1,900 withheld. Poor Tom has to pay another $100 with his 2014 tax return. For 2016 he owes $2,000 but he has $2,100 withheld. Now Tom is happy because he is getting $100 back. What really happened? He still owes $2,000 in total income tax before any payments. Because of the $100 refund, the NC Legislature hopes Taxpayer Tom is tricked into thinking 2016 was a good tax year while 2014 was a bad tax year.

Conclusion

So taking more money up front and then returning it later is a tax cut? Sadly, the NC Legislature will fool quite a few people with this ploy. So is tricking taxpayers part of the Legislature’s job?

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Good time to adjust withholding for 2015

2015 federal withholding form

Now is a good time to adjust withholding allowances for 2015 federal and state income tax purposes. Employers are allowed up to 30 days to implement any change so start now to have the right amount withheld.

Things you might want to consider:

  1. This is our third year with the new Net Investment Income tax (NIIT). The NIIT is a tax on investment income that is partially used to fund the Affordable Care Act (a/k/a Obamacare). NIIT generally includes interest income, dividends, capital gains, capital gain dividends, rental income and other passive income. The NIIT is an additional 3.8% on investment income for married people with more than $250,000 of income (jointly) and single people with more than $200,000 of income. The IRS has a page dedicated to the NIIT.
  2. The NC individual tax rate changed again on January 1, 2015. This probably is not a big deal for NC withholding purposes as NC adjusts the withholding tables accordingly. It may have a small impact on your expected 2015 federal income tax for those who itemize as their state income tax deduction may be lower.
  3. Your income and/or deductions may have changed. For example, you have a new dependent or lost a dependent. If you bought a new home, you may have a higher mortgage interest as an itemized deduction for 2015 resulting in the need for more withholding allowances to reduce your withholding to more closely match what you owe.
  4. It is the beginning of the year so it is much easier to increase or decrease your total withholding to more closely match what you owe.
  5. The IRS and the states charge a penalty for paying in too little regularly during the year.
  6. Finally, very few people like to owe at the end of the year.

Where to get the forms:

IRS form W-4 (PDF)

NC withholding NC-4 (PDF)

Making the calculation:

Please read the withholding allowance form instructions carefully and make sure you understand them. Reading just the form and making assumptions can lead to the wrong amount of withholding and possibly a penalty. If you may owe alternative minimum tax, have a lot of income without withholding (e.g. interest, dividends, capital gains, or Social Security), and/or you are married and both spouses work then the calculation is more complex than it is for the single person with no dependents and claiming the standard deduction. If you cannot figure out the forms, please get some help.

All other things being the same, increasing withholding allowances decreases the amount of tax withheld. And the opposite applies, decreasing withholding allowances increases the amount of tax withheld.