JEFFERSON CITY, Mo. — A 15-year-old formula error did cause the Missouri Department of Revenue to considerably under-withhold on individual income taxes and they probably could have communicated better but, Joel Walters noted, there is a bigger component to lagging revenues.
The Director of the Missouri Department of Revenue testified on that issue to the Senate Appropriations Committee on Tuesday morning. This was the second time Walters has explained the lagging revenues to the legislature, having testified before the House budget committee last week.
“[The withholding error] does not impact the amount of tax a person owes,” Walter emphasized throughout his testimony. “It impacts the timing of payment.”
As of mid-January 2019, the state had collected $532 million — roughly 10 percent — less in tax revenue than in the same time frame in the previous year, not taking into account that there is a projected revenue growth for FY 2019, the current operating year, of 1.7 percent.
The reason for the lagging revenue is two-fold: a formula error and tax changes on the federal level.
The formula error has been in the individual income withholding tables for since 2004, as for back as the department has gone in their records. The formula was failing to correctly take into account the standard deduction which results in a relatively small under-withholding in the past.
But when the standard deduction was doubled, the issue was exacerbated. The Department of Revenue issued new withholding tables in September 2018, after the error was discovered. It is unclear how many businesses actually changed the withholdings to the new tables because they knew the state would be issuing new tables in January 2019.
The formula error has gotten the most attention in recent weeks, but it’s the changes to the federal income tax code that are the bigger component, according to Walters.
“This is actually the more important piece…the changes at the federal level, it was a 1,100-page bill, the biggest tax changes in 30 years, made massive changes to all the federal tax laws. That, in turn, is having an impact on people’s withholding because the changes are so dramatic but withholdings stayed the same,” said Walters.
The federal tax overhaul lowered taxes for many income brackets and roughly doubled the standard deduction. It also eliminated many itemized deductions and placed caps on others.
Because of those changes, particularly for those that did not adjust their W-4, many will be seeing less of a refund or will owe taxes this year.
The example Walters used was that folks who previously over-withheld by claiming fewer deductions will potentially be seeing a significantly smaller refund. In the scenario, the person who, prior to 2018, qualified for four deductions only claimed one deduction in order to get a significant refund in April. But with the tax overhaul, that one deduction is more accurate and withholds an amount closer to what is actually owed, which means that person will see a small refund than expected.
In order words, people who did not change their withholds enjoyed more take-home pay during 2018 instead of waiting for a cash refund after filing taxes. Walters referred to this as “the new normal.”
“This is a phenomenon that is happening at the federal level, it is happening at the state level — I know Idaho is having exactly the same discussion, and it is happening at our level,” said Walters.
He noted that the IRS put out a notice last week advising taxpayers that their refund might be lower than expected or they may owe a little more than expected. The reason is that the W-4 on file with employers, in light of the massive federal changes, were not withholding at the same level.
New W-4s have been issued to reflected the changes made on the federal level.
Less refunds are expected to be distributed, indicating that the state is collecting an amount closer to what folks actually owe. In fact, Walters said that he expects the vast majority of the withholdings to result in lower refunds.
“We will be monitoring it very closely to make sure that the phenomenon does reverse the way it is expected to,” said Walters. “If not, then we take action.”
He noted that the department is working on communicating with people. And they are gearing up on working with folks who come across issues when filing taxes.