Associate Partner Julie Strohlein, CPA walks taxpayers through the process of updating Form W-4, especially in wake of the Tax Cuts & Jobs Act of 2017.
The form is used to let employers know how much income tax to withhold from paychecks. For many years, the Form W-4 was virtually unchanged. Many employees probably filled out the form when hired, and never updated it unless they got married, had a child, or experienced some other event that changed their family structure. The old tables calculated withholding based upon filing status and number of withholding allowances claimed. Allowances could be claimed for the employee, his spouse, if using the filing status “head of household,” if he had at least $2,000 in dependent care expenses, or if he expected to claim the child tax credit. This means that a married taxpayer with three children might have been claiming up to twelve withholding allowances.
Then along came the Tax Cuts and Jobs Act of 2017.
The tax reform legislation passed in December of 2017 made sweeping changes to the way individuals will calculate taxable income. Personal exemptions are gone, itemized deductions are less likely to exceed standard deductions, and the child tax credit is increased. Overall tax rates went down for most taxpayers, as well. This means that the old method of computing withholding allowances no longer works, and the old Form W-4 didn’t reflect the new tax law. Shortly after the tax reform was passed, the IRS issued new withholding tables. The take-home pay for most workers increased as the withholding amounts were adjusted for the new lower tax rates. For example, a married person claiming three allowances and earning $1,000 per week would have had $73 withheld each week for federal income tax in 2017. As of February, 2018, the weekly withholding is only $58.
The IRS issued a new Form W-4 during 2018. The updated version still calculates allowances for the employee and spouse, allowances for the child tax credit for both eligible children and other dependents, and “other credits.” It also includes a section for the employee to estimate his itemized deductions. If expected to be higher than the standard deduction, additional allowances might be calculated. For the first time, the W-4 form has a place to estimate “nonwage” income such as interest and dividends as well as adjustments to income for items like alimony paid or IRA deductions. These changes do a more complete job of estimating tax liability since consideration is given to many items on the tax return in addition to the wages earned.
The draft of the 2019 W-4 looks substantially different. Of course, it could change again before the final version is released, but the draft indicates the general direction in which the IRS is leaning. There are no longer any lines for withholding allowances. There are optional lines to estimate nonwage income, itemized deductions, tax credits, and wages earned at other jobs. Filling out this section is essentially like doing a tax projection for the entire tax return. It is designed to do an even more accurate job of calculating appropriate tax withholding. The draft instructions for the new form include several worksheets to aid in the calculations.
The lines which indicate other income, deductions, and tax credits are optional. If an employee leaves them blank, the withholding will be automatically calculated based upon filing status. The default is to use two allowances for single and married filing separately, and three allowances for married filing jointly and head of household. Although leaving the optional lines blank does maintain a sense of privacy, it could result in an inappropriate amount of tax being withheld from each paycheck.
The draft W-4 has a line for “additional amount, if any, you want withheld from each paycheck.” This means that you can designate a flat dollar amount to be withheld in addition to the amount calculated upon the default allowances. If an employee thinks the default tax is too much, he can enter an amount on the line for tax credits.
The IRS has a withholding calculator tool https://www.irs.gov/payments/tax-withholding that can help do the math. This way, all the other sources of income and deductions can be part of the calculation, but the details don’t need to be shared with the employer. This is a great tool that anyone can use to see if the withholding paid so far this year is going to be adequate. There are still several months left in the year if changes need to be made for the remaining pay periods.
The current 2018 Form W-4 as well as the proposed draft of the 2019 Form W-4 are federal forms. They are not meant to help calculate state withholding, although many state withholding tables have traditionally been developed to follow the federal W-4. Everyone should evaluate state withholding based upon the state’s specific tax rules and whether or not it follows the federal rules. Many states have not adopted the changes of the Tax Cuts and Jobs Act.
Because the changes to the tax law are so drastic, many taxpayers will find that their tax liability is quite different even if the amounts and sources of income are similar to prior years. They may also find that the updated withholding tables didn’t appropriately adjust for their particular situation. Some taxpayers accustomed to tax refunds every year may end up owing money. Other taxpayers may find that their refund is even larger than before, which means they could have taken home more of their own money with each paycheck throughout the year.
It is more important this year than ever to actively check your withholding. Give your employer a new W-4 if you need to make changes. The new tax law will have an impact on virtually every taxpayer’s tax return. Contact a tax professional if you aren’t sure how to do the evaluation or use the IRS tools. If you need assistance or would like to set up an appointment with one of our tax advisors, contact Alloy Silverstein.
Associate Partner
Julie has over 20 years of experience in public and private accounting, representing varied clientele including the medical, legal, and real estate industries and trusts.
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