Taxpayers who earn wages as an employee pay in most of their federal and state income taxes through payroll withholding. This is a great system if the calculations are correct. The taxpayer gets to spread his tax burden out over the entire year and there may even be a refund when the tax return gets filed.
But how do we know if the calculations are correct?
In prior years, if a taxpayer ended up owing money on his tax return, he could change his W-4 so that his employer would begin withholding more tax with each paycheck. Similarly, if the taxpayer’s refund was too big, he could request less withholding to have more take-home pay with each paycheck. Hopefully these adjustments made the following year’s tax return turn out as desired.
Things are much more complicated after the Tax Cuts and Jobs Act. The new laws will change almost everyone’s 2018 tax return, even if the income is substantially the same. Although many people may end up paying less tax, that might not be the case for everyone. Some taxpayers accustomed to getting a refund each year may find themselves owing money with their returns in April.
Further Reading:
The only way to truly know a taxpayer’s tax is to do his tax return. This is what accountants have been doing for years. A professional tax projection looks almost exactly like a tax return. All the different types and sources of income are considered, along with different tax rates for various items. Deductions and credits are factored in. Lastly, the total amount of withholding and estimated tax payments are subtracted from the projected to tax. If the result shows more tax will be due, then the accountant might recommend making an additional estimated tax payment. Even if the taxpayer decides to pay the balance due in April, at least he will be expecting it and can make arrangements to have the necessary funds available.
A taxpayer that files his own tax return may not have access to planning software. The IRS has a tool that can help, called the Withholding Calculator. This tool works much like popular do-it-yourself tax software. It asks a few questions and then tailors the following questions based upon the answers to the first. If you are married, it asks about your spouse’s income as well as yours. It asks about children and dependent care, other forms of income, expected deductions, etc.
Some of the questions might be difficult for a typical taxpayer to answer. For instance, there is a box that asks for the total value of “other tax credits” you expect. This is a catch-all that could be used for a variety of tax credits other than the dependent care credit, child tax credit, or earned income tax credit. You can skip many of the sections of input if you don’t know the answer or if you know it doesn’t apply to you, but the analysis may not be as accurate. You would also need a current year-to-date pay stub to enter the withholding already paid. The tool will calculate the estimated remaining withholding when you enter the amount from the current pay period. It uses the current date and the pay frequency you indicate.
Based upon the results, a course of action is suggested. A sample calculation returned the following results:
Based on your responses, your anticipated income tax for 2018 is $16,299. If you do not change your current withholding arrangement, you will have $9,500 withheld for 2018 leaving $6,799 due when you file your return. To meet your anticipated tax of $16,299 change your current withholding arrangement by claiming 0 allowances plus an additional amount of $6,991 for the balance of 2018. Here’s how:
Based on the information you entered, if you file a new Form W-4 for the rest of 2018 , your withholding will approximately equal your anticipated tax, and any refund or balance due should be less than $25.
Using the withholding calculator to its full capability will take some work. The effort is worth it, however, since you will get a good idea of how you will stand in April when you file your tax return. Alternatively, you could consult a tax professional to do the work for you. You will still need to gather the information the accountant will need to do the full analysis. Of course, you could also stick your head in the sand and keep your fingers crossed!
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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