Are your employees having enough money withheld from their regular paychecks? The Tax Cuts and Jobs Act (TCJA) has made several significant changes to the tax rules for individuals for 2018 through 2025. As a result, many taxpayers who previously itemized deductions are expected to claim the standard deduction, starting in 2018.
How is withholding affected by the TCJA? The amount your employees elected to have withheld on their Forms W-4 under the previous tax law might need to be revised under the new law. If they withhold too much, they're effectively giving the IRS an interest-free loan to use their money until it's refunded after they file their 2018 returns sometime next year. Conversely, if they withhold too little, they'll face a stiffer tax bill when they file the return.
Unfortunately, it's not easy to figure out the right withholding amount under the TCJA. A "paycheck checkup" can help you assess your situation.
The 2018 tax return isn't due until next April. But your employees generally can't wait until they file their tax returns to pay the full amount of tax they owe. Instead, employers are required to withhold taxes from the paychecks of employees. Likewise, self-employed individuals and retirees and others with investment income or retirement account withdrawals must make quarterly estimated payments.
They might need to do both — have tax withheld and pay quarterly installments — if they earn substantial income outside of their regular salaries. If they fail to comply with the requirements, they could be liable for an estimated tax underpayment penalty, in addition to the tax liability.
The due dates for the quarterly estimated payments for a tax year are:
- April 15,
- June 15,
- September 15, and
- January 15 of the following year.
These dates are adjusted for weekends and holidays. So, the next quarterly installment for income earned in 2018 is due Monday, September 17, 2018.
Your employees can avoid an estimated tax underpayment penalty using any one of these three safe harbor rules:
1. They pay at least 90% of the current year's tax liability. This requires them to make a calculated guess of their current tax situations.
2. They pay at least 100% of the prior year's tax liability. (Or they pay at least 110% of the prior year's tax liability if their adjusted gross income for the prior year exceeded $150,000.) This safe harbor is usually the easiest one to use because they know the exact amount of their previous tax liability.
3. They pay at least 90% of the current year's "annualized income." The annualization method often works well for certain individuals, such as independent contractors, who receive most of their income on a seasonal basis.
Despite these safe harbor rules, the IRS encourages taxpayers to use withholding (if possible) to navigate their way around potential penalties.
If your employees have been having "just the right amount" withheld for their circumstances in the past, the TCJA has altered the landscape. Examples of major changes that will affect individuals for 2018 through 2025 include the following:
- The standard deduction is almost doubled to $12,000 for single filers, $24,000 for joint filers, and $18,000 for heads of households.
- The itemized deduction for state and local taxes combined is limited to $10,000 per year. This applies to any combination of 1) state and local property tax and 2) state and local income tax (or state and local general sales taxes if you choose to deduct them instead of state and local income taxes). Previously, these amounts were fully deductible by most taxpayers who itemized deductions.
- The itemized deduction for mortgage interest is potentially reduced under the new law. Specifically, the interest deduction for new acquisition debt is limited to interest paid on the first $750,000 of debt, down from $1 million. (Pre-TCJA home acquisition debts of up to $1 million are grandfathered under prior law.) In addition, the deduction for interest paid on up to $100,000 of home equity debt is generally repealed (unless the home equity debt is used to buy, build or substantially improve the home secured by the debt, in which case it can be treated as acquisition debt subject to the $750,000 limit).
- Itemized deductions for most miscellaneous expenses — such as investment advisory fees and unreimbursed employee business expenses — are eliminated.
- Personal and dependent exemptions are eliminated.
- The child tax credit — which generally applies to dependent children under age 17 — has been increased from $1,000 to $2,000, and the income phaseout thresholds have been significantly increased (to $200,000 for singles and heads of households and $400,000 for married couples who file jointly). So, many more households will be eligible for the increased credit. In addition, a new $500 credit is available for other qualified dependents, including a qualifying 17- or 18-year-old, a full-time student under age 24, a disabled child of any age, and other qualifying (nonchild) relatives if all the requirements are met.
In light of these changes, many taxpayers who have itemized in the past may instead opt for the standard deduction starting in 2018. This could have a major impact on their withholding obligations.
Even if they expect to continue to itemize under the TCJA, they can benefit from a "paycheck check-up," especially if you have older children who won't qualify for the $2,000 child tax credit or you report income from more than one job. (See 3 families who might need to adjust their withholding at right.)
Of course, their withholding choices should also reflect their personal preferences. For instance, some taxpayers prefer to overpay taxes during the year so they can receive a big tax refund from Uncle Sam. Others like to just break even.
For your employees to adjust their withholding, they will need to request a new W-4 form from you, the employer, then fill it out and then submit it. Any withholding change will show up in the next payroll calculation.
The IRS offers worksheets for estimating the "right" amount of withholding, as well as a new online withholding calculator to help you crunch the numbers. Unfortunately, the online calculator requires your employees to input a lot of financial information, which can be time consuming. And many people aren't comfortable putting sensitive personal data into cyberspace.
To minimize the hassle and potential security risks, have them discuss their withholding with a tax advisor. He or she can help them sort through the provisions of the TCJA that will affect your tax situation and address other withholding objectives in the coming years.
Have questions about how to implement changes to your employees' withholding? Reach out to your payroll specialist!
|3 families who might need to adjust their withholding|
The Miller family
The Millers are a married couple who file jointly. They live in a state with high income and property tax rates. Last year, they claimed more than $35,000 in state and local income and property taxes.
Under the Tax Cuts and Jobs Act (TCJA), the Millers' 2018 itemized deduction for state and local taxes will be limited to only $10,000. Depending on their other deductions, they might decide to claim the standard deduction of $24,000 instead. So, it's a good idea for the Millers to re-evaluate their withholding for 2018.
The Patel family
The Patels are a newly married couple who bought a home in an expensive area in March. With the new acquisition debt of $1 million, their mortgage interest payments are expected to be around $7,000 a month, or $70,000 for 2018.
The Patels expect to itemize deductions, but interest on only $750,000 of acquisition debt will be deductible under the TCJA. This couple should assess their withholding to determine whether they need to set aside more or less in 2018 to cover their estimated tax obligation.
The Smith family
The Smiths are a married couple who file jointly. They have four dependent children, including twins who will turn 17 in November. The other two children are younger. In the past, this family itemized deductions. But, under the TCJA, their expected itemized deductions will total only $20,000. So, they expect to take the $24,000 standard deduction.
In addition, the Smiths will lose out on the tax benefit of six personal exemptions — but two of their children will qualify for a $2,000 child tax credit. Their twins will each qualify for a $500 tax credit, but they won't qualify for any higher education tax credits until they go to college in 2019. The Smiths may need to revise their withholding in 2018 and then again when the twins go off to college.