2018 Withholding Updates – The Latest IRS Guidance

January 26, 2018 : Gil Charney

IRS news release IR-2018-5 announces recent updates to income tax withholding for 2018. The updates reflect changes made by the Tax Cuts and Jobs Act (TCJA). Employers are encouraged to implement the changes as soon as possible, but no later than February 15.

Among many changes made by the TCJA to individual taxes, new tax rates and brackets, increased standard deductions, and the elimination of personal exemptions have a direct impact on payroll withholding for 2018. IRS Notice 1036 is an early release of 2018 withholding tables meant to incorporate these changes.

According to IRS’s guidance, employees are not required to complete a new Form W-4, Employee Withholding Allowance Certificate at this time. The updated withholding tables are designed to use the number of allowances on existing Forms W-4 to arrive at the correct amount of withholding for the rest of 2018. However, this may be a good opportunity for employees to review existing allowances claimed on Forms W-4 and make updates as necessary to ensure withholding for 2018 is accurate. For example:

  • Taxpayers who previously itemized deductions and expect to claim the standard deduction in 2018 may want to decrease their allowances.
  • Taxpayers who were previously phased out of the child tax credit and expect to be able to claim it in 2018 may want to increase their allowances.

How Withholding Works

Although discussions about paycheck withholding and Form W-4 often use “allowance” and “exemption” interchangeably, the terms do not quite mean the same thing.

  • Each allowance is an amount subtracted from an employee’s pay.
  • A tax formula is then applied to the remainder to calculate federal income tax withholding for that employee.
  • Thus, more allowances result in more subtracted from the employee’s pay and a smaller taxable remainder. Conversely, fewer allowances result in less subtracted from the employee’s pay and a larger taxable remainder.
  • Both the allowance amount and the formula vary based on pay frequency (weekly, semi-monthly, etc.) and whether the employee uses the single or married withholding rate.

Form W-4 does not ask the employee about how many exemptions he or she intends to claim. Rather, it asks questions about the employee’s spouse and dependents, filing status, itemized deductions, and tax credits to arrive at a number of allowances.

Ultimately, the appropriate number of allowances and resulting tax withheld are meant to get the employee as close as possible to breaking even, given the tax law in place each year.

Example: Steve is single, has no dependents, and earns $50,400 in 2017. His W-4, completed according to form instructions, has 2 withholding allowances. He is paid on a semi-monthly basis. The result is that $242 in federal income tax is withheld from each paycheck and $5,808 is withheld for the year. Steve’s actual tax liability for 2017, given the standard deduction and one personal exemption, is $5,739.

Under the new tax law, based on the same income, the new rates, higher standard deduction, and no exemptions, Steve’s tax liability for 2018 will be $4,418. If Steve’s employer implements the new 2018 withholding table for the first February pay period of 2018, total withholding for the year will be $4,554 (two pays at the old $242 rate and 22 pays at the new $185 rate).

 

Final Thoughts

It is rare that an employee would wind up having withholding and a tax liability that match exactly. In this very simple scenario, the employee is pretty close both years. As in prior years, he would have the option of decreasing or increasing the number of allowances, resulting in more or less withholding.

Even though a new W-4 form is not required right now, in addition to the reasons mentioned above, employees may want to revise the number of allowances if they have personal changes (marriage, divorce, new baby, etc.), start a second job, receive other types of income such as dividends and capital gain, and so on.

The IRS is working on releasing a new  Form W-4 and withholding calculator. The release includes a Frequently Asked Questions about the new law as it relates to 2018 withholding and Form W-4.

 

Note: Notice 1036 contains revised percentage method withholding tables updated for the TCJA. Using the tables requires a two-step process and explained earlier: determining the allowance amount to subtract from employees’ pay and then applying the tax formula to determine withholding. We expect that Pub. 15, Circular E, Employer’s Tax Guide will be revised soon as well to include updated wage bracket tables which simplify and streamline the process.

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Gil Charney

Gil is the Director of Tax Law and Policy Analysis for The Tax Institute at H&R Block.