Am I Withholding Enough Taxes? How to Estimate Your 2018 Tax Liability

March 02, 2018 : Gil Charney

Determining the “right” amount of federal and state taxes to withhold from each paycheck is not a new challenge, but the new Tax Cuts and Jobs Act (TCJA) is causing many taxpayers to revisit this question: should I change my withholding? .

Why is it important? The amount of federal and state taxes you withhold from each paycheck determines whether you’ll get a refund, break even, or owe taxes when you file your return. The goal is to eliminate any surprises at tax time.

Some taxpayers like to get a large refund, some prefer a small refund, and others prefer a small balance due, taking comfort in knowing they didn’t make an interest-free loan to the government. Regardless, everyone should aim to withhold at least enough to avoid any underpayment penalties.

Use Form W-4 to adjust your tax withholding, if necessary, after you have an idea what your tax situation looks like for the full year. Without estimating your tax liability (see below) and taking actions to reduce it, changing your withholding is like shooting a target while blindfolded. This is especially true in a year when there are so many tax law changes, even if you expect no changes in your personal life.

 

To figure out if you are withholding enough federal taxes, follow these steps:

  1. Review last year’s tax return. If you just filed your tax return for 2017, take a look at your “total tax” (line 63, Form 1040; line 39, Form 1040A, or line 12, Form 1040EZ).
  2. Estimate your 2018 tax liability. Look at last year’s return and project your 2018 tax return based on any known or expected changes in your personal tax situation. This is an important step and sometimes complicated step, so you may want to get help from a tax professional or use H&R Block’s tax calculator. Changes in your life (children, marriage, new job, etc.), or other complexities (like owning a small business or earning extra income from a side job) can significantly change your tax bill, as can the new tax law.
  3. Determine how much has been withheld so far. You can find this information on your last earnings statement or payroll stub.
  4. Subtract the withheld taxes from your projected tax bill. This is the amount of withholding you’ll need for the rest of the year to closely match your estimated tax liability for the year.
  5. Divide the amount you still owe by your remaining pay periods. This is the amount you should withhold from each paycheck for the rest of the year to cover your estimated tax bill.
  6. To make changes, complete a new Form W-4. If you want a larger refund, reduce your “withholding allowances.” This increases the taxes your employer withholds (and reduces your take-home pay). Or, you can add a fixed amount to be withheld from every paycheck. If you want a smaller refund, or a balance due, increase your allowances. This will reduce your withholding (and increase your take-home pay).
  7. Complete the new Form W-4 as soon as possible. The longer you wait, the fewer pay periods you’ll have to take advantage of your new withholding amount.

 

Here’s an example:

You and your spouse earned a combined $80,000 in 2017. You have a 15-year old daughter. You claimed the child tax credit and you itemized your deductions. Your federal tax bill for the year was about $4,800, and you withheld $4,920. So, you received a refund of $120.
In March, you noticed that your take-home pay was about $100 more than in previous pay periods, so you’re curious about what that $100 per pay period will mean when you file your 2018 tax return.

Time to roll up your sleeves – and do a few calculations to estimate your tax liability.

You don’t expect any major life or job changes this year – but you’ve read that under the TCJA, the standard deduction has increased, dependent exemptions have gone away, the deduction for state and local taxes has been capped, and the child tax credit has doubled. What does that mean to you?

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After following the steps above, you estimate that you’ll owe about $4,300 in 2018 – almost $500  less than in 2017.

Despite no changes in your personal life, there are several tax changes that will affect you in 2018, including:

  • Lower tax rates – your marginal tax bracket was reduced from 15% to 12%
  • Loss of personal exemptions (worth $12,150 in 2017)
  • Larger standard deduction ($24,000) that you expect to exceed your itemized deductions
  • Larger child tax credit, doubling from $1,000 to $2,000

The good news? Your tax bill was reduced by almost $500! The bad news? By not adjusting your Form W-4, the reduced tax withholding of $100 per pay period means that you’ll owe a balance or have a smaller refund when you file your 2018 tax return in early 2019. However, the lower withholding also means more take-home pay throughout the year, so you can decide which is more important to you.

 

It’s best to plan for tax changes early in the year

It’s a good idea to take a look at your tax situation now so that you’re not surprised at tax time with a smaller refund or a balance due. Follow the steps above to learn how to estimate your tax liability, use H&R Block’s tax calculator, or go see a tax pro for help with planning your W-4 withholding. You just may thank yourself a year from now.

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Gil Charney

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