Withholding Updates: A New Form W4 and a New IRS Withholding Tool
11 Questions Your Employees Might Be Asking
An important deduction taken from paychecks each pay cycle is the amount of federal tax withholding an employee tells their employer to set aside based on what they submit on their Form W-4. This past tax season was the first under tax reform and new withholding tables, and it left many taxpayers with a surprise tax bill. If your employees would like to minimize that surprise come next tax season, encourage them to update their Form W-4.
To make this process easier, the IRS has released a new Tax Withholding Estimator. Abacus Payroll also has a W4 Assistant Calculator for reference.
New IRS Online Withholding Tool
The IRS just launched a new Tax Withholding Estimator on its website. This new tool is completely redesigned and much more user-friendly than the old version.
Why should I check my withholding?
After the new tax law took effect for 2018, many people were unpleasantly surprised when they didn’t receive their customary tax refund on their 2018 tax returns. Often, they actually paid less tax overall but didn’t really notice it because they took home a little more from their paychecks each week (which means there was less withholding), and then were shocked to find out they weren’t getting a big refund or that they owed more tax on their returns.
Doesn’t everyone want a big refund?
Remember that a tax refund isn’t simply a gift from your generous Uncle Sam. A tax refund is just your own money coming back to you because you paid in too much during the year. You really gave the government an interest-free loan all year. If you see a tax refund as a way to force yourself to save money, consider having part of your take-home pay automatically deposited into a savings account instead.
Should I just wait and pay in all my tax with my tax return each year?
If the idea of giving an interest-free loan to the government disturbs you, you might be tempted to wait and pay in all of your tax burden for the year on April 15th when you file your tax return. This is technically allowed, but you will also incur penalties for not paying in your tax evenly throughout the year. Ideally, your withholding or estimated payments should approximate your actual tax burden, and there should only be a small amount due or refund on your tax return.
Why is the new IRS tool better?
The previous withholding calculator was somewhat difficult to use. There were lots of questions that required you to gather all sorts of information. It essentially amounted to doing your own tax projection, which is not something most people are equipped to do. The new tool uses very plain, clear language and asks questions in a logical order. You will need to have a year-to-date check stub for all jobs (the taxpayer and the spouse, if applicable). Answer the questions as you work through the tool. When you get to the end, you can go back and change your answers if you want to.
What does the tool tell me?
The results will indicate your total expected withholding, your anticipated tax obligation, and the resulting estimated refund or balance due. If you don’t like your results, you can select an option to “get my balance close to zero” or “I’d like to get a refund.” The tool will then tell you how to complete a new Form W-4 for each job in order to achieve the desired result. Just remember that the accuracy of the results will depend upon the accuracy of the answers you supply. If you have a complicated tax situation or if you own your own business, you probably still need the help of a professional.
New Form W4 for 2020
Ever since the passage of the Tax Cuts and Jobs Act (TCJA) in late 2017, there has been much discussion about the amount of tax withheld from wages. Although most provisions of the new law took effect in January of 2018, the IRS didn’t release updated withholding tables until February of 2018. The new tables were designed to withhold tax amounts appropriate under the new law, but most people didn’t bother to fill out a new W-4 with the new law in mind.
The TCJA lowered tax rates for most taxpayers, and therefore the tax withholding tables caused less tax to be withheld from most employees. For many, this meant smaller refunds when they filed their 2018 tax returns earlier this year. For some, this was an unpleasant shock even though they had actually been taking more money home with each paycheck.
Why does Form W-4 matter?
An employer withholds income tax from an employee according to information the employee provides on Form W-4. If the information provided is inaccurate, the amount of tax withheld may not be sufficient to satisfy the employee’s tax liability.
So what’s the big deal?
The problem is that filling out a Form W-4 might not be that easy. If a taxpayer is single, only has one job, doesn’t have any other forms of income, and doesn’t itemize his deductions, then the Form W-4 is fairly straightforward and the tax withholding should be on target. The problem is that most people have a more complicated tax situation. Taxpayers with more than one job, a working spouse, children, and income from investments have a much more difficult time using Form W-4 to accurately calculate their withholding needs.
Didn’t the IRS try to help employees with more complicated situations?
Yes, the IRS did originally create a new Form W-4 that tried to encompass a taxpayer’s entire tax return. The problem was that it was difficult for most people to fill out. Also, it required the disclosure of information an employee might not want to share with his employer. For instance, many employees might not want their employers to know how much their spouse earns or how much (or little!) they earn in interest and dividend income. After many comments from both taxpayers and CPAs, the new, complicated W-4 was scrapped and the form used for 2018 looked much like it did in prior years. The problem with this one was that it still had information about allowances, even though the TCJA did away with personal exemptions.
How is the 2020 version of Form W-4 better?
The IRS recently issued a draft form of the W-4 they expect to publish for 2020. It is in draft form because they are seeking comments and feedback about the form and its instructions. The form is relatively simple, with only a few lines to complete. It attempts to solve the issue of a two-income household by including a chart that lists annual wages for the highest paying job down one side and for the lower paying job across the top. Find the intersection of the two incomes, and the amount listed will be an “additional amount” of withholding that an employee should request based upon the fact that the spouse also works. The draft form also has a line where an employee could list “other income” for which they would like to have tax withheld. For instance, if you know you will have significant dividend income, you could include it on the W-4 and the tax withheld from your wages would be increased. This brings us back to the problem of disclosing information to your employer that you might not want to share.
What if I just want to tell my employer what to withhold without giving details?
The IRS recognizes that many taxpayers may want to keep their income and deduction details to themselves. As referenced above, there is a fairly robust estimator tool on the IRS website that allows taxpayers to do a detailed review of their income and tax withholding. If a tax deficiency is calculated, the employee can simply turn in a new Form W-4 that lists the appropriate “additional amount you want withheld from each pay period” without disclosing anything about how the number was calculated.
Can I really do this myself?
If you take the time to look up all the information required, the calculator can do a fairly accurate job. Or, if you are happy with the amount of tax due or refunded on your 2018 return, and your income is about the same for 2019 and 2020, you won’t need to do anything. Of course, many taxpayers with complicated tax returns should consult a professional. The tax law is complicated, and no two tax situations are identical. A thorough review of your prior tax returns coupled with a complete tax projection for the current year is the best way to avoid all surprises on April 15th.
Author: Julie Strohlein, CPA
This content is also published on AlloySilverstein.com.
