Millions of Americans will soon find extra money in their paychecks because of the new tax law — if they haven’t already. The new tax withholding will come into effect no later than February 15th.
According to the Tax Policy Center, about 80% of US households will get some sort of tax cut – for a mean average of $1,600 in 2018. (Most benefits are going to those making more than $300,000 a year.) The new tax brackets are 10%, 12%, 22%, 24%, 32%, 35% and 37%.
While this is certainly a good thing, there are some potential pitfalls. And hey, when it comes to taxes, doesn’t this always seem to be the case?
New Tax Withholding Laws
And to understand the drawbacks, you need to take a look at withholding, which is the process of how your employer reduces your paycheck for taxes. Because the US has a pay-as-you go tax system, withholding takes place for each paycheck.
The amount of your withholding is generally based on how you fill out your W-4 form. Based on factors like your marital status and itemized deductions, you will indicate the number of allowances. The more allowances you have, the fewer taxes are withheld from your paycheck.
OK, so how does the new tax law make things more dicey?
Well, the IRS has not updated the W-4 form. As a result, you might be in a position where the withholding amount is far off the mark. If it is too low, then you will likely owe a tax when you file your return — as well as a penalty. Or, if the withholding is too high, you may wind up with a substantial
What to Look for When the IRS Releases 2018’s W-4
If you’re wondering when to update your W-4, there are many triggers. Here’s a look:
- Self-Employment Income: This is becoming more and more common with the popularity of Lyft, Uber and Airbnb. Still, many contract workers do not set aside enough for the taxes. (The IRS has a process called “estimated payments” to handle this.) This can often cause major tax problems as the taxpayer may not have enough money to pay the balance owed to the IRS.
- Major Life Changes: These would include a marriage, a divorce, a new child, adoption, a death of a spouse and the start of a new job.
- Requirements Of The New Tax Law: Congress has pared back various tax advantages, which could mean that your taxable income will increase. Some of the notable ones include the $10,000 limit on state income and property tax deductions and $750,000 limit on mortgage deductions. For the most part, if you will no longer itemize your deductions, you should look at revising your W-4.
- Non-Salary Compensation: If you get bonuses, commissions or stock option income, then the gains may be withheld at 22%, down from 25%. For high-income people, this could mean a substantial change in the amount owed.
Because of the rush to pass the tax bill, the IRS will not have a new W-4 for this year.
Yet the agency plans to have an updated online calculator this month, which will help you provide the right number of allowances. It should be located at this web link.
Of course, there are many qualified tax experts to seek help from, such as Enrolled Agents or CPAs. But do not expect any assistance from your HR department. Keep in mind that they are not allowed to provide any personal tax advice.
Tom Taulli is an Enrolled Agent and also operates PathwayTax.com, which is a tax advisory and preperation firm. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.