As you are probably aware, in most cases federal income taxes are withheld from your paychecks. But did you know just how much control you have over the amount that is actually being withheld? In this blog post we’ll discuss the importance of having an accurate W-4 holding, including how recent changes to the tax code present a unique situation for taxpayers in 2018.
Let’s start with how the W-4 actually works. In a nutshell, your employer adjusts your gross pay and calculates how much federal income tax to withhold from your paycheck based on the withholding allowances you claim on Internal Revenue Service (IRS) Form W-4 (Employee’s Withholding Allowance Certificate). Each allowance you claim exempts a portion of your income from federal tax withholding and thereby increases what you receive in your paycheck. So, if you claim too many allowances, not enough tax will be withheld from your paycheck, and you will owe the IRS come April 15. If you claim too few allowances? An unnecessarily high amount of tax will be withheld from your paycheck, and you will get a tax refund.
Of course, no one wants to get hit with a large tax bill. But getting a tax refund is not necessarily a better option. It simply means you have paid more than your share in federal income tax and essentially have given the federal government an interest-free loan. As such, the optimal result from a cash flow and financial planning standpoint is to land right in the middle: maximizing income received in each paycheck without owing additional taxes when you file.
Time to check your W-4 Withholding
Best practice is to review your W-4 annually. It is especially important to check when you experience a major life event, such as marriage, birth or adoption of a child, a spouse getting or losing a job, or a significant pay raise or pay cut. Each of these events can directly affect the amount of tax you will owe. This year presents a unique situation, however, because the implementation of the Tax Cut and Jobs Act means that everyone’s tax situation has changed in 2018. With seven new income tax brackets, many people, making the same income in 2018 that they did in 2017, will find themselves in a lower tax bracket. This means more money in their paychecks in 2018 compared with 2017. The new tax law also increased the standard deductions across the board and eliminated miscellaneous itemized deductions.
So what does this mean to you?
The amount you will owe in federal income tax, the deductions you will be able to take, and the amount that should be withheld from your paycheck will have all likely changed.
Finding your “Sweet Spot”
The simplest and most accurate way to determine your appropriate W-4 withholding election is to use the IRS Withholding Calculator, available on the IRS’s website. Keep in mind that this calculator is designed for most taxpayers.
The calculator will ask for your filing status, your family situation, your income, your current withholding, and other information that could affect your 2018 taxes. If the calculator recommends adjusting your withholding, there’s no need to wait! You can adjust your W-4 withholding with your employer at any time, and the change will be reflected in your future paychecks.
Want to learn more?
Of course, this is a general discussion of ensuring accurate W-4 withholdings. If you have additional questions or would like more in-depth information about your withholding, feel free to reach out to me for a free consultation.
2018 Commonwealth Financial Network®