- On Jan. 11, 2018, the IRS released updated tax withholding tables for 2018 in response to the recent tax overhaul.
- The IRS guidance instructs employers how to appropriately withhold taxes from employees’ paychecks in 2018.
- The 2018 withholding calculation should be implemented by Feb. 15, 2018, and employers should check with their service provider that tables will be implemented in a timely manner.
- Paychex has updated its systems to reflect the new 2018 withholding rates.
On Thursday Jan. 11, 2018, the Internal Revenue Service (IRS) updated tax withholding tables for 2018. IRS Notice 1036 instructs employers on how to appropriately withhold taxes from their employees’ paychecks in 2018. This is a response to the federal tax bill, which made significant changes to how individual income is calculated, and withholding revisions are now required.
Withholding has always been based on how individual income is calculated. The W-4 and withholding amount are meant to help the employee get closer to their liability. If withholding is done right at the end of the year when employees file their taxes, their withholding will be closer to their tax liability. This has never been an exact science, as many factors play into where an individual’s tax liability falls, and complete accuracy isn’t guaranteed. Additionally, some employees choose to withhold differently so that they receive a refund at the end of the year.
What are the changes to the withholding tables?
Withholding rates and brackets have been adjusted as follows:
- The withholding amount on regular wages was adjusted to reflect the new tax rates, tax brackets, and standard deduction, as well as factoring in the elimination of personal exemptions.
- The withholding rate on supplemental wages for $1 million or less is 22 percent (previously 25 percent).
- The withholding rate on supplemental wages over $1 million is 37 percent (previously 39.6 percent).
- The back-up withholding rate is 24 percent (previously 28 percent).
- Amount to add to non-resident alien wages is $7,850 annually.
These changes did not attempt to factor in a retroactive rate to encompass the fact that they would be implemented after Jan 1.
Changes should be implemented as soon as possible but no later than Feb. 15, 2018.
How does the new withholding work with the old W-4?
The withholding rates and brackets were changed to reflect the new rates and significant change to standard deduction. However, the withholding changes included in the IRS notice maintain allowances as a factor in their calculation to have the tables work with the old W-4 that still factors in personal exemptions. It should be noted that the new calculations maintain the use of the personal exemption even though the recent tax overhaul removed it. The personal exemption amount for the purpose of withholding is $4,150 annually. Keep in mind, the calculation does not add the personal exemption amount on top of the new standard deduction. Essentially, to get the withholding closer to the tax liability, it encompasses the personal exemption amount that would typically be claimed on the old W-4 to get to the new standard deduction amount for those without children. The calculation deviates more once children or itemized adjustments are factored into the equation (see example below).
The following are examples of how the math works personal exemptions that are claimed on the W-4 into withholding when individual income taxes no longer have withholding:
Simple scenario: no children or itemized deductions
Presuming you are single with no dependents, the old W-4 would be single claiming 2. That means removing $3,700 from the taxable amount, and if you factor in 2 exemptions (4,150 x 2 = $8,300), you come up with the standard deduction of $12,000. The withholding tables back into this formula.
Similarly, if you start with the old W-4 and are married with no children, you would claim married with 3 exemptions. Again, the withholding calculation factors this in as 3 exemptions (4,150 x 3 = $12,450), which means the married filing joint tax calculation presumes a deduction of $11,550, and equates to the married filing jointly standard deduction of $24,000. This simple scenario makes the withholding tables correspond to the changes in individual income tax. As mentioned earlier, these tables do not make the changes retroactive to Jan. 1, 2018, so it’s not perfect.
Complex scenario: dependents and itemized deductions
Once you start factoring in children, the math can get fuzzy when applying the old W-4 to the new tables. Each child you claim on your W-4 will reduce your taxable income for the purpose of withholding by $4,150. Remember, when you file your individual income taxes, this personal exemption no longer exists. However, the child tax credit was increased by $1,000. A tax credit (unlike a tax deduction) directly reduces the amount of tax liability; the tax deduction only reduces your tax liability at your incremental tax rate. So this $4,150 tax deduction is approximately equal to a $1,000 tax credit when the person’s individual incremental tax rate is 24.10 percent This exemption may be close to your tax liability if your incremental tax rate is close to 24 percent and you previously qualified for the full child tax credit. However, as you go up or down the income incremental income tax rate, it doesn’t work as well.
Additionally, the full tax credit expanded to include more middle class families, which previously had the credit phase-out. So the gain on the tax credit may be more than $1,000 for many middle class families. Again, this makes the withholding calculation deviate further from equating to the end of the year tax liability. These calculations show that once you add dependents, the math isn’t as clean.
The rules of engagement have changed for itemizing deductions. Those individuals who have itemized deductions and made adjustments to their W-4 to encompass this methodology will not be able to calculate the adjustments to withholding using the old W-4. This means they may need to reevaluate if they are itemizing and how it impacts their withholding under the tax code.
More still to come from the IRS
You may receive questions from your employees on how they should fill out the old W-4 to adjust their withholding. At this time, there is no direct guidance how to adjust withholding on the old form. The IRS has released FAQs that indicated they are expecting to release:
- Additional guidance on withholding;
- A new W-4 to more accurately reflect the new tax law; and
- A new withholding calculator to assist individuals.
In 2019, the IRS anticipates making more adjustments in withholding to coalesce with the changes to the individual tax code.
What do employers need to do?
Employers should ensure the 2018 withholding calculation is implemented by Feb. 15, 2018. If you work with a payroll service provider, you should check that they have implemented the tables in a timely manner. Paychex has updated its systems to reflect the new 2018 withholding rates, and going forward its clients’ payrolls will be processed using the new withholdings.
If employees wish to adjust their withholding, they will need to use the old W-4. Although employers will need to implement any withholding changes, it’s up to the employee to initiate these changes. Eventually, employers may be required to get new W-4s from their employees or a certain subset of their employee population. We will await IRS guidance when a revised W-4 is released.
For more updates on the tax overhaul, please visit our tax reform resource center.