If you have not updated your Form W-4 to provide for changes in the recently passed Tax Cuts and Jobs Act, you could be in for a surprise. Your previous Form W-4 likely provided for personal exemptions which were eliminated under the new tax law. A new Form W-4 should be resubmitted to exclude any personal exemptions or you may find yourself under withheld when you file your 2018 tax return with possible penalties.
For many wage earners the link between Form W-4 and how much withholding their employer sends the government on their behalf is a mystery. To pull aside the veil, the information provided on Form W-4 allows an employer to reconstruct an annualized taxable income, and the tax thereon. The amount of annualized income subject to withholding tax begins by adjusting gross wages for both a standard deduction and the number of exemptions indicated on Form W-4. The tax on that income is then determined and apportioned for the amount received per pay period. When a taxpayer doesn’t use a standard deduction, or has other sources of income, things become more complicated. The calculation is both clunky and arcane, translating net deductions and other income to units of personal exemptions. It becomes yet more complicated when there are multiple income earners in the same tax household.
Recently the IRS issued new withholding tables to account for changes in the tax law, likely rendering the number of exemptions indicated on many existing Form W-4s incorrect. With personal exemptions eliminated under the new Federal tax law, any personal exemptions currently represented on a Form W-4 may be inaccurate. Also, with significant changes in the size and make-up of itemized deductions, the amount representing deductions in excess of the standard may be much different in 2018. Each exemption under the new rules is considered to represent an additional $4,150 of income not subject to tax when withholding is calculated.
Employers are required to use the last Form W-4 submitted to calculate withholding. If that Form W-4 includes exemptions representing personal exemptions, or itemized deductions in excess of the standard deduction, that no longer exist for the taxpayer, the taxpayer will have a shortfall in tax withheld. That shortfall will result in taxes due, and if too large, penalties come filing time. If you have any questions on specific provisions of the how the new withholding rules may apply to your situation, please feel free to reach out to us for a consultation.
Written by Damien Falato, CPA, MST, CGMA, Tax Director