The new Tax Cuts and Jobs Act gives taxpayers something to cheer about, thanks to lower tax rates on more of their income, a nearly doubling of the standard deduction and higher tax credits for families with children. But some taxpayers could find themselves owing the IRS if they don't adjust their tax withholding.
The IRS is urging all taxpayers to do some planning now, so you won't have sticker shock when you file your 2018 tax returns.
One recommended tool is the free Withholding Calculator on the IRS website, which will allow you to perform a "paycheck checkup" to make sure you are withholding the right amount of federal tax from your paycheck.
The Withholding Calculator will ask you to enter estimated values for your income in 2018, the number of children you would claim (to estimate the new and expanded Child Tax Credit and Earned Income Tax Credit) and the amount that was recently withheld for federal tax on your last paycheck. It only takes a few minutes and all you'll need is your most recent pay statement. If you have access to your 2017 tax return, that can also help to speed up the process.
It's important for folks who fall into several groups to do a paycheck check up using the IRS' calculator, such as:
- People with children who claim the Child Tax Credit
- Taxpayers who itemized deductions in 2017
- Those who received a large refund or paid a large tax bill on their 2017 tax return
- Two-income families
- Workers who held two or more jobs during the year
Below are a few details about the first two groups of taxpayers:
Taxpayers with children
Tax payers with children who claim the Child Tax Credit could find that their 2018 tax refund is significantly larger than in 2017. That's because the Child Tax Credit was increased from $1,000 to $2,000 per qualifying child.
Also, many taxpayers whose income was too high in 2017 to receive any benefit from this tax credit may now qualify. That's because the child tax credit now phases out at $400,000 for married filers and $200,000 for singles, compared to 2017 income limits of $110,000 for couples and $75,000 for singles.
If you are in this situation, you may find that you're having too much tax withheld from your pay. If you'd like more take home pay, use the Withholding Calculator and follow the steps to complete a new Form W-4 to lower the tax withheld.
Taxpayers who itemize
Contrary to popular belief, most taxpayers don't itemize deductions. Only about 25 percent of all tax returns filed in 2017 included a Schedule A, which is filed to calculate and claim itemized deductions.
But folks who typically itemize deductions could find they are not paying enough tax through withholding because the new tax law limited some popular tax deductions they claim. (I recently wrote about nine popular tax deductions repealed in 2018 by the Tax Cuts and Jobs Act.)
For instance, the limit for state and local income tax deductions is capped at $10,000, and the deduction for home mortgage interest is limited for specific uses. Having too little tax withheld could result in an unexpected tax bill or even a tax penalty when you file your 2018 tax return.
By doing the paycheck check up now, you'll have time to make an adjustment to your tax withholding now and spread out the additional amount you'll owe over the remaining paychecks this year.
A significant gap
So how much could the mismatch be between what your having withheld from your pay and what you might owe on your 2018 tax return?
Using an individual's actual pay statement, I found the difference to be significant. This taxpayer's gross income is $75,000, and he's contributing $10,000 to a 401(k), while $447 is withheld for federal tax on his bi-weekly paychecks. Based on the information entered into the calculator tool, his anticipated income tax in 2018 is $7,605 -- but about $11,288 will be withheld. That means he would overpay the IRS by $3,683.
The IRS tool advises that if he wants his withholding to more closely match his anticipated tax owed, then he should file a new Form W-4 with his employer with the "single" box checked and 12 allowances. By doing this now, his take-home pay now will increase by about $400, and his 2018 tax refund will be close to zero.
If you prefer less tax withheld now and to receive more take-home pay, it's worth looking at your situation. If you do, just remember this; a mid-year withholding change in 2018 will have a different full-year impact for 2019. Make sure you repeat the process of using the tool again in January 2019 to avoid having too little withheld for 2019.