How New Withholding Tables Impact Employees: A Primer(1)

From Daily Tax Report®

February 1, 2018

By Robert Lee

Tax practitioners largely agree that most of the burden is on employees to ensure their paychecks are correct and their withholding amounts are accurate for 2018.

The Internal Revenue Service has revised its withholding guidance in light of the 2017 tax act (Pub. L. No. 115-97), which overhauled the tax code for the first time in more than 30 years. The IRS released its 2018 withholding tables (Notice 1036) on Jan. 11 to reflect new provisions, including adjusted tax rates and brackets, a higher standard deduction, and repeal of personal exemptions.

Withholding allowance amounts were retained in employer withholding calculations for 2018, with the optional supplemental wage withholding rate set at 22 percent. The amount of additional wages to be added to tax calculations per pay period to nonresident aliens more than tripled, according to Notice 1036.

It is important that employers begin using the new withholding tables as soon as possible, but no later than Feb. 15, as instructed by the IRS, Amy Wang, senior manager for tax policy and advocacy at the American Institute of CPAs in Washington, told Bloomberg Tax. Meanwhile, “the biggest responsibility for employees every year, but especially this year, is to verify that everything looks correct on their paycheck,” she said.

Here are the biggest questions tax practitioners say employees should consider.

Do Employees Need to File New W-4 Forms?

Right now, employers can use the 2017 Forms W-4, Employee’s Withholding Allowance Certificate, already filed by employees, through Feb. 28, the IRS said Jan. 29 in Notice 2018-14. The W-4 is being revised to reflect the new law’s changes but may not be released until after Feb. 15, the IRS said.

Employees should be aware there are parts of the 2017 W-4 that won’t apply under the new law.

For example, the second page of the 2017 Form W-4 contains two worksheets that don’t appear to reflect the elimination of personal exemptions and the doubling of the standard deduction, James R. Gadwood, tax counsel at Miller & Chevalier Chartered in Washington, told Bloomberg Tax. “It’s not clear to me how those page-two worksheets should be filled out,” he said.

Gadwood said that although the IRS has said employees can continue to use the 2017 form this filing season, those employees should run new calculations using the revised Form W-4 once it is released.

Pete Isberg, president of the National Payroll Reporting Consortium Inc. in Rochester, N.Y., said it was “just a little strange” for the IRS to revise the Form W-4 and withholding tables separately when “there are W-4 allowances on the old form that don’t even relate to 2018 law.”

Practitioners said they expect the IRS to offer more guidance on the withholding changes. Guidance on penalty relief for potential underpayment of taxes is needed immediately because of the recent withholding table revisions, the AICPA said in a Jan. 29 letter to David J. Kautter, assistant secretary for tax policy at the Treasury Department and acting IRS commissioner, and William M. Paul, principal deputy chief counsel and deputy chief counsel (Technical) at the IRS.

“Right now, people know enough to know that things have changed under this new law, but yet at the same time they’ve been told to keep using the same W-4 they have on file. And I think people are finding that to be a disconnect and are wondering whether they’re really entitled to more take-home pay this year, or a surprising tax bill instead,” Michael O’Toole, senior director of publications, education, and government relations at the American Payroll Association in New York, told Bloomberg Tax. “Without more guidance materials from the IRS, we can’t really determine that yet.”

Will Employees See Paycheck Changes This Year?

Ninety percent of employees will see an increase in their take-home pay under the updated guidance, Treasury Secretary Steven Mnuchin said in a Jan. 11 news release announcing the new tables.  The IRS has said individual paycheck increases under the updated 2018 withholding tables could come as early as February.

Howard Gleckman, a senior fellow in the Urban-Brookings Tax Policy Center in Washington, said it is more important than ever for employees to verify their withholding amounts.

“I think there is more risk of underwithholding or overwithholding during this year’s filing season,” Gleckman said. “Withholding tables are always pretty crude estimates, but are going to be especially crude this year. Changes like the new child tax credit and the $10,000 limit on state and local taxes are not going to be reflected in the withholding tables and could really affect the accuracy of your withholding.”

In Notice 1036, the IRS said its online tax calculator would be revised, along with additional information to help people determine whether to adjust withholding when accounting for repeal of personal exemptions, the higher child tax credit, and other changes. The agency said the calculator will be released by the end of February.

Gleckman said the hope is the calculator will be simple to use and able to provide a reasonably accurate estimate for individuals with specific situations.

“We need guidance in the form of a tax calculator so people can determine what their withholding is going to be versus what their tax liability is going to be, so hopefully the IRS has that out sooner rather than later,” O’Toole said.

Will There Be Withholding Changes on a State Level?

The next big question is how states will respond to federal withholding changes and whether they’ll decide to decouple from the law, O’Toole said.

Nine states currently require the use of the federal Form W-4, and many states use up to three additional elements of the federal tax code in the withholding process, a recent Bloomberg Tax analysis showed. These states “will have to decide in the middle of their fiscal years and legislative sessions what they’re going to do and whether they’re going to piggyback on the federal system,” Gleckman said.

A number of outcomes could arise from the new federal withholding changes, Michael Brown, a compliance professional on payroll and tax with Ceridian HCM Inc. in Atlanta, told Bloomberg Tax. States that use federal wages to calculate state withholding could adjust their own withholding amounts to avoid raising tax rates, or states could abandon the use of the Form W-4 for state withholding and create their own instead, he said.

“It’s going to be a real mess,” Gleckman said. “The states are still trying to figure out what the new federal law is going to mean for their revenue systems, so it’s very hard for people to figure out how much they’re going to have to withhold.”

Wang said she recommends that employees interested in how their withholding will be adjusted should consult their human resources department and payroll provider to see how the changes are being addressed by their company.