The Treasury Department released new income tax withholding tables in January, with updates to reflect the Tax Cuts and Jobs Act, which eliminated personal exemptions, raised standard deductions and cut individual income taxes. These changes may affect your take-home pay as early as February 2018. However, the IRS is still working on updates to form W-4, that you complete to instruct your employer how much tax to withhold from your earnings. If you’re withholding too much, you can expect a refund at the end of the tax year, but if you withhold too little, you’ll have to pay out in April, 2019. It’s possible you may even incur tax penalties.
More Now, Less Later
While seeing more take-home pay now is usually a good thing, there’s some concern that the Treasury Department tables aren’t suggesting levels high enough to cover your tax liability by the end of the year. While many taxpayers will remain in about the same position in years past, some investment professionals see about half their clients in a position where they’re not withholding enough, and they may fall short by as much as $5,000 when completing their taxes for the 2018 tax year.
If you’re one of the 30% of Americans who claim itemized deductions on your tax returns, you should probably take a look at how recent changes affect your deductions and, in turn, how this affects your withholding. In past, using itemized deductions was often a way for those who keep complete and detailed records to pay less tax that they would had they chosen the standard deduction method. The more you deducted under the itemized method, the less tax you needed to withhold from your earnings.
However, the Tax Cuts and Jobs Act eliminates a number of substantial deductions, including caps on the amounts of state and local property and sales tax you may be used to deducting. You may no longer reach the threshold, and that kills any value in using itemized deductions. If you’re counting on these to bring your taxable income down to the level of tax you’re withholding, you may be in for a shock at tax time.
The New Standard
The carrot dangled in return for the reduction in allowable itemized deductions is a doubling of the amounts used with the standard deduction method. It’s not just a matter of switching over to standardized deductions though, since there are other changes that affect taxable income and withholding amounts. While the child tax credit amount has doubled to $2,000, personal and dependent exemptions have been axed. So, if you’ve claimed allowances for your children in past, you’re losing a chunk of taxable income reduction that may invalidate your previous W-4 tax withholding status. Without these allowances, you guessed it, you may not be withholding sufficient earnings now to break even or create a refund in 2019.
High Income Happenings
Individual income tax rates for high income earners are changing between the 2017 and 2018 tax years. If you’re earning between $200,000 and $500,000 annually, you may be affected. Not everyone will be, but the brackets have changed enough that you could seem more of your income taxed at a higher rate. That’s even before examining the other provisions provided under the new Act. Higher earning taxpayers are traditionally more likely to use the itemized deductions method for tax preparation, so changes to tax brackets are not likely to be offset by deductions.
A Quick Check
Since there’s the potential for a big tax bill at the end of the year, have your accountant run last year’s returns using next year’s tax rules to see how your overall tax picture may change. While you may pay a little extra now for the service, you may be spared an expensive surprise come next tax season.