This past tax season had big surprises in store for many filers. The Tax Cuts and Jobs Act, which went into effect for the 2018 tax year, was the biggest update to our tax code in more than 30 years. Unfortunately, that means many people who usually get a refund ended up owing money this year.
For some, it was because they lost valuable deductions and credits. But for others, it was because they had too little in taxes withheld from their pay throughout the year and had to pay the difference come tax season.
According to the IRS, new withholding tables were needed for 2018 to reflect changes to tax rates and tax brackets, an increase in the standard deduction and other changes made by the TCJA. That means that even if your overall tax liability decreased last year, you could have ended up owing some money because you didn’t update your W-4.
Here’s what you need to know about how tax withholdings work and how to update yours.
Understanding The All Important W-4
Every time your employer pays you, it has to withhold some money from your paycheck for taxes. So whenever you start a new job, part of the onboarding process includes filling out an Employee’s Withholding Allowance Certificate, also known as a W-4. This form tells your employer how much of your income to set aside for taxes. You can also update your W-4 any time, such as when you experience a major life change like a big raise or a new child. It’s a good idea to review it each year.
The W-4 is a fairly simple form to complete. It includes a few worksheets to help you determine how many allowances to claim.
“Generally speaking, the lower the number of allowances, the more tax is withheld from an employee’s paycheck,” said Dane Janas, an enrolled agent and owner of digital tax firm Boundless Tax.
For example, if you claim an allowance of zero, you have the most tax withheld from your paycheck and be more likely to end up with a refund. On the other hand, claiming an allowance of one or two means fewer taxes are withheld, resulting in a bigger paycheck. Of course, you could end up with a whopper of a bill come spring if you withhold too little. “This can further be tweaked by requesting additional withholdings from your paycheck in terms of a dollar amount,” Janas said. Your goal should be to break even at tax time.
If your situation is fairly simple ― single, one full-time job, no dependents ― figuring out your ideal withholding isn’t too difficult. But when you have a family, or maybe a second freelance job that requires you to estimate and pay your own taxes, things can get tricky.
To make matters more complicated, the IRS is in the process of developing a new W-4 that better reflects the recent tax law changes, which it plans to release later this year. It’s expected to be much more complex. In fact, some experts say that filling out the new W-4 will be akin to actually doing your taxes.
In the meantime, though, everyone is still relying on the old W-4. And if you owed taxes last year ― or got a giant refund ― it’s a good idea to revise your W-4 so that the correct amount of taxes are withheld this year.
How To Adjust Your Withholding
A September 2018 survey conducted by Liberty Tax found that 70 percent of respondents knew the purpose of a W-4, but about the same amount (69.5 percent) had not checked their withholding within the last six months. The problem is many taxpayers weren’t aware of how the tax law changes would impact this aspect of their taxes. Eighty-five percent of survey respondents said they were slightly familiar or not familiar at all with the changes that may affect them.
“Regardless whether you were one that received a rather higher or lower tax bill for 2018, getting your tax withholding right is extremely important,” said Paige Knight, marketing coordinator for accounting firm Gurian CPA, PLLC. “If you found yourself with an unexpectedly high tax bill for 2018, it is even more important to adjust your tax withholdings to avoid interest and penalties.”
1. Rely on the worksheets: According to Knight, there are two key numbers you need to fill in your W-4: The number of allowances you’re claiming and any additional tax you’d like to have withheld from your paycheck. Use the worksheets that come with the W-4 to help you determine the right amounts. These worksheets include:
- Personal Allowances Worksheet
- Deductions, Adjustments, and Additional Income Worksheet, which you should use if you plan to itemize deductions, claim certain adjustments to income or have a lot of non-wage income that isn’t subject to withholding, such as freelance income.
- Two-Earners/Multiple Jobs Worksheet, which helps you determine the right number of allowances if you have multiple jobs, or you’re married and both you and your spouse work.
2. Use the IRS withholding calculator: Filling out the worksheets and estimating how much of your pay should be held for taxes can be confusing. To help you double-check whether you claimed the right number of allowances, the IRS offers a free withholding calculator. To use it, be sure to have recent pay stubs and your tax return from last year handy.
3. Check with a pro: If you have any questions or concerns about filling out your W-4 correctly, have a tax professional look at your withholdings. “Many professionals will provide this service at no cost, especially if you are an existing client,” Janas said. They’ll be able to tell by looking at your W-2 and tax return if your withholdings are too low or too high, and how to go about adjusting them.
Even though we’re already more than four months into 2019, it’s a good idea to go through this process if you fear you will owe again for the 2019 tax year. Getting hit with a surprise bill can be a blow to your budget, and paying taxes late can result in hefty penalties. “A late adjustment is better than none at all,” Janas said.