Posted in Payroll | by: Caleb Newquist

Remind Your Employees to Double-Check Their Withholding Before 2018 Runs Out

Judging by the amount of pumpkin spice crap in my line of sight, autumn is here. That means shorter days, crisper air, changing color, and in 2018, an unpleasant activity. No, I’m not talking about raking leaves or screwing up some new soup recipes; I’m talking about double-checking the amount of taxes that have been withheld from your paycheck this year.

There are only a few months left in the year, and W-2 workers should be sure that the new tax law won’t put them in a tight spot come tax time.

The tax cuts that went into effect this year mean you likely owe a different sum this year than in previous years. If your withholding doesn’t keep up to what you owe, you’ll have to cut a check to make good with the IRS.

Why you, and your employees, should care

Now, you might be saying, “Um, didn’t tax rates go down? Why would I need to check if I’m withholding enough tax when I will be paying less tax?”    

On the one hand, yes, many people will be paying less tax. But this means many people will potentially have a much larger refund heading their way. That might sound great, but, as we’ll address below, a BIG refund isn’t all it’s cracked up to be.

On the other hand, yes, tax rates did go down, but it’s also not quite that simple. Changes made by the Tax Cuts and Jobs Act (TCJA) also eliminated or limited certain deductions—like the state and local tax (SALT) and mortgage interest deduction for some taxpayers. If deductions you normally take have been limited, there’s a chance you could wind up owing tax if you don’t adjust your withholding.

And that’s a problem. Americans are notoriously bad at saving, so many won’t have the cash on hand. Plus, an unexpected or larger-than-expected bill is especially stressful when you have to make good with the IRS. They are accommodating to taxpayers who need to make arrangements for paying their tax due; however, they are not so pliable if you fail to do so. Interest and penalties can pile up quickly, and you might have to hire a professional to help resolve the situation.

We’ll go into more specifics of the law below, but first let’s cover what you should do about your withholding to make sure you’re not one of the folks who ends up with a surprise bill.

The clock is ticking on 2018

If you’re a business with full-time employees, now—like, RIGHT NOW—is a great time to remind those employees to check their year-to-date federal tax withholding. This is how much money from their paycheck has already gone to Uncle Sam this year.

For most people, there are only six or seven paychecks left in the year. That means anyone who is behind on paying taxes through the federal withholding from their paycheck has only a handful of opportunities to increase the amount they pay in.

Hang on, what’s withholding, again?

For W-2, full-time employees, the income tax system works on a “pay-as-you-go” basis. Employers withhold money from their employees’ gross pay (i.e., your hourly wage or salary) for federal and state taxes.

Yes, everyone hates to see those amounts come out of their pay, (see example below). But it does save you the trouble of paying your income taxes yourself—and dealing with the IRS or state(s) department of revenue when things get screwed up.

Who should double-check their withholding?

Really, all your employees should double-check their withholding—especially this year, and especially those people who haven’t changed it in a while.

A recent report from the Government Accountability Office (GAO) cautions that, due to the changes under TCJA, some taxpayers who are accustomed to receiving refunds could wind up underwithholding, meaning they haven’t paid enough in taxes. Not good!

And if you itemize deductions or have children, you can also expect some changes. The GAO report shows hypothetical scenarios where married taxpayers who itemize deductions, have young children, and earn $180,000 in wage income along with $20K in non-wage income could be at risk for underwithholding. But even taxpayers who don’t fit those criteria may experience some changes this year.

That’s why it’s vital that everyone check their withholding as soon as possible. Better safe than sorry, right?

OK, OK, but how do employees double-check their withholding?

The easiest way is to nudge your team to ring their accountant or other preferred tax pro. Whoever they go to will probably ask for their most recent pay stubs and non-wage income (e.g., interest, dividends, capital gains) information. This, along with last year’s tax return, should be enough for an accountant to tell someone if their taxes are on track, if some adjustments are needed, or—gulp—an estimated payment should be made to help them make up the difference.

What if your employees don’t have a go-to accountant? No sweat, they can still figure out where their taxes stand. Tell them to:

  1. Collect their tax info — This includes their most recent pay stubs, last year’s tax return, and information on any non-wage income they may have. I can’t stress this enough: It’s essential to use the most accurate information possible to calculate the most accurate estimate. A “wild guess” or even a “best guess” for any input is not recommended. We’re talking about taxes, remember.
  2. Use the IRS’s withholding calculator — Once the tax info is in hand, tell your employee to head over to the IRS’s website and answer the withholding calculator questions. Again, it’s important to answer these questions as accurately as possible using pay stubs and last year’s tax return. If your employee experienced changes in the past year (e.g., got married, had kids), that will be relevant to include as well.

Some scenarios

There are a few different scenarios that people are likely to encounter when revisiting their withholding. None of this should be taken as tax advice, but here’s how your employee could potentially proceed with each:

  1. Underwithheld a little (i.e., less than $1,000) Depending on their financial situation, your employee might not need to do anything. They should just know that they may need to pay a bit extra when filing their tax return in 2019. If they’d rather not do that, they can complete the new Form W-4 that the IRS released earlier this year to adjust their withholding.
  2. Underwithheld a lot (i.e., more than $1,000) — Hey, it’s OK. No need to panic. First thing, anyone who’s underwithheld by a lot should fill out a new Form W-4 and make the necessary changes to catch up on the withholding. It’s also a good idea for your employee to start saving after-tax money to put toward making a payment when it’s time to file their tax return. They could also make an estimated tax payment on January 15, 2019 to help catch up, too. All these options are a little painful, but they won’t hurt as much as a big tax bill.
  3. Overwithheld a lot (i.e., more than $2,000) — Um, is your employee OK with Uncle Sam holding on to their money all year long? If they could use that money throughout the year to pay bills, invest, or buy funny hats, your employee should fill out a new W-4 and get their money back.
  4. Overwithheld a little (i.e., about $1,000 or less) — Chill.

Now, some people might be wondering: What makes for a good withholding number? The answer is different for everyone, but in general, a withholding number should get a taxpayer as close to meeting their tax obligation as possible.

As noted above, a small refund is ideal, and owing a small amount is usually fine for most people. A big refund isn’t great because you’re essentially giving the federal government an interest-free loan, and a large underpayment is… ugh… not good.

How about some background?

For those of you who are a little late to the party or want a refresher, here’s the deal: The Tax Cuts and Jobs Act became the law of the land in 2017, and the changes in our tax code went into effect on January 1, 2018. Part of these changes included lower tax rates, which affected the tax tables used to calculate how much federal tax is withheld from workers’ paychecks.

Furthermore, the tax law also changed who would be eligible to deduct things such as mortgage interest and charitable donations. More people will now take the increased standard deduction to determine their taxable income. And while this simplifies tax returns for many, the combination of less tax being withheld and fewer deductions could result in some taxpayers not paying enough in taxes, and thus having to cut a check to Uncle Sam.

Why is this unusual? Because in the majority of cases—75 percent in 2017—individuals who file tax returns are due refunds. If a taxpayer has received a refund several years in a row and hasn’t revisited their W-4 during that time, the new tax law could throw a wrench into their tax situation.

Are you good? OK, jump back up to get the lowdown on how your team can adjust their withholding.

Don’t waste another minute

There is only so much time left in 2018, so don’t mess around. Encourage your employees to revisit their withholding to see if they’re comfortable with their tax situation. And take a look at your withholding while you’re at it! Everyone will feel much better.

About Caleb Newquist

Caleb Newquist is Editor-at-Large at Gusto. In 2009, he became the founding editor of Going Concern, the one-of-a-kind voice on the accounting profession, serving in the role for 9 years. Prior to Going Concern, Caleb worked as a CPA for nearly 6 years in New York and Denver. He lives in Denver with his wife, daughter, and two cats. You can follow him on Twitter at @cnewquist.