With 2018 already nearly half gone, it’s a good time to double check your income tax withholding to see if you are having adequate withholding done to cover your total 2018 tax liability. While most employers have employees fill out a Form W-4, Employee’s Withholding Allowance Certificate, annually, the calculations done using that form in most employers’ payroll systems are fairly mechanical and may miss situations where the withholding should be adjusted.
|Income Range Individuals||Income Range Married Filing Joint||Tax Rate|
|$0 - $9,250||$0 - $19,050||10%|
|$9,526 - $38,700||$19,501 - $77,400||12%|
|$38,701 - $82,500||$77,401 - $165,000||22%|
|$82,501 - $157,500||$165,001 - $315,000||24%|
|$157,501 - $200,000||$315,001 - $400,000||32%|
|$200,001 - $500,000||$400,001 - $600,000||35%|
|over $500,001||over $600,001||37%|
Here are some common situations where the simple payroll tables may cause over or under withholding and a more detailed calculation is warranted:
- For taxpayer’s filing married-filing-jointly where both spouses work, use of the regular calculation driven by information only from Form W-4 may cause under withholding – this is because the tables assume as a starting point that a working spouse is the only breadwinner in the family. In calculating the actual income taxes, the spouse’s income is “stacked” on top of each other, pushing the couple further up the ladder of tax brackets (refer to the table above to see where the 2018 tax rates fall). This is the so-called “marriage penalty” that you see references to in articles about tax fairness.
- Where a taxpayer works more than one job at a time – here again, the income from each job is stacked on top of the income from the other job, pushing the taxpayer higher up on the income tax bracket ladder. The tables for payroll withholding that the Form W-4 is fed into assume that each job is the sole job of that taxpayer.
- If you take an early distribution from a §401(k) or other retirement plan. If you’re under age 59 ½ at the time of the distribution, the distribution will generally have a tax penalty of 10% tacked on, in addition to be subject to income tax. Often the retirement plan will employ an arbitrary withholding rate of 10%, 20%, or other rate, without taking into account your other income during the year. This may make you over or under withheld for the year on that income.
- If you live in a state where that has an income tax and you pay more than $10,000 in state and local taxes – while the 2018 federal tax tables were adjusted to reflect the new federal income tax rates (generally, lower rates for most individuals), the tables don’t take into account changes to itemized deduction limitations – for example, state and local tax expenses exceeding $10,000 are no longer deductible in calculating federal income taxes after 2017. This may cause the normal payroll tables to under withhold in income taxes.
- If you are self-employed or part of the new “gig” economy – income tends not to be periodic and may have peaks and valleys during the year or from year to year. This may cause any withholding done to be off significantly.
- Investment income is generally not subject to federal withholding of any kind. If you have other the minimal interest, dividend, or capital gain income, you should do a careful evaluation of your estimated tax liability and either make separate estimated tax payments or adjust wage withholding up to cover the liability.
What happens if you’re off?
Over payment through withholding or estimated taxes generally incurs no penalty, but you lose the use of your money during the time between when the IRS receives it and when you get your refund. Underpayment of taxes may qualify for relief from any penalties under one or more of a few provisions, but if a penalty is due, it’s calculated like interest based on an annual rate that is currently 5% (although that varies, based on the interest rate the federal government pays on certain debt).
What can you do to avoid a penalty?
The IRS maintains a more detailed calculator than can help with determining whether you’re on track for your withholding for the year. The 2018 version is located here and can be used by most filers. To use the calculator, you’ll need a copy of your last year’s (2017) tax return and good estimates of your 2018 income sources and the withholding you’ve had taken out so far. This may help you avoid a penalty and/or having significant underpaid taxes due next April 15. If your situation is too complex for the online calculator, this might be a good time of year to talk to a CPA about helping you with the calculations.
If you are taking the Required Minimum Distribution from an IRA and have income from investments (i.e. do not use the W4), you are probably paying quarterly estimated income tax. I avoid the hassle of trying to estimated anticipated income, by using the option to pay either 100% or 110% (for higher income situations) of the previous years tax. It is withheld quarterly, when I take my RMD payments.
In the past few years, and especially now with the economy growing, I end up owing the government under $1,000 and avoid any penalties, even if my tax due would otherwise incur one.