Mind your federal withholding on your paycheck & avoid big tax bills come April
Over the last few years we have seen radical decreases in the federal withholdings on W2s. People weren’t making changes to their payroll yet they found themselves owing more taxes come April.
We began to test our theory that something was wrong with the IRS’s payroll withholding tax tables. We did this by some simple math - dividing the federal withholdings by your taxable wages, that percent was compared to your income tax bracket. Almost always they were low. What’s scary is by no fault of your own or employer.
How federal and state withholdings on your paycheck are determined is via withholding tax tables prepared by the government. All payroll processors are linked to these tables in real time. As the government pumps out tax changes they are ‘updating’ these tables. The problem is they are wrong, causing taxpayers to be in a potential bind come April 15th.
Our theory is being confirmed as national studies are stating results that indicate up to 21% of taxpayers are not having enough withheld due to changes in withholding tables. This is up 18% that were under withheld in 2017. That means the trend will continue in 2018 and people can unexpectedly owe come April. In our opinion the percentage impacted is much higher.
What can you do?
- Test your withholdings just like us outlined above. You can find your tax bracket rate at the bottom of the 2 Year Comparison Report provided in your 2017 tax return. Use the effective tax rate.
- Using another handy report called the Tax Projection Worksheet found within your 2017 tax return you can compare your current withholdings to the amount on line 79 Income tax withheld to see if you are in line to meet that amount. Take a current paystub with the total withholdings year-to-date, add to that a calculation of what you expect to have withheld for the remainder of paychecks for the year. This will give you a gage if you’re under/over withheld. Word of caution, make sure you don’t have any significant taxable changes, if you do the next option below is the safer bet for accurate planning.
- Full tax planning is a process where we gather current tax documents and using tax projection software we estimate your year-end tax liability for this year. Armed with this knowledge you can adjust quarterly tax payments or paycheck withholdings.
Changing Exemptions & Adding Additional WithholdingsBelieve us when we say this is something that can sneak up and bite you unaware. If you feel you are under withheld and are paid via a W2 paycheck you can inform you employer to withhold an additional set amount of federal withholdings each paycheck. This will add to the IRS calculated withholdings. We recommend this as a safer way then simply changing your exemptions.
Exemptions are when you claim Married (or Single) 0, or 1, 2, 3 etc. By decreasing the number you are having more taxes withheld from your pay. Increase the number, less is withheld. Married folks CAN claim Single. Single 0 is the most taxes withheld the IRS tables generate. There’s no way to know ahead of time exactly how changing your exemptions will pan out. If you want to do this, I’d suggest change it and immediately retest using option 2 above. Just know that changing your exemptions are linked to what we know are flawed government tax tables. It can help, but not guaranteed.
To wrap this up, I’d suggest you do one of the options above to test the waters and see if there’s a potential problem. Then review your exemptions, and test changes. Add extra withholdings to cover gaps. Or see us for a full tax planning review!
Remember, you are going to pay these taxes no matter what, it’s just a matter of when; smaller amounts with each pay period, or as one big amount at the end of the year. This flaw isn’t costing you MORE taxes.
Following this practice of minding your withholdings is a very smart money management habit. There are certainly much more enjoyable swings to experience!