The Tax Cuts and Jobs Act (TCJA) made significant changes in the way an individual’s tax liability would be computed, from changing the tax rates to eliminating the deduction for dependents. Many taxpayers were surprised at the disconnect between their withholding for 2018 and their tax liabilities since Form W-4, the instructions to employers on how much to withhold from an employee’s pay for federal income taxes, hadn’t been revised to reflect those changes.
Beginning in 2020 there is a new W-4 designed to reflect the changes in the TCJA. While the IRS claims to have “reduced the form’s complexity”, we’ll leave that to your judgment.
Taxpayers starting a new job or who want to change their withholding are required to use the new Form W-4. Withholding for employees who don’t complete the new form will continue to be based on the withholding allowances on the last W-4 submitted. Those employees should be aware that the withholding may not be sufficient and consider filing the new W-4 even though not required to do so.
The new form takes the employee through five steps. Only the first and fifth are mandatory. The first step is pretty straightforward (name, address, social security number) but does require the selection of a filing status. That selection alone will determine the standard deduction and tax rates used to compute withholding.
Step 2 of the form is for employees with more than one job or married employees who will file a joint return with a spouse who also works. There are three options in this section. To get the most accurate withholding estimate the IRS suggests using the estimator located at www.irs.gov/W4App (available in January). The estimator should also be used if either employee or spouse has self-employment income. If additional taxes are computed, that is entered as extra withholding in Step 4(c) of the form.
Alternatives to the estimator are a Multiple Jobs Worksheet (page 3 of the form) or using Box 2(c) which will be accurate if there are two jobs, both with similar pay. This would be appropriate withholding for spouses who have jobs with similar pay if both check this box.
Step 3 of the form accounts for the credit for dependents. This credit is available only to taxpayers filing jointly with less than $400,000 of income, $200,000 for singles or married filing separately.
Step 4 takes into account additional factors that go into the computation of the ultimate tax liability:
- Other income (like investment income) on which there is no withholding
- Deductions for those not using the standard deduction or who will be deducting student loan interest, contribution to a traditional IRA, etc. There’s a worksheet on Page 3 of the form to compute that as well. Be very careful to include only amounts in excess of the standard deduction on line 4(b).
- Additional withholding requested for each pay period. This section can be used by employees who don’t want to disclose additional income in Part 4(a) and can also account for, if applicable: household employment taxes, the additional .9%
- Medicare tax, and the 3.8% tax on net investment income.
NOTE: employees exempt from withholding should write EXEMPT in Step 4(c).
The only thing remaining for the employee now is to sign the return. The employer has the hard work of determining the amount to withhold from each paycheck for federal income taxes. There’s a new IRS Publication (15-T), not yet available in final form, to assist employers in making this calculation. That publication is over 20 pages long and looks far from simple, so if an employee feels that withholding is not appropriate based on the W-4 submitted, a follow up with the employer is recommended.
The new Form W-4 is designed to approximate the taxes that a taxpayer will owe based on factors expected at the time the form is filed. Changes in marital status, anticipated income, or allowable deductions could mean a new form should be filed so that at the end of the year, withholding, along with any estimated taxes paid, is sufficient for the taxpayer’s liability for 2020.