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Update your W-4 to avoid an unpleasant tax surprise

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By Thanh Ngo

Sunday, March 18, 2018

With the tax cuts passed by Congress in December 2017, the nonpartisan Tax Policy Center estimates that 65 percent of households will see higher take-home paychecks and 6 percent will see lower paychecks.

As excited as you might be to see larger take-home paychecks, it is critical to check and adjust your withholding tax information on the W-4 form to avoid nasty surprise of owing more money in taxes in April 2019.

The W-4 form is an IRS form you provide to your employer to determine how much money to withhold from your paycheck for federal taxes. The IRS recommends employees to revise and submit new W-4 tax form each year. However, employees typically fill out the form when first hired, and rarely pay attention to updating the form afterwards unless there are major life changes such as marriage, divorce or new birth in the family.

Under the old withholding system, the amount of income tax withheld from your pay was based upon various personal exemption criteria such as whether your spouse works, whether you have children and whether you itemize. The more allowances you claim, the less federal income tax will be withheld and the larger your take-home paycheck.

The tax overhaul revokes the personal exemptions and replaces them with doubled standard deduction. Individual filers can now deduct $12,000 (an increase from the old $6,350) from their income before the tax rates are applied.

For joint married filers, the new deduction is now $24,000 in comparison to the old $13,000 standard deduction. As a result, your employer can under- (or over-) withhold your federal tax using the old W-4 form on file. Under-withholding could mean an unexpectedly high tax bill in April 2019, while over-withholding is equivalent to lending Uncle Sam your money with zero interest.

For example, case studies by Urban-Brookings Tax Policy Center show that a family of four could claim four allowances ($4,150 for each allowance, adjusted for inflation) on top of the standard deduction of $13,000 for married filing jointly, shielding up to $29,600 from tax ($4,150 × 4 + $13,000).

Under the new tax law, the family can take the standard deduction of $24,000 for married joint filers without personal exemptions. In addition, the couple would benefit from the enhanced child tax credit of $4000 in total ($2000 per child). Thus, the amount of tax liability might be different for this family between 2017 and 2018. This might result in too little withheld tax if the filers do not adjust their existing W-4 form for the withholding amount.

In February 2018, the IRS released the withholding calculator (available at https://apps.irs.gov/app/withholdingcalculator/ ) to help tax filers to figure out the amount they should withhold on their W-4 form to avoid under-withheld tax and consequently unexpected tax bill or penalty in April 2019.

You do not have to reveal personal information in order to use the calculator. The withholding calculator shows the expected amount of tax owed under your existing withholding schedule (as specified on your current W-4 form), provides suggested adjustments to the existing withholding schedule, and projects the amount of tax refund based upon the suggested adjustments.

Thanh Ngo is an associate professor in the Department of Finance in the College of Business at East Carolina University.

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