Time to Check Your W-4’s

A question came up recently about tax withholding on employee paychecks and a significant change with the new tax law. As most employers and many employees know, Form W-4 “Employee’s Withholding Allowance Certificate,” is the federal tax form that tells employers how much tax to withhold from an employee’s paycheck. It’s one of the standard new employee forms, but employees can update it at any time to adjust withholding. In the past, employees sometimes claimed to have many dependents as a way to have less tax withheld from their paycheck, but that strategy might not work so well in the future.

First, a few important definitions are in order:

  • Dependents. These are the people that a taxpayer can claim “depend” on him or her for their living needs. This can be a spouse or other adult in some circumstances but most commonly includes minor children.
  • Exemptions. In tax lingo this is the amount that taxpayers can claim for themselves and dependents so that it won’t be taxed. Exemptions are subtracted off of adjusted gross income before any tax is calculated.
  • Allowances. This is what the employee calculates and reports on Form W-4 in order to guide how much the employer withholds. The more allowances an employee claims, the less the employer withholds from the paycheck for taxes.
  • Tax credit. This is an amount that taxpayers can claim to reduce their tax owed, dollar for dollar, after taxes are calculated.

The new tax law passed in December 2017 has an important change. No longer will the number of dependents you have be a factor in the number of allowances you can claim on your W-4. Compare the 2017 W-4 to the 2018 W-4, note that the 2017 form asked for the number of dependents in line D of the personal allowances worksheet, the 2018 version omits that. This is because the Tax Cuts and Jobs Law passed in December 2017 phases out personal exemptions for the years 2018 through 2025. The new tax law increases the amount of child tax credits in order to offset the effect of eliminating personal exemptions. See here for a more thorough discussion of this issue.

So, what does all this mean? Let me illustrate with an example: An employee, in an effort to minimize tax withholding, claims a large number of allowances on his W-4, more than the worksheet would indicate. So, the employer doesn’t withhold enough for taxes on paychecks throughout the year. At the end of the year, this employee does his tax return and gets a nasty surprise. He finds out that not only will he not get a refund, he actually owes additional tax. Why? Because he really doesn’t have as many allowances as he claimed on W-4 and the child tax credit is only given for children with Social Security numbers and who are living in the U.S.

On a related topic, employers have asked if claiming too many allowances on Form W-4 is a government red flag. First, W-4 isn’t normally sent to the government, the employer simply retains it and uses it to calculate withholding, although IRS can review it in an audit. There used to be a rule requiring employers to report any W-4’s claiming 10 or more allowances but that rule has been scrapped.

I encourage employers and employees to discuss this and other tax issues with a qualified tax professional. For further reading, here’s an article about doing a paycheck checkup.

Special thanks to Libby Eiholzer from Cornell Cooperative Extension and Darius Arezzo from Farm Credit East for identifying this issue and engaging in a spirited discussion of the implications!


By Richard Stup, Cornell University. Permission granted to repost, quote, and reprint with author attribution.
The post Time to Check Your W-4’s appeared first on Cornell Agricultural Workforce Development.

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