Did your employer recently notify that your next paycheck will be updated? And now are you thinking, “Wait, but I didn’t tell them to change anything with my paycheck!?”
Don’t worry; this is the tax law going into effect. Do you remember way back when, when you started your job and your employer asked you to fill out a Form W-4? Here is a LINK TO A W-4. On this form you told your employer how many exemptions you would likely be taking on your tax return. The W-4 showed 1, 2, 3, etc. exemptions.
If you did not pay much attention to what those numbers meant, you’re not alone. Now, all you know is when you get your paycheck, there are some taxes withheld. Well that 1, 2, 3, etc. on Form W-4 tells the employer what taxes to withhold.
How Tax Deductions on Your Paycheck Work
Using absolutely made up numbers that make the math easy (meaning these numbers DO NOT tie to the actual withholding tables), here’s an example of what your employer does if you selected, “Single”, “4” on your W-4:
- Gathers your information
- Adjusts for paycheck deductions such as retirement account contributions
- Reads the Withholding Tables
Since the IRS generates Withholding Tables, every employer uses the same ones. Assume the withholding tables for Single, 4, and $2,000 net pay reads $153.40. Then your employer will withhold this amount from your paycheck and send it in to the IRS.
Impact of the New Tax Law
Unless you’ve been in a coma the last month, you know there’s a new tax law, even though you may not know everything that’s in it. Well, one of the things it changed is that there are no longer any personal tax exemptions (at least on a federal level). Please look out for a future blog post that explains what exemptions were and why it matters when you’re trying to understand your 2018 tax liability.
So, in the example above, even though your W-4 says “Single” and “4”, the “4” no longer has any meaning. Employers have been waiting to receive the new withholding tables to tell them, “For a Single person with $2,000 net pay, how much do I withhold?”
These new withholding tables have been issued. That is why your employer is notifying you, “Hey, employee, your net paycheck is going to be different than what you’re used to seeing.” I have not seen the new withholding tables, but it is my understanding that for most people the federal amount being withheld from your paycheck will decrease slightly (meaning your net paycheck will increase). So, in the above example, when the employer reads the withholding table for “Single” and $2,000 net pay, the amount to withhold will be $145 (vs. the previous $153.40).
Determining Your Tax Liability
Again – THE ABOVE NUMBERS ARE RANDOM AND DON’T TIE TO THE TRUE WITHHOLDING TABLES AT ALL. It’s just a numerical example to help explain why your paycheck is changing even though you didn’t ask your employer to change it.
ALSO, as a tax accountant, I have to point out–whatever amount you withhold does not actually equal your tax liability! Withholding is a guesstimate of how much tax is associated with your income. You may be over-withholding, under-withholding, or it may be pretty close. The only way to know if your tax liability increases or decreases based on the new tax law to compare your tax liability for 2017 with the tax liability for 2018 (NOT THE REFUND).
Keep an eye out for a future blog about understanding your taxes. There, I’ll talk about how using your tax refund to determine if you’re properly planning your taxes is like a department store telling you how much you saved on sale item rather than how much money you spent.
I hope this helps explain the correspondence you are getting from your employer, stay tuned for another Plain Speak Explanation coming soon.
Cecily Welch, CPA, CFP®, PFS
Has to be said, the above general information is not to be interpreted as specific tax advice and before implementing any tax strategies, consult your own tax advisor.
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