2018 is well underway, and the affects of the new tax plan are starting to hit our paychecks. If you are an employee that is paid on a regular basis, you may have noticed that your paycheck just got a little bigger. The questions I’d like to address are “Why did my paycheck change?” and “Should I keep the extra money?”
First, let’s talk about why your paycheck just changed. Every year, the IRS establishes federal income tax withholding tables that all employers have to follow. These tables indicate how much should be withheld from your paycheck, and depends primarily on 4 major factors:
1. Whether you indicate on your W-4 form that you are filing married, single, or married and filing as single. The W-4 is a form that you filled out when you first started working and probably haven’t thought much about since,
2. How many exemptions you filed on your W-4. This generally indicates how many dependents are counting on you (excluding your pets). The more dependents you have, the less the IRS is going to withhold,
3. How often you are paid (weekly, bi-weekly, semi-monthly, etc.), and
4. Your estimated annual pay.
The tables take all that information, estimate how much you are going to pay in federal taxes and tell your employer how much to withhold from your paycheck. The state that you live in issues similar tables, but I am just addressing the federal withholding tables.
The reason your paycheck just changed is because the IRS has updated the tables. They have looked across all of America and decided that as a result of the most recent change in the tax laws, most of America’s taxes are going to go down. They are trying to recognize that and give you more of your money now, instead of giving you a bunch back in April 2019. Isn’t that nice of them?
This leads to my second question: Should you keep the extra money that you are getting from your bigger paycheck? The answer to that question is, of course, it depends. There are two scenarios:
• If your taxes really are going down, you can either keep the money or (better yet) change your direct deposit instructions with your employer to put that extra money into a savings account. You were rolling along without the extra money…just keep setting it aside in a savings account for you, rather than sending it to the IRS as taxes.
• If your taxes are either going up or staying the same, then you need to take steps with your employer to push the withholding back to its previous levels, or maybe even a little higher. If you don’t, you are going to end up owing more taxes than you expect next April, and no one wants that kind of surprise. The easiest way to do this is to fill out a new W-4 and put the amount of the decrease in the withholding on Line 6.
So how do you know whether your taxes are going to go up or down? There are a couple of ways to determine this:
• If you have someone do your taxes for you, ask them to prepare a 2018 tax estimate, based on the new tables and the new rules. Then look at your paycheck and make sure that whatever is being withheld, times the number of paychecks you get in a year, at least equals the estimate. If so, you are in good shape. If not, you’ll want to update your W-4, especially if you are going to come up short.
• If you do your own taxes, you can follow this general guideline (and remember, this is a very general guideline, so you’ll need to do some number crunching to determine if this applies to you):
• If you currently take the standard deduction and don’t have more than 2 children, your taxes will likely go down. The change in the tax tables is probably fine and you can spend or save the amount in your bigger paycheck.
• If you own a home in a state that has a high property taxes and high sales taxes (i.e. California), you have a mortgage, and/or you have 2 or more children, your taxes will likely stay the same or perhaps edge a little higher. You should take a good look at your withholdings to make sure you aren’t under-withholding as a result of the change in the tax tables.
All of this tax stuff can get overwhelming, but hopefully, this makes it a little less confusing and helps you be better informed and more in charge of your finances.