The Wealthy Accountant (MMM's accountant FWIW)
has found that every one of his clients that he has met with since the new withholding tables were implemented by employers is under withholding for next years taxes, so it seems pretty likely that a number of people here are as well.
His suggested solution is to hire an accountant, even if you don't normally use one, to help you figure out your withholding, which doesn't seem quite necessary to me, so I thought I'd write up a little primer on making sure your withholding is right regardless of what form W4 is calculating as the "correct" number of allowances.
Also note that I think
@MDM's case study spreadsheet can do a lot of this for you.
Onward...
Step 1: Figure out how much you want to withhold
Option A: Withhold enough based on your 2017 tax liability that you won't owe a penalty.
The advantage of this is that you can figure out exactly how much you need to withhold so you won't own a penalty. The disadvantage is that you still might owe something in 2018 if you make more money or the new tax bill effects you unfavorably. The other disadvantage is that you might overwithhold (give the government an interest free loan) if you make less money or the tax bill effects you favorably.
You can find your 2017 tax liability (this is not the amount you owed or received as a refund, this is your total tax liability regardless of the amount you paid during the year) on line 63 of your 2017 Form 1040.
As long as your total withholding in 2018 is at least 100% of the amount on line 63 (110% if your AGI, found on Form 1040 line 37, is under $150k) of the amount found on line line 63, then you may owe tax (or get a refund), but you will not owe a penalty.
Option B: Withhold near enough what you will owe in 2018 that you won't owe a penalty.
The advantage of this is that you won't owe a penalty and you'll pay pretty close to what you owe, so you will neither owe a large amount, nor give the government a large interest free loan. The disadvantage is that it will be a little while before there are 2018 tax calculators available, and the DIY version (below) will only work if you have a pretty simple tax situation, so this option is somewhat "dangerous" in that if you badly miscalculate you may owe a penalty.
If you have a simple tax situation, then you can probably get a pretty good estimate of your 2018 tax liability by guessing what your income after deductions (like health insurance, 401k, HSA/FSA, etc) will be, subtracting your standard deduction ($12k single, $24k married), multiplying that by each
tax bracket you fall in, and subtracting $2000 times each child you have (as long as your AGI is under $200k single/head-of-household, $400k married) for the child tax credit.
If your situation is less simple, like you own a business (how the new 20% QBI deduction will work is still up in the air), you expect to still itemize despite the higher standard deduction and limitations to itemized deductions, or your income is high enough then you'll need to do more research.
As long as you:
1) Owe less than $1,000
OR
2) Paid at least 90% of you total tax liability
Then you won't owe a penalty
Step 2: Figure out what you have already had withheld
This should be available on your paystub, or from your HR department. If your HR department takes a few pay cycles to implement withholding Form w4 changes then you may want to include those expected amounts in your step 2 amount by adding the amount withheld from your most recent paycheck multiplied by the number of pay cycles you expect it to take before the changes you'll make take effect.
Step 3: Figure out how much you need withheld from the rest of your paychecks this year
Part A: subtract Step 2 from Step 1 to find out the total amount you need to withhold the rest of the year.
Part B: Divide Step 3, Part A by the number of pay periods you have remaining in 2018 to find out the amount you need withheld from each future pay check.
If you expect a change in pay during the year you can still do this, you'll just need to do this process again at that point starting at Step 2.
If you have variable pay you can still do this, but you'll probably want to repeat this process a few times starting at Step 2 and using a guess of average pay in Step 4. The larger your variation, the more often you'll want to repeat to stay on track.
Step 4: Figure out your withholding
You can learn how your payroll department has been instructed to compute your withholding from
Publication 1036.
For each allowance you mark on Form w4, you will subtract the following amount from your taxable income (income after deductions like health insurance, 401k, HSA/FSA, etc) depending on how often you're paid.
Payroll Period | For Each Withholding Allowance |
Weekly | 79.80 |
Biweekly | 159.60 |
Semimonthly | 172.90 |
Monthly | 345.80 |
Quarterly | 1,037.50 |
Semiannually | 2,075.00 |
Annually | 4,150.00 |
Daily | 16.00 |
Look up the appropriate table in
Publication 1036 based on how often you're paid and whether you plan to mark Single or Married on your Form W4.
Part A: Next, take your income after deductions for each pay period (found on your paystub), subtract your number of allowances times the amount for each allowance from the table above, and find the withholding calculation in the appropriate pay period table for this amount.
So, say you selected married and 3 allowances, and you're paid $5000 monthly after deductions. You would then have an income after allowances of $5000 - $345.80 x 3 = $3962.60 You would then look at Table 4 and find that you subtract $2550 from $3962.60, multiply by 12% and add $158.70, so your withholding per paycheck will be ($3962.60 - $2550) x 0.12 + $158.70 = $328.21 per monthly pay check.
Part B: Compare Step 4, Part A to Step 3, Part B.
- If your calculated withholding is less than your desired withholding, try adding an allowance and start Part B over again
- If your calculated withholding is more than your desired withholding, try removing an allowance and start Part B over again. If have a very large number of allowances and you're still withholding too much then you'll need to ask your payroll department what the largest number of allowance they'll let you set is, use that, and know you'll probably get a refund.
- If your calculated withholding is less than your desired withholding and adding one more allowances causes it to be more, congratulations, you're almost done! Enter the number of allowances you used in this calculation on your Form w4
If you're a 2 income household, you may find that you under withhold by a lot even with 0 allowances. In this case try using the single table for your pay period. If this works better then you'll mark "Married, but withhold at higher Single rate" on your Form w4. Or you could just enter a larger amount in Part C.
Part C: Subtract Step 4, Part A from Step 3, Part B. This is the amount you should enter as the additional withholding amount on your Form W4.
Step 5: If your spouse works, include their withholding in these calculations.
The IRS doesn't care which spouse does the withholding, so you can set it up any way you want. For example, if one spouse is higher paid you may want to have them do most of the withholding so the other spouse can afford to max out their retirement accounts. You'll need to include the withholding to date (Step 2) from each spouse, and you'll need to perform Step 4 for each spouse separately, then add them together. It might be easiest to get one spouse pretty close with Step 4, Part B and then only move on to Step 4, Part C with the other spouse such that only one spouse has an additional withholding amount entered.
Step 6: Check back when you get your next paycheck to make sure your employer is withholding the amount you calculated, and as in Step 3, if you get a pay raise during the year or you have variable pay check back in periodically.
And that should do it! No need for an accountant, you won't owe a penalty, you won't owe too much, and you won't give too big an interest free loan.
Remember that if you based your target withholding on last year (Step 1, Option A), you may still owe a lot (but no penalty), so you may want to try out some 2018 tax calculators as they become available and do a test run of your taxes when your preferred tax software releases a draft version in the fall to make sure you aren't surprised. You can always change your withholding at that point.