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If you receive an employee paycheck from your company—physical or direct deposit—you might be wondering how your company magically knows how much tax to withhold. Here’s a secret—they are guessing (estimating, really), and you might need to double check to make sure they’re right.
It all goes back to the form you filled out years ago when you started with your company, the W-4. It might be lost in your memory, as it was presumably the least exciting part of your new job. You were told to fill out the W-4 with your exemptions, and based on that amount your employer or payroll company will estimate what your tax picture may look like.
How long ago did you start your job? Months? Years? Since then you might have gotten married, had kids, took on a mortgage, or other financial fluctuations, but you’ve never changed that form. It was done at a busy point in your life, with a lot going on at your new company, and it likely wasn’t a priority.
Now, years later, not only has your life changed but so have the tax laws. Next April when you file your taxes, you might be shocked by how much you owe, or that the government is sending you a massive refund. While the refund sounds great, it is simply a loan that you have been giving the government over the last year.
What’s different?
Because of the tax law signed in December 2017, the amount of tax withheld from your paycheck probably changed for 2018 and beyond based on the new tax withholding tables. There are a lot of factors at work, such as how often you get paid and what you filled out on your W-4. You might have even put in an extra withholding on your form since you had a steady salary and roughly knew how much you would owe.
But now that number has most likely changed. The tax brackets are no longer the same, and you hopefully owe less taxes this year. Come next April, you might be thrilled to receive a hefty check—but that’s your own money that you are getting back. You’re lending the government a loan, and they aren’t paying any interest.
What do I need to do?
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Update your W-4- even if you just filled it out last year
You might not have had any big life changing moments in the past six months, but the tax code has had a major overhaul and your situation likely no longer has the same tax implications.
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Do your own tax math and don’t assume your company has it right
Because of the changes in the tax code, lower tax rates don’t tell the whole story. Certain items are no longer deductible, and with the standard deduction doubled, the taxes you owe could be affected by things outside of your employment income. Things that your employer may know nothing about.
In other words, an outdated or incorrect W-4 can cause even greater swings in a refund or the money you owe at tax time than the actual changes in tax rates. Some examples are mortgages, advisor fees, property and state taxes, or even the size of your family.
As much as you trust your employer, or the payroll company they employ, they don’t know your full financial situation. The IRS has a Tax Withholding Calculator, updated for 2018, to help you crunch your numbers.
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Don’t forget the second page
I’m only slightly joking. There’s a lot to the W-4 that could apply to you—to make sure you don’t miss it. There’s a great guide on page two, and if you walk through the worksheet you’ll likely get a lot closer to the right amount of withholding
After the April deadline passes, taxes might be the last thing on your mind. But now is a great time to evaluate your tax situation. Did you get a refund? Owe a big check? Take a look at all of the paperwork you’ve already collected to get an idea of next year’s taxes, and be ahead of the game.