The Impact of Increased Take Home Pay on Your Tax Return

What could increased take-home pay mean for your 2018 tax return?

The recent tax reform has instituted a variety of changes in both individual taxes and business taxes starting in 2018. Many Americans can expect a decrease in tax, and with the new federal withholding tables released earlier this year, an increase in take home pay. Less tax and more pay, what’s not to like?

The goal of this change in federal withholding tables was to adjust for the new changes that will impact individual taxpayers. Some of the major changes include a decrease in tax rates, an increase in the standard deduction, and a repeal of personal exemptions.

However, we have found that the change in withholding may not be enough to cover tax liability in many cases. In the past, many relied on Form W-4 without much extra thought to get them close to the amount needed to pay their tax. This year, we suggest analyzing it a little further. Taxpayers may get less of a refund than they are used to or even owe tax in April 2019, even though their tax rate is lower.

Example: Vince is single, has no dependents, and earns $50,000 in wages in 2017. He is paid on a bi-weekly basis. The result is $296 in federal income tax being withheld from each paycheck or $7,707 withheld for the year. Vince’s actual tax liability, including the 2017 standard deduction of $6,350 and exemption of $4,050, is $5,645. This gives Vince a refund of $2,062.

Under the new tax law, assuming the same income, the 2018 standard deduction of $12,000 and no personal exemption, Vince’s tax liability will be $4,370. Due to the withholding changes implemented in February, Vince’s federal income tax being withheld for the year will be $6,247 (The above $296 for two pay periods and the new rate of $236 for twenty-four pay periods). This gives Vince a refund of $1,877.

As you can see above, although Vince’s tax liability decreased $1,275 from 2017 to 2018, he receives less of a refund. This example does not take into account any extraneous circumstances such as investment income, itemized deductions or dependents that many taxpayers have. If Vince has other sources of income and got a smaller refund for 2017, he could owe tax for 2018.

Luckily, the IRS has released a tax calculator to help check how much you should be withholding in 2018. If you are not familiar with how to use the calculator, this video will demonstrate how.

If you identify a needed change in your withholding, please contact your employer to fill out a new Form W-4. LBA Haynes Strand can also provide additional analysis and answer any other questions you might have about this subject.