The sweeping tax bill (H.R. 1) signed into law by President Donald Trump on December 22, 2017, will impact almost every area of taxation, including corporations, pass-through businesses, and individuals. How will the tax bill impact payroll and your paycheck?
Employers and employees can expect to see changes to wage withholding in 2018 because of the elimination or suspension of many exclusions and deductions. The bill keeps the seven individual federal income tax brackets currently in place, but lowers most of the rates, including the highest marginal tax rate. The new rates of 10, 12, 22, 24, 32, 35, and 37 percent take effect Jan. 1, 2018, and expire Dec. 31, 2025. To help businesses transition to the new law, the Treasury Department is allowing the use of 2017 percentage income withholding methods as late as February 15, 2018. The changes impact federal income tax withholding only and do not impact social security and Medicare payroll taxes, which will remain the same.
The format of the Employee’s Withholding Allowance (Form W-4) will eventually need to be changed because the tax bill suspends personal exemptions until at least 2025. However, the Internal Revenue Service (IRS) has designed the new 2018 tables to work with the existing W-4 format, even though personal exemptions are no longer recognized in the new tax law. This means that employers and employees can continue to use the existing W-4 format until the new format is released by the IRS. Therefore, it’s not expected that the IRS will require employees to file the new W-4 form before the 2019 tax year.
To help people determine their withholding, the IRS is revising the withholding tax calculator on IRS.gov. The IRS anticipates this calculator should be available by the end of February. Individuals are encouraged to use the calculator to adjust their withholding once it is released.
While the new tax law suspends personal exemptions until the end of 2025, the law replaces them with an allowance amount for each employee. However, the new tax law does not explain what an allowance amount is. This means the Internal Revenue Service will need to decide whether an allowance is equivalent to a personal exemption and/or equal to a specific amount. This all must be decided before the new W-4 form is created.
According to the IRS, “an alien is any individual who is not a U.S. citizen or U.S. national. A nonresident alien is an alien who has not passed the green card test or the substantial presence test. The amount added to Nonresident Alien Employee wages for calculating withholding has almost tripled for 2018. The new additional amounts can be found in the IRS Notice 1036.
States with income tax withholding policies that use the federal personal exemption will be affected by the new law. Because of the elimination of personal exemptions, states that plan to follow the federal system in 2018 would have to change their withholding methods as well. The 30 states that allow use of the federal Form W-4, Employee’s Withholding Allowance Certificate, may need to change their policies in 2018.
The ten states which require the use of federal Form W-4: Colorado, Idaho, Montana, Nebraska, New Mexico, North Dakota, Oklahoma, Oregon, South Carolina, and Utah. A change in the W-4 form is expected to impact these states.
Many states use additional elements of the federal tax code in the withholding process, so state withholding could very well be impacted by the federal changes.
The optional flat tax rate used to withhold on supplemental wages such as bonuses and commissions is set to decrease from 25% to 22%. The federal income tax withholding rate on supplemental wages exceeding $1 million falls to 37% from 39.6% starting Jan. 1, 2018.
Outside of withholding, a big change for payroll is the elimination of tax-free moving-expenses as of Jan. 1, 2018. Because employees will not be able to deduct moving expenses for payments made after Dec. 31, 2017, employers must include as wages any related reimbursements or payments after that period. This means that moving expenses that used to be treated as non-taxable reimbursements will now be taxed similarly to other earnings.
The law will also eliminate the qualified bicycle transportation fringe benefit of $20 a month. Contrary to early reports, the pretax treatment for qualified transportation benefits will remain, although employers are no longer able to write-off any expenses related to those benefits.
Backup withholding is used to assure that federal income tax is paid on earnings in cases when an independent contractor or recipients of other, nonwage payments lack taxpayer identification numbers. Generally, such nonwage earnings are reported by employers on Form 1099-MISC, Miscellaneous Income. Under the new law, backup withholding will be reduced from 28% to 24%.
It is likely that most people will see an increase in their net pay due to the change in the 2018 withholding tables. For example, an employee who earns $60,000 a year, files single with no allowances, and is paid twice a month will see her semi-monthly federal withholding decrease from $423.49 in 2017 to $346.90 in 2018. This will increase her net pay by $76.59 on each paycheck.
A different employee who also earns $60,000 a year, files married with two allowances, and is paid twice a month will see her semi-monthly federal withholding decrease from $231.46 in 2017 to $184.88 in 2018. This will increase her net pay by $46.58 on each paycheck.
Payroll calculator websites like paycheckcity.com can help you review your expected 2018 withholding based on your salary, pay frequency, and filing status.
Whether you agree or disagree with the tax changes, there is no disputing that they are now law. With the new withholding tables going into effect by Feb. 15, 2018, most employees will be seeing some increases in their net pay.
Want more payroll answers? Check out Matt’s Money Matters posts.