Why Federal Employees, Retirees Should Recheck Federal Tax Withholding for 2018

Early in March 2018, the IRS released an updated federal income tax withholding calculator and a new version of Form W-4 (Employee’s Withholding Allowance Certificate). The purpose behind the updated income tax withholding calculator and Form W-4 is to help individuals check and review their 2018 federal tax withholding following the passage of the Tax Cuts and Jobs Act (TCJA) in December 2017. Almost all of the tax cuts resulting from TCJA’s passage became effective Jan. 1, 2018.

This column discusses in more detail why federal employees and retirees should recheck their federal tax withholding for 2018 and, if necessary, make changes to their federal income tax withholding from their paychecks and CSRS or FERS annuities.

Tax Changes from the New Law

Among the major tax changes resulting from TCJA’s passage made were:

1. Increased standard deductions for all filing categories (single, head of household, married filing jointly or separately);
2. elimination of personal exemptions;
3. increased child tax credit amount and higher AGI “phase out”;
4. limitation or elimination of certain deductions including all miscellaneous itemized deductions; and
5. decreased marginal tax rates.

While withholding changes made for 2018 certainly do not affect 2017 tax returns recently filed, individuals are encouraged to use their completed 2017 tax returns as a basis for working with the new IRS withholding calculator in order to determine proper withholding for 2018 and to avoid issues when they file their 2018 returns in spring 2019.

In general, federal employees and annuitants are highly encouraged to annually perform a paycheck or annuity “withholding checkup”. Such a checkup can help protect against having too little tax withheld and potentially facing an unexpected large tax bill or penalty at tax filing time the following spring. It can also possibly prevent employees from having too much tax withheld. In fact, the average refund this recently concluded filing season averaged $2,800. Most employees would prefer to have less tax withheld every two weeks and receive more net pay biweekly.

But with TCJA’s passage and resulting tax cuts, there are additional reasons why employees and annuitants are encouraged to review their Federal income tax withholding for 2018. For example, those individuals who were invested in the stock market during 2017 were ecstatic as to their investment returns. Most equity-based mutual funds had returns averaging 15 to 20 percent during 2017. Many financial advisors bought and sold stocks, ETF’s and other equity-based investments on behalf of their advisory clients and reaped huge investment gains.

With these huge investment gains associated with equities held in non-retirement accounts, taxes had to be paid. Many investors saw large tax bills, paying more in taxes in 2017 than they did in 2016, thus diminishing their overall investment returns. Also, many investors paid their stockbrokers and financial planners huge advisory fees – in some cases $25,000 to $50,000 – to invest their money. These advisory fees were deductible on 2017 tax returns as miscellaneous itemized deductions.

While some do not expect the stock market to perform as well in 2018 as it did in 2017, investors nevertheless need to be prepared with respect to taxes. They should adjust their tax withholding with the expectation of a “decent” stock market performance during 2018. Investors should also note that the advisory fees they paid during 2017 are no longer deductible. Until TCJA’s passage, advisory fees were part of one’s miscellaneous deductions (included on Schedule A) for Federal income tax purposes. Effective Jan. 1, 2018, miscellaneous deductions are no longer part of Schedule A and therefore not deductible.

As a first step to reflect the tax law changes resulting from the TCJA, the IRS released new withholding tables in January 2018. The tables can be downloaded here.  These tables are designed to produce the correct amount of tax withholding, thus avoiding under- and over-withholding of tax for those with “simple” tax situations. This means that employees with simple situations might not need to make any changes. Examples of “simple” tax situations are single employees and married employees in which only one spouse is working. They have no dependents, do not claim itemized deductions adjustments to income or tax credits.

Which Federal Employees Should Check Withholding for 2018?

These employees include:

1.  Married employees in which both spouses are working;
2. employees with two or more jobs at the same time or who work for only part of the year;
3. employees with children who claim tax credits such as the Child Tax Credit;
4. employees who itemized deductions on their 2017 tax returns, particularly those who paid more than $10,000 in state and local income taxes and property taxes; and
5. employees with incomes exceeding $300,000 and have more complex tax returns.

5 Tips for Using the IRS’ Updated W-4 Calculator for 2018

The following are some suggestions for using the IRS withholding calculator:

1.   Use the most recent statement of earnings and leave (LES) or CSRS or FERS annuity statement. Check to make sure it reflects the amount of Federal income tax that has been withheld so far during 2018;

2.   Have a completed copy of one’s 2017 federal income tax return available. Information on that return can help estimate income and deductions for 2018;

3.   Note that the TCJA made significant changes to itemized deductions; it is possible that using the standard deduction rather than itemizing may result in a lower tax liability

4.  As a general rule, the fewer withholding allowances one enters on the Form W-4, the higher the tax withholding will be. Entering a larger number of withholding allowances means less tax withholding. This results in a smaller tax refund or a balance due and possibly an under-withholding penalty.

5.  Keep in mind that the IRS’ withholding calculator results are only as accurate as the information entered. If an employee’s financial circumstances significantly change during the year, the employee is encouraged to go back to the IRS W-4 Calculator and rerun the withholding calculation with the most recent income information.