When I got married in 2016, my wife and I updated our paycheck withholding status to “married” and kept our previous withholding allowances the same as part of the flurry of changes that followed. In the past, we generally received a tax refund when filing as single with two allowances. We could now itemize our deductions since we bought a house and had mortgage interest, real estate taxes, sales tax and a small amount of charitable giving. Even with several thousand dollars of deductions above the standard deduction, we’re still going to owe Uncle Sam a meaningful amount. To avoid underwithholding taxes in the future, as well as a penalty, we took the W-4 tables for two earners seriously and chose the proper amount of extra tax withholding from each paycheck going forward.
It turns out that this problem is common with most married couples where both spouses work. This underwithholding usually surprises couples in the first one to two years of marriage. It makes sense, though, because the tax tables assume you’re the only working spouse if you enter “married” on the W-4 unless you determine the appropriate amount of extra withholding with the two-earners/multiple jobs worksheet.
With the doubling of the standard deduction, the elimination of personal exemptions, and the increase in child tax credits because of the recent tax reform taking effect at the start of 2018, I made sure to revisit our household W-4 forms to see how these changes impact our tax withholdings. The IRS has now released their updated W-4 and their tax withholding calculator, which helps with this process.
Households with two earners are most likely to underwithhold on their taxes, so we’ll use a married couple, Phil and Sue Smith, as our case study. To provide background, they both earn $125,000 from their respective employers. They realized that with the new tax reform and the recent birth of their second child, it would be a good idea to revisit their W-4 forms to ensure they’re withholding enough for taxes. In previous years, their itemized deductions were $21,000 – $14,000 of mortgage interest, $5,000 of real estate taxes and $2,000 of sales tax. Also, they expect to receive $10,000 of non-wage income from dividends, capital gains and interest from their investment portfolio.
Before Phil completes the first page of the W-4 that gets turned into his employer, he needs to complete the worksheets provided in the W-4 packet to determine whether he can enter any withholding allowances, or if he needs to add another withholding per each of his remaining paychecks for the year.
Note: Only the spouse with the highest paying job in the household needs to do this exercise. The spouse with the lower or equal income should select 0 allowances and $0 extra withholding per paycheck on his or her W-4.
Step 1: Personal Allowances Worksheet
The Personal Allowances Worksheet helps determine how many allowances you can enter based on whether your spouse is working and how many children and dependents you have. Phil can’t enter any numbers on line D because Sue also works and earns greater than $1,500. Since the Smiths’ joint employment income is $250,000, and they have two children, they can enter 4 on Line E (2 eligible children X 2). The Smiths’ children are under age 17 and they don’t have any other dependents, so line F is left as 0.
Step 2: Deductions, Adjustments, and Additional Income Worksheet
You use this worksheet to determine whether you can withhold less due to having a greater amount of itemized deductions than the new $24,000 standard deduction for married couples. As mentioned earlier, the Smiths are expecting to have $21,000 of itemized deductions in 2018 between their mortgage interest, real estate and sales taxes. Since their expected itemized deductions are less than standard deduction, they’ll enter 0 on line 3. With the doubling of the standard deduction, it will be common for many households like the Smiths who used to itemize to now use the higher standard deduction.
While Phil and Sue don’t have a perfect idea of how much dividends, capital gains and taxable interest their investment portfolio will generate in 2018, Phil entered $10,000 on line 6 because that’s how much investment income they received in 2017. Based on the Smiths’ worksheet and situation, they can’t take any additional allowances based on itemized deductions.
Step 3: Two-Earners/Multiple Jobs Worksheet
This is the last worksheet Phil needs to complete before filling out his W-4. Since the Smiths both earn $125,000, the lowest paying job would return a 12 from Table 1, which is entered on line 2. Due to their level of income, line 3 tells them that they can’t take any personal withholding allowances. This 0 can be entered on line 5 of the W-4 (total number of allowances you’re claiming).
Now that Phil knows he won’t receive any tax withholding allowances, he needs to determine if he should withhold extra taxes from future paychecks. The corresponding withholding for the Smiths’ highest income of $125,000 in Table 2 is $910. Per the 6 listed on line 6, Phil needs to withhold an extra $5,460 (6 X $910) throughout the year. Since it’s March 1 and there are 20 pay periods remaining for Phil’s twice-a-month paycheck, he needs to withhold an extra $273 ($5,460/20 remaining pay periods) from each paycheck. He can enter this extra withholding on line 6 of the W-4.
Step 4: Employee’s Withholding Allowance Certificate W-4
Now Phil can complete the W-4 that he’ll return to his employer. He enters his personal information, marks “married” on line 3 since he completed the worksheets assuming he’d be filing married. The 0 on line 5 and $273 on line 6 came from the worksheets. The Smiths can leave line 7 blank as they aren’t “exempt” from withholding taxes.
Sue doesn’t need to repeat this exercise. She can by default enter 0 allowances on line 5 and $0 additional withholding on line 6 of her W-4.
Note: You can complete this exercise by working through the W-4 worksheets by hand as shown in this case study, or use the IRS’s new tax withholding calculator.
Please contact Merriman if you have any questions about how the recent tax reform impacts your situation or for any of your other financial planning needs.
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Geoff has always enjoyed talking with people about finance, learning about their investments, financial strategy, and business sense. His interest only deepened with time, and what began as a hobby has now become a life-long passion, with an unparalleled passion for continuing education that makes him an expert in many subjects from traditional taxes and investments to business succession planning and executive compensation negotiations.
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