In late December, President Trump signed into law the first major overhaul of the US tax system in 30 years, referred to as the Tax Cuts and Jobs Act (TCJA). While many individuals and businesses are scrambling to determine how this tax reform will affect them, an area that might be overlooked is employment tax. With a reduction in 2018 individual income tax rates, employees may be expecting more take-home pay in their paychecks.
Every year many employers await the update of the IRS Publication 15 that explains an employer’s tax responsibilities for withholding, depositing, reporting and paying employment tax, including updated income tax withholding tables and the percentage method. However, this year it has become more complicated due to tax reform and the change in the individual income tax rates (see below).
Individual Income Tax Rates
The IRS released Notice 1036 on January 11, which includes updated income-tax withholding tables for 2018 reflecting the changes of the TCJA. However, the IRS stated that employers should continue to utilize the existing employee Form W-4 on file when applying the revised 2018 income tax withholding tables and percentage method. The IRS continues to work on revising Form W-4 and updating the withholding tax calculator on the IRS website for the changes made in the TCJA. The IRS is encouraging employers and payroll services to utilize the 2017 withholding tables and systems until the updates from Notice 1036 can be implemented, noting that the updated tables should be implemented no later than February 15, 2018.
For certain conditions, businesses are required to withhold a backup tax from nonwage payments. This backup withholding is linked to the fourth tax bracket, which for 2017 was 28 percent, and for payments paid on or after January 1, 2018, will be adjusted to 24 percent.
Based on current law, employers may optionally use a flat rate of income tax withholding on supplemental wages. The optional flat tax rate for 2017 is the third tax bracket, or 25 percent. In order to utilize the 25 percent withholding rate, supplemental wages must be separately identified and not exceed $1 million. In addition, income tax is required to be withheld from the regular wages of the employee in the current or preceding year. Based on Notice 1036, employers now can decrease the withholding on supplemental wages less than $1 million to 22 percent.
For employees whose year-to-date supplemental wages exceed $1 million, employers are required to withhold at the highest income tax bracket, which was 39.6 percent for 2017. For supplemental wages paid on or after January 1, 2018, employers are immediately allowed to lower their withholding to 37 percent for supplemental wages that exceed $1 million.
What should employers watch for?
While the IRS is clear that the withholding guidance in Notice 1036 is based on the existing W-4s provided by employees, employers should be aware that a revised W-4 may be required in the future to account for the suspension of personal exemptions for individual income taxation. If the IRS issues a revised W-4, employers would need to obtain an updated Form W-4 for all of their employees who claimed additional allowances for the personal exemption deduction currently. This could be a significant administrative undertaking.
In the meantime, employees may be confused as to why their paychecks have not been adjusted for the reduction in 2018 individual federal income tax rates. Employers should consider communicating with their employees that, in general, before any reduction in an employee’s federal income tax withholding could take place, guidance was needed from the IRS. Now that the IRS guidance surrounding withholding tax has been issued, implementation will take place no later than February 15.
Lynn Mucenski-Keck is a manager based out of our Rochester, NY office.