Employers Should Encourage Their Employees to Revisit Their Tax Withholding Elections in Light of the New Tax Law

Daniel L. Morgan

Since January 1, 2018, the date changes to the tax law passed by Congress at the end of December (the “Tax Act”) became effective and provided new individual marginal tax rates and modified deductions, the Internal Revenue Service (“IRS”) has been scrambling to provide guidance as to how those changes are to be taken into account for income withholding tax purposes.

Yesterday, February 28, 2018, the IRS introduced an online calculator to help employees determine the correct amount of income taxes that they should have withheld from their 2018 wages. The IRS has also issued a new Form W-4, Employee’s Withholding Allowance Certificate.

Because of the Tax Act’s doubling of the standard deduction, many employees will be able to reduce their Federal income tax withholding, although the repeal of personal exemptions may mean (particularly in the case of families with several children) that some employees who would otherwise benefit from the increased standard deduction will find the opposite to be the case.

Even with the reduction in marginal Federal tax rates, many executives and other highly-paid employees will be faced with higher Federal income taxes in 2018 and, therefore, with a potential need to increase their tax withholding. The highly-paid employees most likely to be in this category are those impacted by the $10,000 cap on the deductibility of state and local income and property taxes, but other deduction changes—notably, new limits on the deductibility of certain mortgage interest and the elimination of deductions for miscellaneous expenses—may also come into play.

Highly-paid employees who are doing their tax planning for 2018 should be aware that, as a result of changes made by the Tax Act, the IRS has reduced the tax withholding rate that an employer may elect on so-called supplemental wages paid in 2018, which do not total more than $1 million, from a flat 25 percent rate to a flat 22 percent rate.

Supplemental wages are defined by the IRS to include items such as bonuses, commissions, deferred compensation, and income realized on the exercise of a nonqualified stock option. Supplemental wages paid in 2018, which in the aggregate exceed $1 million, are subject to withholding at 37 percent (the highest marginal income tax rate in effect in 2018). Additional guidance regarding the impact of the Tax Act on 2018 income tax withholding can be found in Notice 1036.

Because of the possibility of both under and over tax withholding, many employers will find it desirable to encourage their employees to review their withholding using the IRS’ online calculator and submit a new Form W-4. Employers, of course, should not provide their employees with individual tax advice.

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