Calculating withholding taxes is arguably the most challenging aspect of administering payroll. One wrong move could result in costly errors, penalties or worse case scenario, an IRS audit. So how do you failsafe your business in an environment with ever-changing tax laws, especially in light of the newest major tax reform — the Tax Cuts and Jobs Act (TCJA)?
Calculating Payroll Withholding Taxes
Before we review the most recent changes to payroll withholding under the TCJA, let’s quickly recap the key elements that go into calculating payroll withholding taxes.
All business owners must withhold taxes from their employees’ paychecks. The amount will generally consist of federal income tax, Social Security and Medicare. Additionally, if you are located in a state with state income tax withholding, you need to deduct that as well.
Social Security is calculated at 6.2% of gross pay on earnings up to $128,400 in 2018. On the other hand, there is no cap on Medicare taxes, and it is calculated at 1.45% of an employee’s gross pay. However, high-income earners or individuals with earned income of more than $200,000 ($250,000 for married couples filing jointly) must pay an additional 0.9% in Medicare taxes.
Of note, the amount withheld from an employee’s paycheck will depend on the following factors:
- The payroll period – this will either be weekly, biweekly, semi-monthly or monthly
- The amount of gross pay for the period
- The employee’s filing status – either single, married filing jointly, married filing separately, head of household or qualifying widow(er) with dependent child
- The number of withholding allowances, and
- Any additional amounts the employee requested to be withheld.
A Look at the Changes Affecting Payroll Withholding
In December 2017, Congress approved a major tax reform that affects both individuals and businesses. Here is a summary of the changes:
- New tax brackets: The new law changes the tax brackets, which means the withholding tables you use to calculate withholding for employees for 2018 wages have been updated.
- Elimination of the personal exemption: In the past, taxpayers were allowed to take a personal exemption of around $3,000, depending on the tax year. However, this provision is no longer available under the new rules.
- Increased standard deduction: $12,000 for singles, $18,000 for heads of households and $24,000 for married couples filing jointly.
- Increased child tax credit: $2,000 per qualifying child and a new $500 credit for other qualifying dependents.
- Changes to itemized deductions include updates to the following:
Now that you have a better understanding of this major tax legislation, here are three action steps you should take to ensure that your small business remains compliant.
Do a paycheck checkup
The first step is to encourage all your employees to do a paycheck checkup using the IRS’ online withholding calculator. This helpful tool allows taxpayers to estimate their 2018 income tax, and compare the amount with their current tax withholding, to help them determine if they need to have more or less money withheld from each paycheck.
According to the IRS, a paycheck check up is especially important for employees who fit into any of the following categories:
- Two-income families.
- People working two or more jobs or who only work for part of the year.
- People with children who claim credits such as the Child Tax Credit.
- People with older dependents, including children age 17 or older.
- People who itemized deductions.
- People with high incomes and more complex tax returns.
- People with large tax refunds or large tax bills in 2017.
Request updated W-4s
Based on the paycheck checkup, many employees may wish to change their withholding, in which case you must request updated W-4s from them.
Tip: According to the IRS, whenever personal circumstances change (e.g. marital status) that reduce withholding allowances an employee are entitled to claim, they must submit a new Form W-4 to their employer within 10 days, claiming the proper number of withholding allowances.
Be mindful of processing errors
Ensure that you have a process flow in place to quickly identify and remedy any paycheck errors that arise due to the recent tax changes. This approach must take into consideration effective ways to communicate with employees, for example, in the event of an overpayment or underpayment.
As you can see, there are many moving parts when it comes to accurately calculating payroll withholding taxes. However, the bottom line is that the responsibility lies with you as the small business owner to ensure that the process is seamless.
The good news is that you don’t have to go it alone. By outsourcing payroll, you can transfer critical payroll tasks to a team of experts who keep a close eye on changing tax regulations.
Here at RQB, we can handle all aspects of your payroll including the following services:
- Creating paychecks, processing direct deposits or creating a PDF for local printers,
- Producing and filing all necessary reports and taxes,
- Weekly payroll reports,
- Job costing, including options for seamless integration with third-party web-based timesheets, and
- Creating and issuing 1099’s* on your behalf (we’ll send you all forms that need to be signed and sent to the IRS, mail copies of the 1099’s to all recipients, and keep a filing copy for your records).
*Tip: If you exceed the IRS’ threshold of $600 in cumulative payments to independent contractors for a tax year then you must complete Form 1099-MISC Reporting for Non Employee Compensation which is due by January 31st each year.