Don't be surprised by a huge tax bill next April.
Recent changes to the tax code went into effect in February this year, but you might have heard of them over the holidays or in January when most changes went into effect.
The paycheck-related changes involve the amount of tax withheld from each of your paychecks. For most people affected, the change started in February, but it depends on exactly when your employer decides to change their tax withholding tables as well as when you get your paychecks.
For most people, this new tax law means more money in each paycheck. As many as nine out of 10 workers will see more pay. However, it's not as simple as making more money. Even though you'll likely see your paycheck go up a little bit, that doesn't mean you should start spending more money.
Why these tax changes happened
In the U.S., you pay taxes as you earn money. The IRS wants to take its percentage of taxes right away if possible, which is why you have money for taxes withheld on each paycheck.
However, the W4 form you fill out when you get hired lets you control how much is withheld for taxes. The information you include on this form is used by your employer's payroll department to determine how much tax to withhold for both federal and state taxes. Factors like your hourly wage amount, whether you're married, and how many allowances you claim for withholding are used to make this decision.
With the new tax law changes, tax brackets have moved around, the standard deduction increased and many personal exemptions were eliminated. Therefore, the tax withholding tables your job used to figure out how much to withhold from your paychecks are different now.
Employers were required to use these new withholding tables by February 15 at the latest, which is why February is when you would have seen these changes most likely go into effect.
There's some bad news
While you'll probably take home more money each month, it isn't all good news.
It always takes a certain amount of guesswork to calculate how much tax to withhold from a paycheck. With these new tax laws in place, the estimates could be even further off the mark than they usually are.
This means you may get more money in your paychecks than you should. Come tax time, the refund you've come to expect might be much smaller, or, worse, you could owe the IRS.
Conversely, if too much money is withheld, each paycheck will be smaller. It's a good idea to go back through your paychecks since February and check to see if these changes affected you and in what way.
The good news? A few employers actually gave out raises and bonuses thanks to these new tax changes.
Navigating the new tax law changes
If you're strategic and understand how the new tax law affects your paycheck, you can avoid unpleasant surprises come tax time next year. Here's what you need to know to keep your money in order.
1. Don't spend
If your paycheck goes up, don't spend that money right away. Keep in mind that the big picture of taxes includes much more than how much is withheld from your paycheck.
If you live in a high-tax state, the new $10,000 limit on local and state tax deductions means you might need all of that extra money when 2019's tax season comes. You could lose some deductions due to these tax changes, although you may also find yourself in a lower tax bracket.
2. Plan ahead
Look back on your past tax years. Have you had large refunds recently, or have you had to pay massive tax bills?
If things have seemed a bit drastic at tax time, you might want to change the way you approach tax withholdings. Not withholding enough over the year means you'll owe money next April. Meanwhile, withholding too much means your refund will be larger, but you'll have to learn to live on less until that time comes.
3. Get educated
Before you change your W4 form, know what you need first. Start by checking if and how your withholdings changed in February, and make sure to wrap up your 2017 taxes to get the answers you need.
After that, you should be able to see if changing your withholdings is a good idea. If so, submit a new W4 form to your employer. You're not required to change your W4 after the tax changes happened, but you are free to change it whenever you'd like.
If you don't want to increase your withholdings but aren't sure what to do with the extra money in your checks, consider contributing to a health savings account to reduce your taxable income. You could also increase your investments in a retirement account.
Exercise power over your paycheck
The more you understand about the new tax law, the more control you have over your finances. With this guide, you're now equipped to make a better financial decision.