I had an experience over the holidays with family that presented a wonderful opportunity to write about. I was asked by an in-law about the new 2020 tax form, and why one spouse will now be taxed higher based on their higher earnings. I will freely admit that caught me totally off guard. In the first place, it takes an incredible amount of time for any tax law to normally get passed – and there are a large number of them that make it a long way and then get squashed. It is simply not worth the time and worry to plan out for every single possible law. We simply wait until something is actually passed, then learn what it is and how it actually applies. She communicated this 2020 tax form to me as it was fact, which sounded like it had been passed. I was on holiday and congress sneaking something in while I was away just sounded… lovely.
After our family event I went looking on my phone for what this ‘new 2020 tax form’ was. Simply put, it is the W4 form for the New Year. However, the IRS redesigned it again, and it looks different yet again from what it did in the past. To be clear, there is no new tax system by which one spouse’s income is taxed higher simply because they make more income. Everything will still operate the way it did in 2018 and 2019. However, this new W4 form is designed in a way to help those more accurately withhold from their checks, since the change to the tax code for the 2018 tax year was so… different, for many taxpayers.
The reason behind the change in the W4 is actually important, and a good fundamental thing to communicate to everyone. The first part is about tax brackets and income. Your tax return is not taxed at a single percentage, you have income likely across multiple brackets. If you are in a 22% tax bracket, you have some income taxed at 10%, some at 12% and the rest at 22%. The 22% is NOT retroactive to all your income – which is a wonderful thing, meaning you pay less total tax than appears at first glance.
Imagine building a tower of children’s wooden blocks. As you stack blocks on top of one another the tower increases in size. This is your income. Now if we were to place a few pieces of paper between 2 or 3 of the blocks in the whole tower, we would create different zones of the tower. Those are the tax brackets. The blocks below the first piece of paper, are 10% blocks, the next blocks are 12% and so on.
Payroll has a set of pre-calculated tables to take taxes out of your paycheck. They are based on the W4 that you provided to them and assume that the income you make at that job is 100% of your total income, thus they start at $0.00. If you make very little, and the income will only be at 10% then the taxes taken out of your check are minimal. If you make a ton, the tables that payroll uses will automatically adjust the withholding to be more cents per dollar making your withholding appropriate. However, the tables that the IRS provided to your payroll company/department to use are all based on starting from $0 and using your salary. What if you have two jobs? Or husband and wife both work? Each payroll assumes a $0.00 starting point (even if both spouses work for the same company). Go back to our tower of blocks mental picture. If you put 4 blocks down for your first job, they start on the ground. Where do the next 4 blocks go? They don’t go on the ground, they go on top of the other blocks. They do NOT start at $0.00. So one job will withhold the right amount, while the next job will not withhold the right amount – simply because the information they have is insufficient. It isn’t your fault or theirs, it is just how it has worked for so long. You may think, well that is ridiculous. It is. There was a complicated table for you to use if there was more than 1 source of income. It showed how much extra to withhold per paycheck so that you weren’t short come time to file your taxes – but honestly hardly anyone knew it existed let alone used it. It is why so many married couples play paper rock scissors to decide who has to instruct payroll to withhold their paycheck at the ‘single higher rate’. One of them has to be at a higher percentage so they don’t owe gobs of money come tax time.
That is what this new W4 form is trying to more clearly communicate. Sort of a ‘Hey, if you have more than 1 job, or your spouse works, you need to let us know!’ That way payroll can use the right table based on your total income to withhold from your paycheck a more appropriate amount and help you avoid paying hundreds or thousands of dollars come next April 15.
There is also a section for deductions and credits which is the proper way to have payroll take less out of your paycheck. In the past it was based on allowances and the A-H list of questions. Those questions and tables were based on the old tax code – the new code eliminated a core component of that math, and it just doesn’t work right anymore, again hence the modest mess that were 2018 tax returns.
The new W4 form is meant to be simplified and helpful. As it does affect how much comes out of your paycheck and your tax return refund or balance due – it is truthfully worth a careful read. It isn’t long, read page 2 first, then page 1. Pages 3 and 4 are used case by case. Page 1 is the important page and all payroll (or your HR department) needs. Page 2 is a page of instructions, or a ‘what am I even doing / what does THIS mean’ page – it is only 1 page, I would suggest reading it once to help you fill out Page 1 better. Pages 3 and 4 only apply if what you need to mark on page 1 requires them. If you are single, one job and no kids – you just need page 1. If you have any further questions please don’t hesitate to give us a call and one of our tax advisors can help.
Senior Tax Advisor