New withholding rules necessitated by new tax law

The IRS issued Notice 2018-14 to provide more guidance on the withholding rules that were changed by P.L. 115-97, known as the Tax Cuts and Jobs Act. The notice (1) extended the effective period of Forms W-4, Employee’s Withholding Allowance Certificate, until Feb. 28, 2018, and permits the use of the existing 2017 Form W-4 to claim exemption from withholding for 2018 until 30 days after the IRS issues a new 2018 Form W-4; (2) temporarily suspends the Sec. 3402(f)(2)(B) rule that employees must notify their employers of changes in status that affect their withholding within 10 days; (3) provides the new rate of optional withholding on supplemental wages; and (4) provides that withholding on periodic payments (such as for annuities) under Sec. 3405(a)(4) when no withholding certificate is in effect is based on treating the payee as married and claiming three withholding allowances.

Use of 2017 Form W-4 to claim exemption from withholding

As the IRS noted when it issued the 2018 withholding tables, it is in the process of revising the 2018 version of Form W-4 to reflect the changes in P.L. 115-97 to itemized deductions, exemptions for dependents, and increases in the child tax credit and the new dependent credit.

The rules under which employees are exempt from withholding because they did not have a tax liability last year and do not expect a tax liability for the current tax year generally require employees to file Forms W-4 to claim the exemption. These forms are usually effective for a tax year up until Feb. 15 of the following year, but the notice extended this period to Feb. 28, 2018. The guidance also allows taxpayers who wish to claim the exemption for 2018 to use the 2017 W-4 form (modified as instructed in the notice) until 30 days after a 2018 version of Form W-4 is issued by the IRS, and describes the procedures for using the 2017 form to claim the exemption for 2018.

Temporary suspension of 10-day rule

Sec. 3402(f)(2)(B) requires employees to notify their employers of changes in status that affect the number of withholding allowances they are entitled to claim within 10 days of the event. The IRS is temporarily changing the 10-day period to file new Forms W-4 until 30 days after the 2018 forms are released but also noted that employees who have a reduction in the number of withholding allowances solely due to the changes made by P.L. 115-97 are not required to furnish employers new withholding allowance certificates during 2018. However, the IRS emphasizes that employees may voluntarily file new Forms W-4 to update their withholding in response to the act and can use the 2017 form until 30 days after the 2018 form is released.

Rate of optional withholding on supplemental wages

Because the new tax law lowered income tax rates beginning in 2018, the rate that employers should withhold on supplemental wages is also lowered from 25%, which was in effect from 2005 to 2017, to 22%. This new lower rate should be implemented as soon as possible, but no later than Feb. 15, 2018. Employers had the option to correct overwithholding at the old 25% rate for wages paid between Jan. 1 and Feb. 15 under the rules applicable to corrections of overcollections of federal income tax.

Withholding on periodic payments

Under prior law, withholding on periodic payments such as pensions and annuities under Sec. 3405(a)(4) for which no withholding certificate was in effect treated the payee as a married individual claiming three withholding exemptions. Because the new tax law no longer provides personal exemptions, the rule has to be changed to provide for withholding assuming the payee is a married individual claiming three withholding allowances.