This week’s question comes from Greg, a part-time accounts payable clerk. I made almost the same amount of money in 2008 as I did in 2007, but the amount of my federal income tax (FIT) withheld is significantly lower. Why did my FIT withheld go down? There are several reasons why your FIT withheld could be significantly lower, even though your income was almost the same.
- Inflation creep. Each year, as inflation reduces the value of the dollar, tax tables in Publication 15 (Circular E) are adjusted so that less tax would be withheld on the same amount of income. This is to adjust for the reduced buying power of the same dollar amount of income.
- Reduced income. At certain low-income levels, no tax is withheld if the withholding allowances claimed are greater than zero. Even FIT withholding of a few dollars each week can add up to a few hundred-dollar difference at year-end compared to no withholding at certain low-income levels.
- Increased withholding allowances. Many employees file a revised Form W-4, Employee’s Withholding Allowance Certificate or Formulario W-4(SP), Certificado de Exención de la Retención del Empleado. If the number of withholding allowances claimed increases, the amount of FIT withheld will decrease. Instead of receiving a big refund when a Form 1040 is filed, the employee receives a small net pay increase each week. Some employees also file Form W-4 claiming exemption from all FIT withholding.
- Claiming Earned Income Credit. Many employees file a new or revised Form W-5, Earned Income Credit Advance Payment Certificate. As in the case of increased withholding allowances, claiming an advance EIC payment will increase net pay received each week, but could reduce the amount of FIT withheld.
- Increase in pre-tax deductions. Employees who increase the amount of a §125 election or elect to contribute more money to a pre-tax retirement plan such as a SIMPLE plan or §401(k) plan, could have a significantly reduced amount of FIT withheld on the same amount of gross pay. Since those amounts are deducted before FIT withholding is calculated, the FIT deduction should be reduced.
Employees should work with their CPA to project their FIT liability for the current year then assess their progress toward meeting that liability each quarter. If the projected FIT withholding be less than the annualized projected liability a revised Form W-4 or Form W-5 should be filed or the need to pay quarterly estimated tax payments using Form 1040-ES should be considered. Employers should update the allowances claimed by logging in to their company file or providing Vision Payroll with the updated information.