Wealthy clients who have taxes taken out of their weekly paychecks should examine their withholdings this year—and maybe as soon as possible—in the wake of tax reform.
The biggest impacts to the wealthy client in regards to their withholdings are the doubling of the standard deduction, elimination of personal exemptions and elimination of the ability to deduct miscellaneous deductions, according to Albie MacDonald, CFP and managing director at MAI Capital Management in Ponte Vedra Beach, Fla.
“For many high-net-worth families, this can be a major surprise if they don’t properly adjust their withholding amounts, as they may think they have deductions that will lower their overall tax when in fact they don’t under the new tax law,” he said.
The Tax Cuts and Jobs Act reduced the taxes taken out of paychecks of many Americans, perhaps most noticeably for those with salaries in the mid-six figures. Clients might need to recalculate to find that best taxpayer balance: not withholding too much to be due a big refund (essentially an interest-free loan to the government), but not too little to owe taxes and possibly penalties in April 2019.
The IRS recommends that several groups of taxpayers check withholdings: clients with high incomes and complex tax returns; those holding two or more jobs or only working for part of the year; clients who itemized deductions in 2017; and two-income families. The IRS has a new withholding calculator and an updated Form W-4; your clients with complex tax situations can also consult IRS Publication 505, “Tax Withholding and Estimated Tax.”
Personal circumstances that clients should consider as soon as possible in connection with withholdings include divorce, starting a second job or a child who is no longer a dependent. Events can also include purchasing real estate, large philanthropic gifts, large capital gain expenses and the sale of property or a business. All "should be discussed in the context of your withholding amounts,” MacDonald said. “Work with a CPA to run tax projections.”
Financial changes influencing withholdings can also include big and sudden gains or losses, such as an inheritance with income-producing assets, second jobs where excess Social Security withholdings can come into play or moving to a taxable or non-tax state.
“Folks who have historically taken the standard deduction ... may consider potentially adjusting their withholding amounts lower, as the deduction will be higher for 2018,” MacDonald said. “Clients who itemized in the past and still have enough deductions to continue to itemize may need to adjust withholding higher, as mortgage interest is capped at $750,000 ... along with the elimination of the deduction for professional fees and other miscellaneous deductions.”
“Most high-net-worth clients pay quarterly estimates and do not solely rely on withholdings as their income is so frequently from other than wages,” said Daniel Morris, CPA and senior partner at Morris + D’Angelo CPAs, headquartered in San Jose, Calif. “A person who makes $2 million a year will see differences, but I don’t think it is tectonic.”
Worried wealthy clients can begin a paycheck checkup with comprehensive questions. Said Morris, “Are they current, looking at all income? Make sure the [federal] government gets what it needs and no more. Why lend money for free? And don’t forget the state taxes: The tables aren’t connected.”