The 2017 Tax Act: Payroll as Implementers

In reacting to the major changes stemming from the recent tax code overhaul, what payroll professionals need to know is not so much the policy-related aspects, but the practical. This is because payroll is required to put in place some of the key pieces of the law. As the first line of tax collecting for the federal government—to the tune of $2.3 trillion a year—the payroll process is integral to the success or failure of any tax program. Payroll professionals are constantly asking: What changed? What processes do we currently have that need to be modified? And when does this all need to take place? Questions related to how to make the changes happen and who is involved in the implementation process also need to be answered.

Discovery

As the legislation was nearing passage, issues crossing the payroll function were that tax rates would change, effective January 1, 2018, and personal exemptions—a big issue for withholding calculations—were to be eliminated. The standard deduction was to be increased, all moving expense costs paid by employers were to become taxable to employees, and employer deductions for certain benefits provided to employees would go away or be reduced.

The elimination of personal exemptions meant an overhaul is necessary for the tax withholding system, set up post-1986 and in place through 2017. Why? Withholding allowance amounts have been based on personal exemption amounts, and with personal exemptions gone, there has to be some other mechanism built to accurately calculate withholding amounts for income tax purposes.

Phased Approach

There was uncertainty as to how these changes would play out, and there still is uncertainty going into the middle and end of the year, which is a demon for effective implementation. These tasks are made difficult in 2018 because guidance on what payroll needs to do has been coming out in bits and pieces, so a complete picture of what is to be done is developing over time.

While the Treasury Department was given the entire year to phase-in implementation of the law, there was pressure politically to provide a noticeable change in employee take-home pay by February. The Internal Revenue Service delivered, releasing 2018 withholding tables January 11 that were to be implemented by employers no later than February 15. That started the first phase.

A surprise to the payroll community was the decision by the IRS to continue applying personal exemption amounts to the withholding tax calculations for 2018 and suggested that employees would not need to adjust withholding allowances on their already-filed Forms W-4, at least for the time being.  This made implementation of the 2018 withholding methods easier, because the base system was not changed, but also raised a concern.

Since the tables did not reflect elimination of the personal exemption amounts, some who did the math on the tables, claimed employee withholding was so “off” that there would be many workers underwithheld for 2018 as a result.

The next phase began February 27, when IRS released the 2018 Form W-4 Form and then February 28, when an individual withholding tax calculator was released. These together are designed to help employees determine if they, indeed, are being underwithheld (or overwithheld) and whether they should be adjusting allowances on Form W-4 accordingly.

The final phase of the transition is going to take a little bit of time to ramp up, because, again, personal exemptions are gone. Still unanswered is how any withholding allowance amounts will be represented in the new form W-4 in 2019, and what will withholding tables look like in 2019?  December 31, 2018, is the end of that transition period that the Treasury Secretary has been given to move forward on the migration of the withholding methods to conform with the new law.  So, database fields will be changing on form W-4, at least by 2019 and so will the mechanisms driving the withholding table calculations.  

Other Issues Remain

Payroll professionals had other tax law implementation concerns beside the withholding tables.

• With moving expenses now taxable, how do employers treat moves completed and charged in 2017 but not paid for until 2018? Are those amounts taxable? There remains some uncertainty about this issue.
• The individual deduction for working condition fringe benefits was removed. Does that mean the employer-provided fringes such as employer-provided education, use of company cars and other personal benefits employees may derive from working for employers are taxable now?  Well, no, according to IRS Publication 15-B, released March 5 by the IRS.
• Were qualified transportation fringe benefits eliminated under the new law? No. But employers can no longer deduct for corporate purposes costs and amounts provided to employees that would be tax-free to them under the benefit.
• Do the changes to the deductions for meals and entertainment affect employee tax liabilities? They shouldn’t. Again, according to legal sources, the law’s primary focus was on the corporate deductibility of the costs expended for these purposes.
• Will inflation-based amounts for 2018 be modified because of the law’s requirement to apply a different consumer price index measure? Yes. The IRS announced in March that several inflation-based limits had to be adjusted down, including the maximum foreign-earned income exclusion amount and the maximum tax-free contribution amount for some health savings accounts. Pension plan limits are unaffected by the change.

Finally, those doing payroll have to deal with states that withhold taxes from wages. These jurisdictions are reacting to the federal changes in a myriad of ways. Some states have decided to conform to the tax changes and some states have said they will not conform. New York recently passed an entirely new payroll tax to address the limitation the new federal tax law has placed on residents deducting state and local taxes on their individual federal returns. Some states have done nothing so far in reaction to the federal code changes, partly because the federal methods for withholding really have not changed much so far.

For the rest of 2018, IRS is expected to focus on fully integrating the new tax code to withholding methods that will be effective the start of 2019. A draft of the 2019 Form W-4 is promised during the second half of the year and big changes to the content are anticipated. The release of that draft form could signal the approach the agency will take for 2019 withholding formulas and tables. States will continue to address the fallout related to the tax code overhaul with their own changes to payroll-related forms and calculations.  So stay tuned. Payroll professionals, as all of us, are living in interesting times.  

Mike Baer is the Managing Editor, Payroll at Bloomberg.