December 21, 2017

Tax reform: How the Tax Bill affects employers and payroll

In Greco-Roman mythology, Hercules was a divine hero, a demi-god with incredible strength and endurance who could perform remarkable feats – not unlike the “herculean task” employers and payroll professionals have to implement sweeping new tax cuts early in 2018.

What are the latest developments?

The Tax Cuts & Jobs Act of 2017, monumental tax overhaul legislation the U.S. House of Representatives and Senate have approved and sent to President Trump to be signed into law, includes sharp reductions in individual income tax rates and broad changes to income tax brackets, all to take effect in January. America’s employers will have to begin implementing the new law only five business days after its passing.

For obvious reasons President Trump and Capitol Hill lawmakers want taxpayers to see the benefits of the new tax reform law as soon as possible in 2018, not when they file their tax returns in April 2019.

Employers, take note: This means that if the IRS makes new withholding tables available (it has said they could be available as early as February), then employees could expect to see the effects of the new law in the form of bigger paychecks early in the New Year. They will not have to wait until April 2019 to feel the impact.

The good news? The ability for employers to execute on this is dependent on the IRS (which we further explain below), however, it will fall to payroll departments to make it all happen – and quickly! – a formidable task even for Hercules.

The challenges for employers—and for payroll

  • Systems will be disrupted

Put simply, many employers’ payroll systems must be reengineered from top to bottom to execute the individual income tax rate cuts and taxable income bracket changes incorporated in the Tax Cuts & Jobs Act of 2017.

The American Payroll Association (APA) captured the enormity of this challenge in its Dec. 8 letter, saying the tax reform measure “will turn much of the system, especially the payroll withholding infrastructure that is the underpinning of our entire economy, upside down.”

  • A new Form W-4 is required

One key part of the payroll withholding infrastructure, of course, is Form W-4 – the form used by employers to withhold the proper amount of federal income tax from employee pay checks. Tax reform is particularly disruptive for Form W-4 because the new law would eliminate personal exemptions.. The IRS will need to completely redesign Form W-4, and consequently, employers will need to collect new W-4s from employees.

As noted by the APA, “every employee in America will be required …to file a new Form W-4 to request withholding on 2018 taxable income.” On this point The Wall Street Journal’s Laura Saunders echoed the APA’s concerns about the huge task “lawmakers are poised to hand up to 155 million workers, and the companies that employ them.”

In addition to the Form W-4 changes, employers will also need to crank new IRS withholding tables into their payroll systems to reflect tax rate cuts and bracket changes in employee paychecks – tables employers must patiently wait for the IRS to publish.

The good news for employers

The good news for employers and payroll professionals is that right now the ball is in IRS’ court. Before employers can execute, IRS must develop and publish new Forms W-4, withholding tables and instructions. These will enable employers to withhold from wages and avoid penalties for under-withholding. Helping employers and payroll professionals adjust tax withholding to comply with the new tax law will be one of the IRS’ most urgent New Year priorities.

President Trump didn’t help matters recently when, in his enthusiasm over the prospect of Congress approving historic tax cuts, remarked that “Americans will see lower taxes and bigger paychecks beginning in February.”

This prompted the IRS to issue a statement clarifying its timetable and reassuring employers: “We anticipate issuing the initial withholding guidance (Notice 1036) in January reflecting the new legislation, which would allow taxpayers to begin seeing the benefits of the change as early as February. The IRS will be working closely with the nation's payroll and tax professional community during this process.”

What should employers expect—and when?

  • A transition period for employers and payroll professionals

If history is any guide, employers and payroll departments should hope to hear the magic word, “transition,” as in transition period. When President Ronald Reagan signed the last giant tax revamp into law 31 years ago, in October 1986, IRS gave taxpayers until October 1, 1987 to file new Forms W-4. Similarly, when President Obama signed the American Recovery & Reinvestment Act into law in February 2009, IRS announced that employers were to begin using new tax withholding tables no later than April 1, 2009.

Indeed, APA reports in the Dec. 8 edition of Compliance Update, that Scott Mezistrano, of IRS Industry Stakeholder Engagement and Strategy, informed attendees on a recent conference call that there would be a transition period in early 2018 during which employers could continue to use 2017 withholding tables while they prepare to comply with the new law.

Mr. Mezistrano acknowledged that payroll professionals would need time to program and test changes made to payroll systems to comply with new tax withholding tables. For all these reasons employers should anticipate that IRS will allow a transition period of up to April 1, 2018.

  • After transition, the onus is on employers

Whether President Trump and the IRS turn out to be correct that “taxpayers will see bigger paychecks beginning in February” will depend on employers, payroll professionals and the contemporary Hercules, human capital management systems.

At some point early in 2018, the IRS will publish new withholding tables and detailed instructions, Forms W-4, Publication 15, the Employer’s Tax Guide and related documentation. As part of that announcement, the IRS will formally direct the nation’s employers as to when they will be expected to bring their employment tax withholding into compliance.

At that point the ball will be squarely in the court of America’s 20 million-odd small, medium and large employers to reflect the Tax Cuts & Jobs Act of 2017 in the paychecks of the nation’s 150 million workers – a Herculean task indeed.

What employers can do right now

There are a few things employers can do right now to prepare. First, employers need to stay informed and pay close attention to IRS pronouncements. They can expect constantly breaking news from Washington about tax reform legislation and its implementation.

Second, and equally important, employers need to make sure they have on board the people and the HCM systems that can smoothly reengineer their existing payroll systems to support compliance with the new tax withholding regime. Not only will the IRS expect employers to comply; workers will have the greatest expectations that their employers promptly will put new tax cuts into their paychecks.

Jim O'Connell

With more than 30 years of experience in federal legislative and regulatory affairs, Jim O’Connell focuses on HR and PAYROLL POLICY ISSUES, keeping customers informed about fast-changing and complex compliance regulations and workforce trends. Follow him on Twitter JOCWashDC

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