Form W-4: How to Ensure Employees Properly Claim Exempt Status
If you’re in charge of hiring employees, you’re no stranger to all the paperwork a new hire must complete before he or she starts day one on the job, including the Form W-4. Details including the employee’s filing status, multiple job adjustments, amount of credits, amount of other income, deduction amounts, and any additional amounts the employee is requesting to be withheld from each paycheck will all be used to calculate how much federal income tax to deduct and withhold from the employee’s pay. If a completed W-4 is not received, an employer must withhold federal income taxes from their wages as if they were single or married filing separately with no other entries on steps 2, 3 or 4 of the Form W-4. In other words, a single filer’s standard deduction - with no other entries - will be considered in determining withholding.
An employee may change the entries on Form W-4 due to changes in their personal or financial situation by submitting a revised Form W-4. This change must be put into effect at the start of the first payroll period ending on or after the 30th day from the date the revised Form W-4 was received. The request must be honored by the employer unless it involves one of the situations outlined in the sections later in this blog titled Invalid Form W-4 and Lock-in Letters.
Form W-4 includes detailed worksheets to help the employee figure the correct adjustments. Employees may also reference the IRS Tax Withholding Estimator for assistance with Form W-4. There are separate instructions for nonresident aliens. Employers may opt to use an electronic system to receive Forms W-4 from employees. Check out the Employment Tax Regulations section 31.3402(f)(5)-1(c) and Publication 15-A, Employer's Supplemental Tax Guide for more information.
Employers should emphasize the importance of submitting an accurate Form W-4. An employee may be subject to a $500 penalty if he or she submits, with no reasonable basis, a Form W-4 that results in less tax being withheld than is required. For more information on this, see Publication 17, Your Federal Income Tax For Individuals.
Exemption from Withholding
Qualified employees use Form W-4 to tell employers not to deduct any federal income tax from their wages. To qualify for exempt status, an employee must not have had any tax liability for the previous year and must expect not to have any tax liability for the current year. A Form W-4 claiming exemption from withholding is only applicable for the calendar year in which the employee submits the form to the employer; if the employee wants to continue to be exempt from withholding in the following year, they must furnish a new Form W-4 claiming exempt status by February 15 of that year. If the date falls on a weekend or holiday, the deadline is the next business day. Failure to submit a new Form W-4 will result in withholding tax as if the employee is single or married filing separately with no other entries in steps 2, 3, and 4.
Invalid Form W-4
Any unauthorized changes or additions to Form W-4 renders it invalid, including removal of any language by which the employee certifies that the form is correct, material defacing of the form, or any writing on the form other than the entries requested. A Form W-4 is also invalid if they indicate that it’s false by the date an employee gives it to you. Don’t use an invalid Form W-4 to determine federal income tax withholding. Tell the employee that it’s invalid and request a new one. If the employee fails to furnish it, the employer must withhold taxes as if the employee is single or married filing separate with no other entries in steps 2. 3, and 4. If the employer has an earlier Form W-4 that’s valid, the employer can continue to withhold as before.
Recordkeeping Requirements
All completed and signed Forms W-4 must be kept for at least 4 years. The form must be made available should the IRS request it, as it serves as verification that you’re withholding federal income tax according to the employee’s instructions. The IRS may direct the employer to send certain hard copy Forms W-4 to the IRS.
Lock-in Letters
The IRS uses information reported on Forms W-2, Wage and Tax Statement to identify employees with withholding compliance problems. In some cases where a serious under-withholding issue exists for a particular employee, the IRS may issue a notice commonly known as a "lock-in-letter" specifying the filing status, multiple job adjustments, and maximum amount of credit or deductions permitted for a specific employee for purposes of calculating the required withholding (see Publication 15, (Circular E), Employer's Tax Guide). The IRS will provide the employee an opportunity to dispute the determination before the employer adjusts withholding based on the lock-in letter. The IRS will send a letter to the employee explaining that the IRS will require the employer to start withholding additional income tax unless the employee contacts the IRS to explain why they shouldn't have withholding increased. Additionally, you'll also receive a notice to provide to the employee.
After the lock-in letter takes effect, the employer must disregard any Form W-4 that results in less tax withheld, unless the IRS notifies you otherwise. Any Form W-4 that results in more income tax withheld than the withholding arrangement specified in the lock-in letter must be honored. Employers who use electronic Form W-4 systems must make sure the employee can't override the lock-in letter to decrease withholding. Lock-in letter provisions also apply to employees rehired within 12 months from the date of the notice. If the employee wants to claim complete exemption from withholding or claim a filing status, multiple job adjustments, or an amount of credits or deductions that results in less income tax withheld than the lock-in letter, the employee must contact the IRS. A toll-free number and address for the unit handling this program is provided in the lock-in letter.
