Understanding Employee Tax Exemptions

When processing payroll in your company, you may encounter employees seeking exemption from tax withholding. Those who meet the criteria can indeed become exempt from income tax withholding. Here are some key points to consider:

Withholding involves deducting amounts from an employee's pay for state and federal income taxes, as well as other taxes.

If eligible, employees can be exempt from withholding, but they must indicate this on a W-4 form.

The exemption applies to income tax but not FICA tax (Social Security and Medicare).

If the IRS deems an exemption invalid, they may issue a "lock-in" letter instructing you to withhold income tax at a specific rate on a specific date.

What Does Withholding Entail?

Withholding refers to deductions from employee pay for federal and state income taxes and FICA taxes (Social Security and Medicare). Certain employees may not need federal income taxes withheld if their income falls below a certain threshold. Employees can claim an exemption from income tax withholding in a given year if they meet specific conditions.

Claiming Exemption and W-4 Forms

A revised W-4 form came into effect in 2020 for new hires and employees making changes. To claim exemption, an employee must write "Exempt" on Form W-4 and complete specified steps. Employees seeking an exemption for a year must submit a new W-4 by February 15 of that year.

Ensuring Compliance with Exemptions

Employers can only adjust withholding based on the documentation provided by employees. Until the necessary forms are submitted, you must continue withholding taxes based on the most recent information. Any withholding exemption solely pertains to federal income taxes, not state or FICA taxes.

Dealing with Lock-In Letters

If the IRS questions an exemption claim, they may issue a lock-in letter specifying withholding allowances. Upon receiving this letter, employers must adjust withholding accordingly and cannot alter the amount without IRS approval.

FAQs on Employee Tax Exemptions

How long should employers retain W-4 forms? Employee forms must be kept for four years to ensure accurate tax withholding.

What if an employee claims exemption on the W-4? If an employee's W-4 indicates exempt status, federal income tax should not be withheld, assuming the individual meets the necessary criteria.