Beware the Exempt W-4

While it is not necessary for your employees to fill out a W-4 every year, this seems to be the time of year when people think about it. And this time of year we often get the question of whether an employee can file EXEMPT for federal withholding.

First, to review, IRS form W-4 is the form every employee needs to fill out and provide to their employer so that the employer can withhold the proper amount of federal income tax withholding from the employees paycheck. The form provides a worksheet that helps the employee figure out the proper number of allowances. The more the number of allowances, the less income tax the employee is likely to owe and therefore the less is withheld.

So, to answer the obvious question of whether an employee can simply mark the highest number of allowances available, or simply claim to be exempt from withholding, the answer is no. Withholding is not really optional. However, there are circumstances that allow an employee to claim EXEMPT on their W-4. And if they do so, they do have to fill out a W-4 each year to make this claim.

In general an employee can claim ‘exempt’ on their W-4 if they had no income tax liability in the previous year (and thus paid no federal income tax or received or had a right to receive a refund of all income taxes paid) and the employee does not expect to have a tax liability this year, or expects to receive a full refund of all taxes this year. To validate that estimate, the IRS looks at a few things such as whether the employee can be claimed on someone else’s return, the level of earned income in the upcoming year and the level of expected unearned income.

Be wary of employees who submit W-4s to you indicating they are exempt. This may be a simple and misguided desire to postpone paying taxes and could lead the employee into trouble down the road and could bring unwanted attention to the employer from the IRS. Be sure to have access to a correctly filled out W-4 from every employee and make sure that your employee’s understand the importance of accurately assessing the number of allowances they qualify for so that they have enough, but not too much, income tax withheld from their paychecks.