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When you hire an employee, you must have the employee complete a Form W-4 withholding allowance. This tells you the marital status and number of withholding allowances to use when you deduct federal income tax from the employee's pay.
After the employee completes and signs the Form W-4, you must keep it in your records for at least four years. While you may allow employees to complete a Form W-4 electronically, you must provide the option for employees to submit a paper copy. Also, you must be able to produce a paper copy of a Form W-4 for inspection should the Internal Revenue Service (IRS) ever request it.
If an employee fails to give you a properly completed Form W-4, you must withhold federal income taxes as if he or she is single and claiming no withholding allowances.
Changes and revisions
An employee may want to change the number of withholding allowances for a number of reasons, such as a change in marital status, the number of dependents, or the anticipated tax obligation for the year.
If you receive a revised Form W-4 from an employee, you must put it into effect no later than the start of the first payroll period ending on or after the 30th day from the date you received the revised Form W-4. This potential for a delay in implementing changes may help you discourage employees from temporarily increasing their withholding for a bonus check, then reverting to the former level for the next regular paycheck.
Total exemption
The Form W-4 is also used to tell you not to deduct any federal income tax. To qualify for this exempt status, the employee must have had no tax liability for the previous year and must expect to have no tax liability for the current year. If the employee can be claimed as a dependent on a parent's or another person's tax return, additional limitations may apply.
A claim of exemption is valid for only one calendar year. To continue that status for another year, the employee must give you a new Form W-4 claiming exempt status by February 15 of that year. If the employee does not give you a new Form W-4, withhold tax as if he or she is single, with no withholding allowances.
Lock-in letters
Some employees will claim 99 exemptions, thinking this will reduce their tax burden, but it may result in under-withholding. If the IRS finds a serious under-withholding problem, the agency may issue a notice (called a “lock-in letter”) to you specifying the withholding rate and maximum number of withholding allowances permitted for a specific employee.
The IRS will send a letter to the employee explaining that the agency will require you to start withholding additional income tax unless the employee contacts the agency to explain why he or she should not have withholding increased. You will also receive a copy of that letter to provide to the employee.
After the lock-in letter takes effect, you must disregard any Form W-4 changes that result in less tax withheld, until the IRS notifies you otherwise. Make sure the employee cannot override the lock-in letter to decrease withholding via an electronic Form W-4 system. However, you must honor any Form W-4 revision that results in more income tax withheld than specified in the lock-in letter. Lock-in letter provisions also apply to employees who are rehired within 12 months from the date of the notice.
State forms
Most state tax agencies offer their own versions of the Form W-4. Employees should be given the opportunity to complete a state form in case they want to claim a different number of withholdings for state taxes. If the employee wants to claim the same number of withholdings, he or she may not need to complete a state form.
Nine states do not require personal income tax and don't have a state version of the Form W-4. Several other states allow for a difference in withholding, but have not adopted their own forms. Instead, they require using the federal form, but stipulate that it be clearly labeled as the state withholding form. The Bureau of Labor Statistics offers a listing of links to the state forms at www.bls.gov/jobs/statetax.htm.