Income Tax Withholding

Submitting Form W-4 to the IRS:

Employees may try to evade the payment of income tax by submitting erroneous Forms W-4, Employee’s Withholding Allowance Certificate, so special rules apply to W-4s that claim exemption from withholding or are invalid.  Additionally, an employer is required to submit a copy of an employee’s Form W-4 to the IRS upon request.  The IRS will make a request if it suspects a W-4 is causing inadequate income tax withholding.

Of course, all Forms W-4 that result in minimal withholding are not false. An employee with numerous dependents and/or substantial anticipated deductions may be legitimately entitled to claim a large number of withholding exemptions. Similarly, an employee may be entitled to claim an exemption from income tax withholding if the employee certifies on Form W-4 that [IRC§3402(n)]:

1. He or she expects to have no federal income tax liability for the current year, and

2. He or she had no federal income tax liability in the prior year.

Sending W-4s to the IRS:

Temporary and proposed regulations, effective back in 2005, eliminated the requirement to send the IRS potentially questionable W-4 copies.  Before then, employers had to send the IRS any Form W-4 claiming

1. More than 10 allowances or

2. Complete exemption from withholding if $200 or more in weekly pay was expected.

Under these temporary and proposed regulations, employers no longer had to submit W-4s to the IRS unless directed to do so in a written notice to the employer or pursuant to future published guidance (revenue procedure or IRS notice, which the IRS has yet to publish).  However, additional guidance is now out in the form of final regulations under Section 3402, discussed below.

Final Regulations: 

In addition to adopting the paperwork-reducing provisions in the proposed and temporary regulations, with a few modifications, the final regulations provide rules for withholding when the IRS notifies and employer and employee of the maximum number of withholding exemptions permitted.  Here are some highlights from the final regulations.

• Routine submission of Form W-4 is not required, but the IRS can require submission by written notice or future published guidance.

• The IRS can issue a notice to an employer specifying the maximum number of withholding exemptions permitted for a specific employee.

• The notice is sent to the employer (with a employee copy) and directly to the employee.  An employee is given time to address a pending withholding change by contacting the IRS.  The earliest the notice may be effective is 45 calendar days after it is dated. 

• The notice of maximum exemptions will also specify the marital status to use in calculating the withholding. 

• Receiving a notice does not impose a requirement to withhold income taxes where one does not already exist (such as wages exempt from withholding because the employee is claiming the foreign earned income exclusion).

• If the employee is still employed by the employer, it must furnish the notice to him or her within 10 business days of receipt.

• An employer is not required to furnish the notice to a worker who it no longer employs.  Employment status is determined as of the notice date, based on facts and circumstances, including if the employer treated employment as terminated for other purposes.  Cases where an employee no longer working is still considered employed are listed.  The employer must notify the IRS that it no longer employs the worker.

• If an employer must notify a worker, it must withhold based on the notice as of the date specified in it unless one of several listed exceptions applies.  See the final regulations for examples.

• Employers may not accept a substitute form developed by an employee.  An employee who submits such a form is treated as having failed to furnish a withholding exemption certificate.

Effective Dates: 

The final regulations are generally effective on April 14, 2005.  However, there are new provisions in them that:

1. Specify when an employee no longer working is considered still employed,

2. Require the employer to withhold based on the notice if a terminated employment relationship is resumed within 12 months and

3. Require employer to refuse to accept substitute withholding exemptions certificates developed by employees.

These new provisions all apply on October 11, 2007.  Taxpayers may rely on the new provisions for notices issued before that date.