As many employees complete their 2005 tax returns they begin turning their attention to assessing their 2006 tax position. Employees often adjust their tax withholdings this time of year based on whether they received a tax refund or had to make a payment to the IRS. As a result, here are a few reminders on some of the rules that employers must follow when it comes to Employee Withholding Allowance Certificates, or Form W-4.
No Form W-4. If an employee does not submit a valid and complete Form W-4, the employer must withhold taxes as though the employee were a single person claiming no allowances.
Altered Form W-4. Any alteration to a Form W-4 submitted by an employee will cause the form to be invalid. The employer should notify the employee that the form submitted is invalid and should request another form from the employee. If the form is not corrected, the employee is considered to have failed to furnish a Form W-4. The employer must withhold taxes from the employee as though the employee were a single person claiming no allowances until a valid Form W-4 is completed.
Substitute Form W-4. If an employee develops a substitute to the Form W-4 and submits it to the employer, the employer can refuse to accept the substitute form. If the employer refuses to accept the form, the employee should be informed of the decision and should be given an opportunity to complete an official Form W-4 or a substitute Form W-4 developed by the employer. An employer may develop a substitute Form W-4 provided that the substitute form contains all the tables, instructions, and worksheets that are in the current official Form W-4 at that time. Until the employee furnishes an acceptable new Form W-4, the employer must either withhold taxes from the employee as though they were a single person claiming no allowances or continue to withhold taxes based on the employee’s prior Form W-4 that was in effect at the time, if applicable.
Exemption from withholding. An employee can claim an exemption from withholding for the 2006 tax year only if both in 2005 the employee had a right to a refund of all federal tax withheld because the employee had no tax liability, and the employee expects to have no tax liability in 2006.
Repaying withheld tax. It is important for employees to continue to evaluate their withholdings as changes in their life and financial situation occur. If an employee determines that they are having too much tax withheld because they did not claim all of the withholding allowances they are entitled to, the employee should complete a new Form W-4 as soon as possible as the employer cannot repay the taxes that were previously withheld. Although, if in error the employer withheld more than the approved amount of tax from the Form W-4 in effect for that employee, then the employee does not have to fill out a new Form W-4 and the employer can repay the amount that was incorrectly withheld. If the amount is not repaid, the employee’s Form W-2 should reflect the full amount actually withheld from the employee.
Valid Form W-4, but withholding amount calculated by employee appears incorrect. If an employer receives a valid Form W-4 from an employee but the withholding amount calculated by the employee appears to be incorrect, the employer should withhold taxes based upon the allowances claimed on the Form W-4. However, the employer should advise the employee that the IRS may review the withholding for adequacy and could issue a lock-in letter.
Lock-in letter from IRS. If the IRS determines that an employee is not having enough tax withheld, it will notify the employer to increase the amount of withholding by issuing a lock-in letter that specifies the maximum number of withholding allowances permitted for the employee. The employer will also receive a copy of the letter for the employee that will explain the process that the employee can follow to provide additional information to the IRS to determine the appropriate number of withholding allowances, and to identify the maximum number of withholding allowances permitted by the lock-in letter. The employer must furnish a copy of the letter to current employees and must notify the IRS with a written response if the individual is a former employee. Once the employer receives the lock-in letter, any Form W-4 submitted by the employee directly to the employer must be disregarded. The employee is given a grace period before the lock-in rate becomes effective. This is to allow the employee time to submit directly to the IRS a new Form W-4 and a statement supporting the information claimed on the Form W-4 for approval that would decrease the federal income tax withholding from the amount calculated in the lock-in letter. The employer must withhold tax in accordance with the lock-in letter as of the effective date specified in the letter. Once the rate specified in the lock-in letter becomes effective, an employer can not decrease the amount of withholding without approval by the IRS. Employers who allow employees to submit or change their Form W-4 online must block employees who have been “locked-in” from decreasing the amount of withholding on their Form W-4. If the employer fails to follow the IRS lock-in letter instructions, the employer will be liable for paying the additional amount of withholding tax.
IRS Withholding Calculator. While employers are not responsible for calculating their employee’s withholding tax, they can recommend that the employee utilize the free IRS Withholding Calculator for valuable assistance in calculating their withholding tax. The IRS Withholding Calculator can be found on the IRS website at www.irs.gov in the “Online Tools” section.
