Withholding Exemptions for Employees

The total federal income tax that you withhold from an employee's wages during the year is supposed to approximate the employee's year-end tax liability.

However, when your employees prepare their annual tax returns, they don't pay tax on their entire gross wages. Rather, they reduce their gross wages (and other income) by personal exemptions for themselves, their spouses, and their dependents and by various deductions in determining the portion of their income that is actually taxable. To account for these exemptions and deductions in the tax you withhold, your employees are entitled to claim withholding exemptions.

Generally speaking, the more withholding exemptions an employee claims, the less tax you'll be required to withhold. Technically, each withholding exemption frees a specified dollar amount of wages from withholding. For 2013, the annual value of a withholding exemption is $3,900 ($3,800 for 2012). In other words, each withholding exemption that an employee claims for 2013 will effectively exempt $3,900 in annual wages from withholding.

Form W-4. Your employees claim their withholding exemptions by filing with you federal Form W-4, Employees' Withholding Allowance Certificate. One of the first things you should do whenever you hire a new employee is to have the employee fill out a W-4. If you don't have a valid W-4 on file for an employee, you must treat the employee as being single with no exemptions for withholding purposes. It's also good practice to remind your employees at the beginning of each year that they should file amended W-4s if their eligibility for claiming withholding exemptions has changed since the filing of their last certificates.

Permissible exemptions. On their W-4, your employees can claim a withholding exemption for themselves, and for a spouse if the spouse is not claiming his or her own exemption on the spouse's W-4. An employee can also claim one exemption for each child or other dependent claimed on his or her tax return. Employees who expect to claim large amounts of itemized deductions on their return may be entitled to additional withholding exemptions.

Although your employees may not claim more withholding exemptions than they're entitled to, they may claim fewer than they're entitled to. Furthermore, employees can request on their W-4 that you withhold additional dollar amounts from their wages. This is often necessary if the employee's spouse is employed, since the couple's combined tax liability will usually be higher than the normal withholding formulas provide.

No-tax liability exemptions. An employee who anticipates having no federal income tax liability for the year and meets other requirements may claim a complete exemption from withholding on Form W-4. This exemption fully relieves you from any obligation to withhold federal income taxes (but not FICA taxes) from the employee's wages. The exemption from withholding lasts only up to February 15 of the following year, unless the employee files a new W-4 that renews the exemption claim.

Sending the W-4s to the IRS. In general, you're under no obligation to confirm that your employees are entitled to each withholding exemption they claim on their W-4s, and you don't have to file the W-4s with the government. However, if you learn that an employee has improperly claimed exemptions, you must inform the employee that the W-4 is invalid, request a new W-4, and send the invalid W-4 to the IRS. You do not need to send the IRS copies of any W-4 on which an employee claims more than 10 withholding exemptions or on which an employee claims complete exemption from withholding. The IRS has a process in place by which they can identify under-withholders and direct the employer to deduct a specific, appropriate amount from such employees.