The amount of federal income tax withheld is based on withholding tables published by the Internal Revenue Service (IRS) and the information provided on each employee's Form W-4, Employee's Withholding Certificate.

The IRS revised Form W-4 for 2019 to reflect the Tax Cuts and Jobs Act of 2017 (TCJA) (Pub. L. 115-97). Employees whose claimed number of withholding allowances was reduced by the TCJA were required to give their employer a new Form W-4 by May 10, 2019. The IRS has developed a Tax Withholding Estimator to help employees determine how many allowances to claim.

The IRS made additional changes to Form W-4 for tax year 2020. The redesigned Form W-4 no longer uses the concept of withholding allowances, which was previously tied to the amount of the personal exemption. The TCJA suspended personal and dependent exemptions through the end of tax year 2025.

Employees who have submitted a Form W-4 in any year before 2020 will not be required to submit a new form merely because of the redesign. Employers can continue to compute withholding based on the information from the employee’s most recently submitted Form W-4.

Beginning January 1, 2020, new hires must use the redesigned form, as must existing employees who wish to adjust their withholding. An employer may ask existing employees to submit a new Form W-4 using the new version, but must also explain that they are not required to do so and that, if they do not, withholding will continue based on the form they previously submitted if it is valid.

Each new employee should fill out a W-4 when hired. If a new employee does not provide a completed W-4, tax is withheld as if he or she is single, with no withholding allowances. Beginning January 1, 2020, new employees who do not provide a completed W-4 are treated as if they had checked the box for “single or married filing separately” in Step 1(c) and made no entries in Steps 2, 3, or 4.

A W-4 remains in effect until the employee provides a new one. Revised withholding must begin no later than the first payroll period ending on or after the 30th day after the date the revised W-4 was received. Employers may establish systems that let employees change their W-4 information electronically.

Regulations finalized October 6, 2020 (85 Fed. Reg. 63019), updated the federal withholding rules to reflect the TCJA changes and accommodate the redesigned Form W-4.

The redesigned Form W-4 no longer uses an employee’s marital status and withholding allowances, which were tied to the value of the personal exemption, because the TCJA eliminated these personal exemptions. Instead, income tax withholding using the redesigned Form W-4 will generally be based on the employee's expected filing status and standard deduction for the year.

Employees can choose to have itemized deductions, the child tax credit, and other tax benefits reflected in their withholding for the year. As in the past, employees can choose to have an employer withhold a flat-dollar extra amount each pay period to cover, for example, income they receive from other sources that is not subject to withholding. Under the new regulations, employees now also have the option to request that employers withhold additional tax by reporting income from other sources not subject to withholding on the Form W-4.

The final rules also include the option for computational bridge entries, to allay concerns that employers would have to maintain two different systems to compute withholding from old and new Forms W-4.

In certain circumstances, the IRS may direct an employer to submit copies of Forms W-4 for certain employees in order to ensure that the employees have adequate withholding. Employers are now required to submit the Forms W-4 to the IRS only if directed to do so in a written notice or pursuant to specified criteria to be set forth in future published guidance.

If the IRS determines that an employee does not have enough withholding, it will notify the employer to increase the amount of withholding tax by issuing a lock-in letter that specifies the employee’s permitted filing status and provides withholding instructions for the specific employee. The employer will also receive a copy for the employee that identifies the permitted filing status and how the employee can provide additional information to the IRS for determining the appropriate withholding and/or modifying the filing status specified. If the employee still works for the employer, the employer must furnish the employee copy to the employee. If the employee no longer works for the employer, the employer must send a written response to the IRS office designated in the lock-in letter indicating that the employee is no longer employed.

The employee will be given time before the lock-in rate takes effect to submit a new Form W-4 and a statement supporting the claims made to the IRS office designated in the lock-in letter. Unless otherwise notified by the IRS, employers are required to begin withholding based on the lock-in letter for any wages paid after the date specified in the notice. Once a lock-in rate is effective, an employer cannot decrease withholding without IRS approval.

After the receipt of a lock-in letter, employers must also disregard any Form W-4 that decreases the amount of withholding. The employee must submit any new Form W-4 and a statement supporting the claims made that would decrease federal income tax withholding directly to the IRS address in the lock-in letter. The IRS will notify the employer to withhold at a specific rate if the employee’s request is approved. If, at any time, the employee furnishes a Form W-4 that results in more withholding than required by the lock-in letter, the employer must increase withholding based on that Form W-4.

Employers that do not follow the IRS lock-in instructions will be liable for paying the additional amount of tax that should have been withheld.

Employers are not required to check the validity of an employee's W-4. If an employee files a W-4 and indicates that it is false, the W-4 is invalid. In this circumstance, an employer may request a new W-4 with valid information. If one is not provided, the employer should continue to use the previous W-4. If there is no previous W-4, and the employee was paid wages before 2020, withholding should be at the rate for a single person with no allowances on the 2019 Form W-4. Otherwise, withholding should be done as if the employee had checked the box for Single or Married filing separately in Step 1(c) and made no entries in Step 2, Step 3, or Step 4 of the 2021 Form W-4.

There is a $500 penalty that applies if an employee files a false Form W-4. There is also a criminal penalty for supplying false or fraudulent information on a W-4 or failing to supply information that would increase the amount withheld.

Employees may want to change the entries on Form W-4 for any number of reasons when their personal or financial situation changes. There is no limit on the number of times an employee may file a new W-4 form. Employers are not permitted to charge a fee for processing revised W-4 forms. A revised W-4 must be put into effect no later than the start of the first payroll period ending on or after the 30th day after the new form is filed.

Tax equalization is a payroll procedure or policy used most frequently when an employee lives in one taxing jurisdiction but works in another. The purpose is to make the net compensation of employees equal no matter whether they’re working in a high tax jurisdiction or a low tax jurisdiction. Thus, it is often used when an employee is asked to work in another country. While more common in Europe where it is likely that an employee could live in one country and work in another, it is applicable to U.S. border areas, particularly with Mexico, because the Mexico nonresident income tax rate is higher than the income tax rate in the United States.

An example of tax equalization would be a company that has two facilities, one on each side of the Texas/Mexico border. An employee who lives in Texas and has been working in Texas is needed to do the same job in the facility in Mexico. An individual commuting daily from the United States to Mexico to work is subject to the Mexico nonresident income tax. He or she, as a resident of the United States, is also subject to U.S. income tax but can credit the amount paid to Mexico against his or her U.S. tax. Because the U.S. tax is lower, the employee will have less net income, although the two facilities may be very close to each other. Tax equalization would restore the employee to the same net financial situation he or she would be in if not transferred to the Mexican facility.

The most common form of tax equalization in this situation involves estimating an individual's taxes for the year and adjusting pay so that the net is the same as it would have been if the employee weren’t transferred. At the end of the year, the expected and the actual tax amounts are further reconciled. Whenever an employee fills out a W-4, he or she is making an estimate of how much tax he or she will owe based on his or her circumstances. This amount is reconciled after the year is over when the employee files a tax return and gets a refund or pays or owes money to the IRS. Adjusting withholding quarterly could result in a somewhat more accurate estimate of taxes owed but is generally not necessary unless there has been a significant change in an employee’s tax status (such as getting married or having a child).

Payroll equalization also has application where an employee is transferred from a low cost-of-living area to a high cost-of-living area. Payroll equalization, particularly tax equalization, is a potentially complex accounting practice and should be worked out by a tax practitioner who specializes in this area.

Employers must deduct from employees' wages for Social Security tax and for Medicare tax. There is a ceiling on the amount of annual wages that are subject to Social Security tax that is adjusted annually, but there is no limit on the amount of wages subject to Medicare tax. For 2021, the tax rate for Medicare is 1.45 percent (amount withheld) each for the employee and employer (2.9 percent total). All covered wages are subject to Medicare tax. In addition to withholding Medicare tax at 1.45 percent, employers must withhold a 0.9 percent Additional Medicare Tax from wages the employer pays to an employee in excess of $200,000 ($250,000 for married taxpayers who file jointly; $125,000 for married taxpayers who file separately) in a calendar year. An employer is required to begin withholding Additional Medicare Tax in the pay period in which the employer pays wages in excess of $200,000 to an employee and continue to withhold it each pay period until the end of the calendar year. Additional Medicare Tax is imposed only on the employee. There is no employer share of Additional Medicare Tax. All wages that are subject to Medicare tax are subject to Additional Medicare Tax withholding if paid in excess of the $200,000 withholding threshold.

In 2021, employers and employees each contribute 6.2 percent of the first $142,800 an employee earns during the year for Social Security, and each contribute 1.45 percent of all taxable earnings for Medicare.

Employers must notify employees who have no federal income tax withheld that they may be able to claim a tax refund because of the EIC. This requirement may be met with a Form W-2 that has the EIC notice on the back of Copy B, or a substitute W-2 with the same statement. For 2020, the IRS encouraged employers to notify any employees whose wages were less than $50,954 ($56,844 if married filing jointly) that they could be eligible.

Supplemental wages are wages paid in addition to regular wages, including, but not limited to, overtime pay, sick leave pay, vacation pay, bonus payments, commissions, severance pay, awards, prizes, back pay, retroactive pay increases for current employees, payments for nondeductible moving expenses, and tips. Withholding practices vary depending on how the wages are paid.

If an employee receives supplemental wages exceeding $1 million in a calendar year, the excess is subject to a tax withholding of 37 percent (or the highest income tax rate in effect for that year). Employers must use the 37 percent rate regardless of the information on the employee's Form W-4.

The following rules apply when an employee receives less than or equal to $1 million in supplemental wages in a calendar year.

Unidentified supplemental wages. When supplemental wages are combined with regular wages without identification, employers should withhold taxes as if the total were a single payment for a regular payroll period.

Identified supplemental wages. When supplemental wages are identified separately from regular wages, the income tax withholding method will depend on how income taxes are withheld from the employee's regular wages.

Employers that withheld income tax from an employee's regular wages can either:

Employers that do not withhold income tax from an employee's regular wages should use method 2, above.

Note: According to the IRS, supplemental wages are subject to Social Security, Medicare, and Federal Unemployment Tax Act (FUTA) taxes regardless of the withholding method used.

Whether severance pay is subject to Federal Insurance Contributions Act (FICA) taxes has often been a source of confusion for employers. However, the U.S. Supreme Court clarified the issue in U.S. v. Quality Stores, Inc., holding that generally, severance pay is subject to FICA tax withholding (United States v. Quality Stores, Inc. (134 S. Ct. 1395 (2014)). Quality Stores, Inc., made severance payments to employees who were involuntarily terminated as part of its bankruptcy. The severance payments were not tied to the receipt of state unemployment insurance and varied based on job seniority and time served. Quality Stores initially paid and withheld FICA taxes, but it later tried to get a refund for itself and its former employees, claiming that the severance payments should not have been taxed as wages under FICA. The District Court and the 6th Circuit both concluded that severance payments were not “wages” under FICA. The Supreme Court disagreed, holding that such severance payments are taxable wages for FICA purposes. The Court noted that FICA defines the term “wages” broadly, and severance payments fit within this definition. It also pointed out that FICA contains no general exception for severance payments. Finally, the Court determined that the Internal Revenue Code chapter governing income tax withholding does not limit the meaning of “wages” for FICA purposes.

Sick leave and disability pay are subject to federal income taxation; however, only the first 6 months of sick and disability pay are subject to Social Security, Medicare, and federal unemployment taxes. Employees may request that third-party payers withhold taxes from sick and disability pay.

The Families First Coronavirus Response Act (FFCRA) authorizes payroll tax relief for qualifying employers. See https://www.irs.gov/coronavirus.

Vacation pay alone is subject to withholding as if it were a regular wage payment. When vacation pay is in addition to regular wages, it should be treated as a supplemental wage.

Federal income tax, FICA tax, and Medicare tax must be withheld from all supplemental wage payments made to employees. For bonuses that are less than or equal to $1 million, employers deduct income tax either according to the individual's schedule or at a flat 22 percent rate. Some executives may want an even larger-than-normal deduction to be made for withholding when the bonus is a considerable sum.

Any bonus can be paid in a separate check. If combined with a regular paycheck, and the portion attributed to the bonus is not specified, the amount to be withheld on the combined amount must then be computed from the regular tables for withholding.

Tips are generally subject to withholding. Employees will report tips on Form 4070 (Employee's Report of Tips to Employer) when tips received are more than $20 per month. Employers may implement a system that allows employees to report their tips electronically.

It is necessary to withhold income tax from students/interns on a summer job unless they claim exemption from withholding on their W-4 form. Even if exempt from income tax, their income may be subject to Social Security taxes.

Complex rules apply to the withholding of taxes on fringe benefits that are taxable. Examples of fringe benefits that may be taxable in whole or in part include cars, free or subsidized parking, mass transit subsidies, airplane flights, discounts, vacations, memberships in country clubs or other social clubs, and tickets to entertainment events that the employer provides. In general, the fair market value of the benefit less what the employee may have paid for it must be included in taxable income.

Complex distribution and income tax withholding rules also apply to taxable payments from pension, profit-sharing plans, and 401(k) plans.

Withholding on periodic payments is done using the same withholding tables as for wages. Recipients may file Form W-4P, Withholding Certificate for Pension or Annuity Payments, to specify the number of withholding allowances, add additional withholding, or claim a withholding exemption. If no W-4P is on file, withholding is at the rate for a married person with three allowances.

Withholding is required on certain lump-sum payments that may be eligible for tax-free rollover treatment made directly to employees. Withholding is not required on direct rollovers from a qualified retirement plan to another qualified plan or an Individual Retirement Account (IRA).

The taxes employers withhold from employees, along with the employer's share of FICA and Medicare taxes, must be deposited to an authorized financial institution.

Generally, deposits during a calendar year must be made monthly or semiweekly depending on how much was deposited during the lookback period, defined as a 12-month period ending on June 30 of the previous year. Employers that reported $50,000 or less of taxes during the lookback period deposit monthly; employers that reported more than $50,000 deposit semiweekly. New employers deposit monthly during their first calendar year. However, if an employer accumulates $100,000 in tax liability on any day during a deposit period, a deposit must be made by the next banking day.

Note: Employers accumulating $100,000 in tax liability on any day automatically become semiweekly schedule depositors on the following day and remain so for at least the rest of the calendar year.

Employers must use electronic funds transfers (EFTs) to make all federal tax deposits (including deposits of employment taxes, excise taxes, and corporate income taxes). Generally, EFTs are made using the EFTPS, a free service from the Department of the Treasury. For additional information, employers should contact the EFTPS at 800-555-4477, or visit them on the Web at http://www.eftps.gov.

With some exceptions, employers that pay wages subject to income tax withholding or Social Security and Medicare taxes are required to file Form 941, Employer's Quarterly Federal Tax Return. Employers may qualify to file Form 944, Employer's Annual Federal Tax Return. Employers that fail to file a form are subject to a penalty of 5 percent of the unpaid tax that was due with that form. If an employer pays the tax late, a penalty is incurred of 0.5 percent per month of the amount of the tax. The IRS permits employers to file these forms electronically. For more information, visit https://www.irs.gov/businesses/e-file-employment-tax-forms.

Employers that have been filing Form 941 and believe their yearly employment taxes will be $1,000 or less in the current calendar year may contact the IRS to request to file Form 944. The request must be made by phone at 800-829-4933 by April 1 or by written request postmarked by March 15.

New employers are also eligible to file Form 944 if they will meet the eligibility requirements. When filing Form SS-4, Application for Employer Identification Number, indicate the highest number of employees expected in the next 12 months, and check the box on line 14 to indicate whether you expect to have $1,000 or less in employment tax liability for the calendar year and would like to file Form 944.

In 2020, the IRS revised Form 941 to include the reporting of credits for COVID-19 paid leave under FFCRA and employee retention under the Coronavirus Aid, Relief, and Economic Security Act. A new Form 7200 also was created so employers can claim an advance payment of these refundable credits. See the Form 941 Instructions for the latest on the status of these credits.

Employers are required to provide employees with Form W-2 (Wage and Tax Statement) by January 31 of each year. Employers may furnish this form to their employees electronically if they obtain the employees' consent to do so.

Employers must annually file Copy A of Form W-2 and Form W-3 (Transmittal of Income and Tax Statements) with the Social Security Administration (SSA). Alternatively, employers may file electronically using SSA's free service at http://www.socialsecurity.gov. Employers filing 250 or more W-2 forms must file electronically unless they receive a waiver from the IRS. Beginning with tax year 2016, these forms must be filed with the SSA by January 31, whether submitted on paper or electronically.

Qualified sick leave wages and qualified family leave wages paid to employees under FFCRA must be reported either on Form W-2, Box 14, or on a separate statement. If a separate statement is provided and the employee receives a paper Form W-2, then the statement must be included with the Form W-2 sent to the employee; if the employee receives an electronic Form W-2, then the statement must be provided in the same manner and at the same time as the Form W-2. (See IRS Notice 2020–54.)

Employers are required to report on Form W-2 the total cost of group healthcare coverage, including the portion paid by the employer and the portion paid by the employee (IRS Notice 2010-69).

How to report. The value of the healthcare coverage is reported in Box 12 of the Form W-2, with Code DD to identify the amount. There is no reporting on the Form W-3 of the total of these amounts for all the employer’s employees.

Calculating the amount to report. In general, the amount reported should include both the portion paid by the employer and the portion paid by the employee. In the case of a health flexible spending account (FSA), the amount reported should not include the amount of any salary reduction contributions. The amount of the health FSA that is required to be included in the cost reported on Form W-2 is the amount of the health FSA for the plan year that exceeds the salary reduction elected by the employee for the plan year.

Premium charged method. The premium charged method may be used to determine the reportable cost only for an employee covered by an employer’s insured group health plan. In such a case, if the employer applies this method, the employer must use the premium charged by the insurer for that employee’s coverage (for example, for self-only coverage or for family coverage, as applicable to the employee) for each period as the reportable cost for that period.

Modified Consolidated Omnibus Budget Reconciliation Act (COBRA) premium method. An employer may use the modified COBRA premium method only where the employer subsidizes the cost of COBRA (so that the premium charged to COBRA-qualified beneficiaries is less than the COBRA applicable premium) or where the actual premium charged by the employer to COBRA-qualified beneficiaries for each period in the current year is equal to the COBRA applicable premium for each period in a prior year. If the employer subsidizes the cost of COBRA, the employer may determine the reportable cost for a period based on a reasonable good-faith estimate of the COBRA applicable premium for that period, if such reasonable good-faith estimate is used as the basis for determining the subsidized COBRA premium. If the actual premium charged by the employer to COBRA qualified beneficiaries for each period in the current year is equal to the COBRA applicable premium for each period in a prior year, the employer may use the COBRA applicable premium for each period in the prior year as the reportable cost for each period in the current year.

Employers that charge employees a composite rate. An employer is considered to charge employees a composite rate if (1) there is a single coverage class under the plan (that is, if an employee elects coverage, all individuals eligible for coverage under the plan because of their relationship to the employee are included in the elections and no greater amount is charged to the employee, regardless of whether the coverage will include only the employee or the employee plus other such individuals), or (2) there are different types of coverage under a plan (for example, self-only coverage and family coverage, or self-plus-one coverage and family coverage) and employees are charged the same premium for each type of coverage. In such a case, the employer using a composite rate may calculate and use the same reportable cost for a period for (1) the single class of coverage under the plan, or (2) all the different types of coverage under the plan for which the same premium is charged to employees, provided this method is applied to all types of coverage provided under the plan. For example, if a plan charges one premium for either self-only coverage, or self-and-spouse coverage (the first coverage group), and also charges one premium for family coverage, regardless of the number of family members covered (the second coverage group), an employer may calculate and report the same reportable cost for all of the coverage provided in the first coverage group and the same reportable cost for all of the coverage provided in the second coverage group. If an employer is using a composite rate for active employees, but is not using a composite rate for determining applicable COBRA premiums for qualified beneficiaries, the employer may use either the composite rate or the applicable COBRA premium for determining the aggregate cost of coverage, provided that the same method is used consistently for all active employees and is used consistently for all qualified beneficiaries receiving COBRA coverage.

Note: An employer is not required to issue a Form W-2 solely to report the value of the healthcare coverage for retirees or other employees or former employees to whom the employer would not otherwise provide a Form W-2.

In addition, the fact that reporting is not required in Box 12, Code DD, has no impact on requirements to report these items elsewhere. For example, while contributions to health savings accounts (HSAs) are not to be reported in Box 12, Code DD, certain HSA contributions are reported in Box 12, Code W.

The IRS has implemented processes for correcting errors on employment tax returns using the X forms. To correct employment tax errors, use the X forms as soon as the errors are discovered. For example, Form 941-X, Adjusted Employers Quarterly Federal Tax Return or Claim for Refund, is used to correct errors on a previously filed Form 941. For overpayments, employers can choose to make an adjustment or claim a refund on the X form. For underpayments, employers must use the X form. Amounts owed must be paid by the time the X form is filed. Payments can be made using EFTPS, by sending a check, or by credit card.

Tax Information for Businesses: http://www.irs.gov/businesses

Forms and Publications: https://www.irs.gov/forms-instructions

Business and Specialty Tax Line: 800-829-4933

In-person assistance, when necessary, is available from local IRS Taxpayer Assistance Centers. The IRS provides an office locator portal for finding the nearest one.