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 redesigned Form
W-4 for 2020 and subsequent years. Before 2020, the value of a withholding
allowance was tied to the amount of the personal exemption. Due to
the Tax Cuts and Jobs Act of 2017 (TCJA) (Pub.
L. 115-97), however, taxpayers can no longer claim personal or dependency
exemptions; therefore, Form W-4 no longer asks employees to report
the number of withholding allowances that they are claiming.
Employees who submitted a Form W-4 in any year before
2020 are not 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.
However, new hires now must use the redesigned form,
along with 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, they should be 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 withholding allowances, which were tied
to the value of the personal exemption, because the TCJA suspended
personal and dependent exemptions through the end of tax year 2025. 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 current 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.