As employees are completing and filing their Federal income taxes, this is often a time for them to review their Form W-4, Employee’s Withholding Allowance Certificate.  Although it is tempting to offer advice to your employees concerning how best to fill out their W-4, you should resist that impulse.  There are many resources available for employees to understand how best to fill out their form, starting with the instructions on the top of the form. The American Payroll Association also recommends that employees read IRS Publication 505 for a detailed explanation and worksheets to assist in calculations to fill out the form. The latest version of the publication is available at http://www.irs.gov/uac/Publication-505,-Tax-Withholding-and-Estimated-Tax-3 .  Without offering advice to your employees, however, there is a special situation that as an employer you should be versed in.

“I claim exempt from withholding.” 

This is a commonly misunderstood item on the W-4, especially for part-time or seasonal employees.  While as an employer you cannot prevent an employee from claiming exemption from Federal Income tax, you can ask them to read carefully what they are certifying:

I claim exemption from withholding for 2014, and I certify that I meet both of the following conditions for exemption.

• Last year I had a right to a refund of all federal income tax withheld because I had no tax liability, and
• This year I expect a refund of all federal income tax withheld because I expect to have no tax liability

Note the emphasis on ‘all’ and ‘no’ in the form language.  Often employees will think they are exempt because they got a refund last year or they are claimed as a dependent.  This may be the case, but is not always so.  Figure 1-A. on page 12 of IRS Form 505 provides a decision tree for employees to follow to determine their exempt from tax status.  Essentially if an employee’s 2014 income exceeds the standard deduction plus personal exemptions, they are not eligible for exemption. For a single person, that amount would be $6200 (the Standard Deduction) plus $3950 (the personal exemption) for a total of $10,150.  (At the Federal minimum wage of $7.25 per hour that is 1400 hours or 27 hours per week.)

“But I am a dependent. . .”  

Being a full-time student and a dependent does not automatically exempt a part-time employee from withholding requirements.  When total income (both wage and non-wage income) exceeds $1,000 and includes more than $350 of unearned income (interest, dividends, etc.) per year, an employee who is being claimed as a dependent by their parents (or someone else) cannot claim exemption from withholding.  Otherwise, the total income tests mentioned above apply.

Additional Items

Publication 505 also notes:

• “If you claim exemption, but later your situation changes so that you will have to pay income tax after all, you must file a new Form W-4 within 10 days of the change.”
• “If you claim exemption in 2014 but you expect to owe income tax in 2015, you must file a new W-4 form by December 1, 2014.”
• “Exempt status is only good for one year and must be reaffirmed with a new W-4 form by February 15 of each year to continue the exemption.”
• And finally this final note to share with your employees:

“You may have to pay a penalty of $500 if both of the following apply.

You make statements or claim withholding allowances on your Form W-4 that reduce the amount of tax withheld.

You have no reasonable basis for those statements or allowances at the time you prepare your Form W-4.

There is also a criminal penalty for willfully supplying false or fraudulent information on your Form W-4 or for willfully failing to supply information that would increase the amount withheld. The penalty upon conviction can be either a fine of up to $1,000 or imprisonment  for up to 1 year, or both.

These penalties will apply if you deliberately and knowingly falsify  your Form W-4 in an attempt to reduce or eliminate the proper withholding of taxes.” 

A careful reading by the employee of the instructions and other supporting materials will result in a properly completed W-4 and no surprises next year at this time.