It's Taxing Determining Proper Withholdings

Benjamin Franklin famously wrote, "in this world nothing is certain but death and taxes." It's the time of year when many employees are asking, "How come I owe money when money is taken out of my check all year?"

Employers need to make sure employees complete Form W-4 upon hire so proper tax withholdings are made - it really "kills" employees to owe a lot at the end of the year. While your obligation as an employer is making the proper withholdings, there is a lot of information you can give your employees to help them through this process.

W-4 Forms

Employees must provide a signed Form W-4 upon hire, which is effective with the first wage payment. If the signed form is not received by the first paycheck, employers must withhold taxes anyway - either as if the employee is single or with no withholding allowances. The Internal Revenue Service recommends that employers encourage their employees to file an updated Form W-4 for the current year, especially if they owed additional taxes or received a large refund in the past year.

Form W-4 helps employees figure the withholding, but the IRS' Withholding Calculator, found at www.irs.gov/individuals, is another useful resource for employees to use to ensure appropriate withholding. The Withholding Calculator does not replace the Form W-4; instead, it aids employees in making sure that they do not have too much or too little tax withheld.

The amount of any federal income tax withholding must be based on marital status and withholding allowances. Employees may not base their withholding amounts on a fixed dollar amount or percentage, but they may specify a dollar amount to be withheld in addition to the amount of withholding based on filing status and withholding allowances.

• Spanish-speaking employees. Forma W-4(SP), Certificado de Exención de la Retención del(la) Empleado(a), may be used in place of Form W-4, Employee's Withholding Allowance Certificate, for your Spanish-speaking employees (available at www.irs.gov). Additional information can be found in IRS Publication 579SP, Cómo Preparar la Declaración de Impuesto Federal.

DE 4 Forms

Because the federal Form W-4 also can be used for California withholdings, Form DE 4 (the California Employee's Withholding Allowance Certificiate) needs to be filled out only by employees who claim different withholding information for California personal income tax than for federal income tax. This can occur when individuals have a different marital filing status, a registered domestic partnership, a different number of regular allowances or an additional withholding dollar amount than the on the federal Form W-4.

Under California law, registered domestic partners are permitted to file income tax returns jointly or separately on terms similar to those governing spouses. Registered domestic partners who file separate income tax returns each report one half of the combined income earned by both domestic partners just as spouses do, rather than their respective individual incomes for the taxable year. As a result, a registered domestic partner may wish to file a DE 4 form to have payroll tax deductions determined as a married individual. Download the DE 4 form.

Although not all employees are required to fill out Form DE 4, it must be available for employees who choose to use it. When an employee submits a new form, keep it (or a copy, if you send the original to your payroll department) with all previous Forms DE 4 in the employee's personnel file or, if separately maintained, in a payroll file.

By completing Form DE 4, employees do not change their federal withholding allowances. If they wish to change their federal allowances, they must submit to you a new Form W-4.

Withholding Gone Wrong

Some employees may qualify for an exemption from federal tax withholdings if they had no tax liability in the previous year and do not expect tax liability for the current year. They must still complete Form W-4 and follow the instructions provided therein. Beware: if the employee can be claimed as a dependent on a parent's or another person's tax return, additional limitations apply.

The Form W-4 claiming exemption from withholding is valid for only one calendar year. To continue to be exempt from withholding in the next year, an employee must give you a new Form W-4 claiming exempt status by February 15 of that year. If the employee does not give you a new Form W-4, you must withhold tax as if he or she is single, with no withholding allowances. However, if you have an earlier Form W-4 (not claiming exempt status) for this employee that is valid, withhold as you did before.

Lock-in Letters

The IRS uses information employers report on Form W-2 to identify employees with withholding compliance problems. In some cases, where a serious under-withholding problem is found to exist for a particular employee, the IRS may issue a notice to the employer, known as a "lock-in letter," that gives the employee the maximum number of withholding allowances permitted. The IRS gives the employee an opportunity to dispute the determination before the employer is required to adjust withholding based on the lock-in letter. The IRS sends this letter to employees at their last known address, and it also sends a copy to the employer.

After the effective date of a lock-in letter, employers must disregard any Form W-4 that claims more allowances or exempt status, until the IRS notifies the employer to withhold tax based on the new Form W-4. If the employee furnishes a Form W-4 that claims a number of withholding allowances less than the maximum number specified in the lock-in letter, resulting in more tax withheld than required by the lock-in letter, the employer must withhold tax based on that Form W-4. Employers who use electronic Form W-4 systems must make sure the employee can not access they system to override the lock-in letter and decrease withholding.

The IRS recommends that employers should inform employees of the importance of submitting an accurate Form W-4. An employee may be subject to a $500 penalty if he or she submits, with no reasonable basis, a Form W-4 that results in less tax being withheld than is required.

The IRS notes the following requirements for employers:

• Furnish a copy of the proposed lock-in letter to the employee(s) immediately upon receipt.
• Impose the new withholding rate 60 days after the date on the original letter and maintain that rate.
• Fax a signed note on company letterhead to the IRS stating the employee is no longer employed by the business, if that is the case. The note should be sent to the Service's Lowell, Mass., office at (978) 474-1326.
• Ensure safeguards are in place to prevent employees from increasing their allowances electronically.
• Maintain the withholding amount specified in the lock-in letter. There could be a penalty if the employer fails to honor the lock-in requirement, and they could be liable for the amount of tax that should have been withheld.
• Remind employees that the notice they received tells them how to contact the IRS if they want to change the withholding status and allowances from single/zero, and that they will need the following information available when they call or write: