Payroll in Practice: 10.7.2024

Question: A company has an employee self-service system through which employees can make online changes to their Forms W-4, Employee Withholding Certificate. Some employees claim exemption from withholding in anticipation of bonus payments to avoid the additional withholding. Is the company responsible if employees end up owing taxes?

Answer: Generally, an employer must withhold based on the employee’s Form W-4 claims. An employee-provided Form W-4 that results in significant underwithholding over the course of the year should not create employer liability for insufficient withholding. When an employee consistently fails to have enough withheld, the IRS has tools to improve compliance, such as a lock-in letter.

Employers may still take actions that improve compliance. The IRS offers suggestions for employers on its website. One recommendation is to inform employees that it is important to submit an accurate Form W-4. Employees may be subject to a $500 penalty if they submit, with no reasonable basis, Forms W-4 that result in significant underwithholding. Another is to encourage use of the IRS Tax Withholding Estimator.

Employers can notify employees when to update Form W-4 and the requirements for claiming exemption through training or with periodic reminders.Employees must submit new Forms W-4 to the employer within 10 days of any change of status resulting in less withholding than their expected tax liability, such as when they can no longer reasonably expect to claim exemption from withholding.

Employees who claim an exemption for which they do not qualify may be subject to perjury penalties. An employee may claim an exemption from federal income tax withholding only if their tax return for the previous year shows no tax liability and the employee does not expect to have a tax liability for the current year.

Taxpayers often mistake the balance due on a return as the tax liability. The IRS provides an objective definition of tax liability in the general instructions for Form W-4 to help taxpayers understand whether they meet the requirements. For exemption in 2024, an employee has no federal income tax liability in previous year if the total tax reported on Line 24 of their 2023 Form 1040, US Individual Tax Return, or Form 1040-SR, US Tax Return for Seniors, is either zero or an amount less than the sum of the refundable credits from Lines 27, 28, and 29. There would also be no federal tax liability in the previous year if the employee was not required to file a 2023 return because their income was below the filing threshold for the appropriate filing status.

Employers that provide electronic self-service for Forms W-4 should ensure that their systems meet all IRS requirements as outlined in Publication 15-T, Federal Income Tax Withholding Methods and federal regulations.

The basic requirements ensure that the submitter is the person named on the form, system access is documented, information presented to the submitter is the same as that presented on the paper form, the electronic signature is that of the person named in the form, and the signature is the last entry prior to submission.

The electronic system must be able to produce a hard copy of any Form W-4 the employee submitted for four years after that form was last in effect. That is, each electronic Form W-4 is to be retained for at least four years after the related tax was due or paid.

The additional requirements specify that the electronic system may not simplify or modify the form. The text and instructions in the electronic form must exactly duplicate the instructions from the face of the paper form and must allow an employee access to and use of all parts of the calculation shown on the paper Form W-4 and its worksheets. No pop-ups or hover boxes are permitted within the steps, any toggles that limit the amount of viewable text must be off by default, and, if the steps are on separate pages, the employee must be required to go to each page before the form is signed.

Other requirements include provision of fields for claiming exempt and for nonresident alien status, links to the paper Form W-4 and instructions, and the ability to add tax credits other than the child and other dependent credits in Step 3.

This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., or its owners.

Author Information
Patrick Haggerty is the owner of a tax practice in Chapel Hill, North Carolina, and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

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