Client Question: What should I do if an employee claims a high number of exemptions?

According to the IRS, if an employee submits a valid Form W-4 that appears to be claiming an incorrect withholding amount, you should withhold federal income tax based on the allowances claimed on the Form W-4. But, you should advise the employee that the IRS may review withholding to ensure it is adequate, and that the IRS may direct you, as the employer, to withhold income tax for the employee at a certain rate if the review indicates the employee’s withholding is inadequate. Once this occurs the employee will not be allowed to decrease their withholding unless approved by the IRS.

In the past, employers were required to submit all Forms W-4 that claimed complete exemption from withholding or claimed more than 10 allowances. Today, employers are no longer required to routinely submit Forms W-4 to the IRS. However, in certain circumstances, the IRS may direct you to submit copies of Forms W-4 for certain employees to ensure that the employees have adequate withholding. You are now required to submit the Forms W-4 to IRS only if directed to do so in a written notice or pursuant to specified criteria set forth in future published guidance.

If the IRS determines that an employee does not have enough withholding, they will notify you to increase the amount of withholding tax by issuing a “lock-in” letter that specifies the maximum number of withholding allowances permitted for the employee. You will also receive a copy for the employee that identifies the maximum number of withholding exemptions permitted and the process by which the employee can provide additional information to the IRS for purposes of determining the appropriate number of withholding exemptions.

If the employee still works for you, you must furnish the employee copy to the employee. If the employee no longer works for you, no action is required at this time. However, if the employee should return to work within twelve (12) months, you should begin withholding income tax from the employee’s wages based on the withholding rate stated in this letter.

The employee will be given a period of time before the lock-in rate is effective to submit for approval to the IRS a new Form W-4 and a statement supporting the claims made on the Form W-4 that would decrease federal income tax withholding. The employee must send the Form W-4 and statement directly to the IRS office designated on the lock-in letter. You must withhold tax in accordance with the lock-in letter as of the date specified in the lock-in letter, unless otherwise notified by the IRS. You will be required to take this action no sooner than 45 calendar days after the date of the lock-in letter. Once a lock-in rate is effective, an employer cannot decrease withholding unless approved by the IRS.

For more information on this topic, contact a ShindelRock tax professional today.