What Happens if You Put Exempt on Your W-4?

The Form W-4, known as the Employee’s Withholding Certificate, is a document employees provide to their employer. This form instructs the employer on the amount of federal income tax to deduct from each paycheck. When an individual indicates “exempt” status on their W-4, it signifies that no federal income tax will be withheld from their wages. This election aims to align an employee’s tax withholding with their actual tax liability.

Criteria for Claiming Exempt

To claim “exempt” status on a W-4, an individual must satisfy specific Internal Revenue Service (IRS) criteria. An individual must have received a full refund of all federal income tax withheld in the prior tax year because they had no tax liability. This means their taxable income was below the standard deduction or was offset by credits.

Furthermore, the individual must anticipate having no federal income tax liability for the current tax year. This expectation is often true for those with very low income or specific tax situations that result in zero taxable income. The “exempt” status is generally not applicable to individuals with substantial income. An exemption is valid only for the calendar year in which it is submitted to the employer.

Financial Implications of Exempt Status

Claiming “exempt” status on your W-4 means your employer will not deduct any federal income tax from your paychecks. This directly increases your take-home pay. While this might seem beneficial in the short term, it is important to understand the potential long-term consequences, especially if the exemption is claimed incorrectly or if your financial situation changes.

If an individual claims exempt status but does not meet the IRS criteria, or if their income increases during the year, they could face a significant tax bill at the end of the tax year. This can lead to IRS underpayment penalties. Underpayment penalties typically apply if you owe at least $1,000 in tax when you file your return. Remember that claiming exempt only affects federal income tax withholding; other payroll taxes, such as Social Security and Medicare taxes, will still be deducted from your earnings.

Adjusting Your Withholding

Employees can claim or change their exempt status by submitting a new Form W-4 to their employer. This form is available from the IRS website or your employer’s human resources or payroll department. To claim exempt status, individuals should complete Steps 1 and 5 of the W-4 and write “Exempt” on Line 4c.

A new W-4 claiming exempt status must be submitted by February 15 each year to continue the exemption. If a new form is not provided by this deadline, employers may be required to withhold taxes as if the employee is single with no other adjustments. Regularly reviewing and updating your W-4 ensures your withholding accurately reflects your current financial situation and tax liability.