What Is Exempt Withholding and Who Qualifies for It?
Understand exempt withholding: what it means to have no federal income tax withheld, who qualifies, and how to manage this tax status.
Tax withholding is the process by which employers deduct a portion of an employee’s wages to prepay federal, state, and local income taxes, along with payroll taxes such as Social Security and Medicare. These withheld amounts are then submitted to the government on the employee’s behalf throughout the year. Exempt withholding represents a specific scenario within this system where federal income tax is not deducted from an individual’s pay.
What is Exempt Withholding
Exempt withholding refers to a situation where no federal income tax is withheld from an individual’s paycheck. This exemption applies exclusively to federal income tax. It does not extend to other mandatory payroll taxes, such as Social Security and Medicare taxes, which will still be deducted from an employee’s pay. Similarly, this exemption does not typically apply to state or local income taxes, if those are applicable in an individual’s location, as state and local tax laws operate independently.
Who Can Claim Exemption from Withholding
To claim exemption from federal income tax withholding, individuals must meet specific eligibility criteria established by the Internal Revenue Service (IRS). An individual can claim this exemption only if two conditions are met. First, they must have had no federal income tax liability in the prior tax year. Second, they must expect to have no federal income tax liability in the current tax year.
“Tax liability” means the total amount of tax an individual is responsible for paying after all deductions and credits are applied. If, after calculating all income, deductions, and credits, the final amount of federal income tax owed for a year is zero or less, there was no tax liability. This status might apply to individuals with very low income, those who qualify for significant tax credits that reduce their tax burden, or certain dependents whose income falls below the standard deduction threshold. For instance, a student working a part-time job might qualify if their earnings are minimal and their tax credits (if any) eliminate their tax obligation.
How to Claim Exemption from Withholding
Claiming an exemption from federal income tax withholding requires completing and submitting Form W-4, Employee’s Withholding Certificate, to an employer.
To claim exemption, an individual must write the word “Exempt” on Line 4c of the Form W-4. If “Exempt” is written on Line 4c, no other lines in Steps 2, 3, or 4 of the W-4 form should be completed. After filling out Step 1 with personal information and writing “Exempt” on Line 4c, the individual must sign and date the form in Step 5. This completed Form W-4 is then submitted to the employer. Once the employer processes the updated W-4, they will cease to withhold federal income tax from the employee’s subsequent paychecks.
Important Considerations for Exemption
An exemption from federal income tax withholding is not permanent and carries annual requirements. This exemption is valid only for the calendar year in which the Form W-4 is filed with the employer. To maintain this exempt status for the following year, an individual must submit a new Form W-4 claiming exemption by February 15th of that year. If this deadline is missed, the employer is generally required to begin withholding federal income tax as if the employee is single with no other adjustments, until a new W-4 is provided.
Individuals should continuously monitor their income and overall tax situation throughout the year. Should circumstances change, such as an increase in income, a change in filing status, or a reduction in available tax credits, an individual might find that they will have a federal income tax liability for the current year, even if they did not in the prior year. In such cases, the individual must submit a new Form W-4 to their employer to adjust their withholding accordingly.
Failure to meet the eligibility requirements or to update the W-4 when circumstances change can lead to an underpayment of tax. This underpayment can result in penalties from the IRS, typically applied if the amount owed at tax time exceeds $1,000, or if less than 90% of the current year’s tax liability was paid through withholding or estimated payments. These penalties are calculated based on the underpaid amount, the period of underpayment, and the IRS’s applicable interest rates.