You use a Form W-4 to determine how much federal tax withholding you need from your paycheck. Form W-4 tells an employer the amount to withhold from an employee’s paycheck for federal tax purposes.

When you file as exempt from withholding with your employer for federal tax withholding, you don’t make any federal income tax payments during the year. (A taxpayer is still subject to FICA tax.)

And without paying tax throughout the year, you won’t qualify for a tax refund unless you qualify to claim a refundable tax credit.

To be exempt from withholding, both of the following must be true:

  • You owed no federal income tax in the prior tax year, and
  • You expect to owe no federal income tax in the current tax year.

So, if your total tax on Form 1040 is smaller than your refundable credits, you owed no income tax. If you expect the same result in the current tax year, you might qualify for exemption from withholding. You’ll still need to complete the W-4. It’s important to remember that if you withhold too little, you may owe tax and a penalty when you file your return.

If an employee wants to claim exemption, they must write “Exempt” on Form W-4 in the space below Step 4(c) and complete Steps 1 and 5.

An employee who wants an exemption for a year must give you the new W-4 by February 15 of that year. If an employee who is currently getting a tax exemption expects to owe tax for the next year, they must change their W-4 by December 10th of the current year.

You can only change withholding based on the documentation the employee gives you. Until the employee gives you the correct form or forms, you must continue to withhold federal, state, and local income taxes based on the most recent forms completed by the employee. You can’t take the employee’s word on the claim of exemption. 

If you claim exempt on your Form W-4 without actually being eligible, anticipate a large tax bill and possible penalties after you file your tax return. If both of the following statements apply, you could face a tax penalty:

  1. You declare withholding allowances on your W-4 that reduces the amount of tax withheld from your paycheck.
  2. You have no justifiable reason for those statements at the time you completed your W-4.
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Clergy Financial Resources serves as a resource for clients to help analyze the complexity of clergy tax law, church payroll & HR issues. Our professionals are committed to helping clients stay informed about tax news, developments and trends in various specialty areas.

This article is intended to provide readers with guidance in tax matters. The article does not constitute, and should not be treated as professional advice regarding the use of any particular tax technique. Every effort has been made to assure the accuracy of the information. Clergy Financial Resources and the author do not assume responsibility for any individual’s reliance upon the information provided in the article. Readers should independently verify all information before applying it to a particular fact situation, and should independently determine the impact of any particular tax planning technique. If you are seeking legal advice, you are encouraged to consult an attorney.

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