On January 29, 2018, the IRS issued Notice 2018-14 to provide additional federal income tax withholding guidance pending the release of the 2018 Form W-4. The IRS is currently revising Form W-4 to reflect changes made by the Tax Cuts and Jobs Act (the “Act”) affecting individual taxpayers – such as changes in available itemized deductions, increases in the child tax credit, the new dependent credit, and the repeal of dependent exemptions. In the meantime, the guidance addresses two situations where a new W-4 is required and other withholding procedures that supplement the Notice 1036 guidance released earlier this year.
Extends effective period of Forms W-4 claiming exemption from federal income tax withholding
Employers are not required to withhold federal income tax from an employee’s wages if the employee claims on the Form W-4 that he or she is exempt from withholding. In order to be exempt from federal income tax withholding in 2018, the employee must certify that he or she:
- Had a right to a refund of all federal income tax withheld in the prior year because the employee had no tax liability; and
- Expects to have no tax liability in the current year.
A claim of exemption from withholding is effective through February 15 of the following year, at which time a new Form W-4 attesting to the exempt status must be filed with the employer. If a valid Form W-4 is not on file, the employer must begin withholding based on the last Form W-4 from the employee that did not claim an exemption from withholding, or if there is none, then the employer must withhold from the next wage payment to the employee as if the employee were single with zero withholding allowances.
Under the usual rules, the Forms W-4 claiming exemption from withholding for 2017 are scheduled to expire on February 15, 2018. The Notice extends the expiration for the 2017 exemptions from February 15, 2018, to February 28, 2018. In order for the employer to exempt wages paid after February 28, 2018, a new exemption must be obtained from the employee. The IRS sets forth procedures that may be used while the 2018 Form W-4 is not available. An employer can rely on an exemption claim made using the 2017 Form W-4 as follows:
- Edit by striking “2017” in the text on line 7 and entering “2018” in its place;
- Complete by entering “Exempt” on line 7; or
- Not editing, but signing in 2018 and submitting under procedures established by the employer for the employee to certify entitlement to exempt status for 2018 by using the 2017 Form W-4 to claim exemption from withholding for 2018.
Employers that have established electronic systems for furnishing withholding allowance certificates may change their electronic systems to substantially conform to the options discussed above.
Temporary suspension of 10-day requirement to furnish new Forms W-4 to employers
In general, the employer should obtain a completed and signed Form W-4 from its newly hired employees, on or before the first day of work. Once obtained, the employer can rely on that Form W-4 unless they have knowledge that it results in under withholding. An employee has the responsibility to submit an amended Form W-4 within than 10 days after a change in status that decreases the number of withholding allowances to which the employee is entitled. This rule is designed to avoid under withholdings.
Pursuant to Notice 2018-14, employees experiencing a change in status that causes a reduction in the number of withholding allowances are not required to furnish employers with new withholding allowance certificates until 30 days after the 2018 Form W-4 is released. Accordingly, employers may continue to rely on the existing Form W-4 until that time.
Insight: Under the regulations, an employee who currently claims an exemption from withholding must submit a new Form W-4 within 10 days after realizing that his or her claim of exemption is no longer valid because the employee will have income tax liability in the current year. Notice 2018-14 does not suspend this 10 day period, which continues to apply.
When an employee voluntarily updates withholding for 2018, the employer may rely on a 2017 Form W-4 modified as described above, provided they receive the modified form no later than 30 days after the 2018 Form W-4 is released. Likewise, the modified 2017 Form is appropriate to establish withholding for new hires provided the employer receives it no later than 30 days after the 2018 Form W-4 is released.
Insight: An employer is not required to obtain a new Form W-4 solely because the IRS releases the 2018 Form W-4, nor because the new lower income tax rates translate to reduced withholding allowances. The impact of the reduced tax rate is handled through the revised 2018 withholding tables that are designed to work with the existing Form W-4 previously furnish by employees. The release of the 2018 Form W-4 does NOT create the need for every employee to provide an updated Form W-4.
Optional flat rate for withholding on supplemental wages
Under certain circumstances, employers may withhold income tax from supplemental wage payments at an optional flat rate. The optional withholding rate for supplemental wage payments that did not exceed $1 million in 2005 through 2017 was 25 percent. Due to changes to the rate tables made by the Act, the optional flat rate changed from 25 percent to 22 percent for wages paid for taxable years 2018 through 2025. Employers paying supplemental wages should implement the 22 percent optional flat rate for withholding on an employee’s first $1 million of supplemental wages as soon as possible, but not later than February 15, 2018. If a higher optional flat rate withholding has been applied to supplemental wage payments prior to February 15, 2018 (for example, employers that withheld at the 2017 optional flat rate of 25 percent or the 28 percent default rate contained in the regulations), the employer may, but is not required to, correct such withholding on supplemental wages paid during the period of January 1, 2018 through February 15, 2018 by applying the over withheld amounts to future wages. The mandatory 37 percent rate applies to supplemental wages in excess of $1 million paid to an employee during the year.
Withholding on periodic payments if no withholding certificate is in effect
Generally, federal income tax must be withheld from pension and annuity payments made to retired employees. Unless otherwise directed, payers and plan administrators must withhold certain amounts, depending whether the payments are periodic, nonperiodic, or eligible rollover distributions. Retirees may use Form W-4P to provide input on the amount they wish to have withheld. If a Form W-4P is not submitted, the payor must withhold on periodic pension payments as if the individual is married claiming three withholding exemptions.
For 2018, the rules for withholding when no certificate is furnished with respect to periodic payments will be the same as the rules for prior years – based on treating the individual as a married claiming three withholding allowances.