IRS sent employer lock-in letter after employee entered ‘exempt’ on W-4

By February 15 each year, any employees who’ve written “exempt” on their Form W-4 for the prior year need to give your Payroll team an updated form.

But if IRS doesn’t agree with certain employees that they’re exempt from withholding, that puts your company in a difficult spot.

Take the case of one employee who claimed an exemption from income tax withholding when she gave her employer a W-4 in 2017. She later received a letter from IRS, telling her she’d filled out the form wrong.

When she refused to budge regarding whether she owed taxes, IRS sent her employer a lock-in letter. It stated the employer should withhold taxes from her wages at the single rate with zero allowances.

The employee continued to argue with IRS about her taxes, eventually requesting a redetermination. As a result, IRS notified her employer again, saying it should change her allowances from zero to two.

The situation escalated into a lawsuit between the employee and the federal government, which she lost.

Form W-4 before and after 2020

This case refers to the pre-2020 W-4, which contained withholding allowances. Although the form has been overhauled, IRS continues to send lock-in letters to employers.

If you receive a lock-in letter, start withholding federal income tax at the rate specified by IRS.

Businesses that don’t comply face costly consequences. According to IRS, employers will need to pay the additional amount of tax that should have been withheld.

Withholding for most employees

Meanwhile, for most employees, you’ll need to withhold federal income tax utilizing the latest tables from IRS.

If any employees have entered a dollar amount in Step 4(c) of Form W-4, be sure to withhold that extra amount. Remember, that line on the form is indicating additional tax to be withheld each pay period — not annually.