When you hire a new employee, he must fill out a W-4 listing his exemptions from tax withholding. Some employees claim exemption from federal tax withholding because of their low income. If an employee does this, you must honor it unless you receive a letter from the Internal Revenue Service informing you that the employee does not have the right to claim exemption.
Employees can claim exemptions to tax withholding if they had no tax liability in the previous year and expect to have no liability this year. Employees must claim exemption by filling out a new W-4 prior to Feb. 15 of each year.
Nonresident aliens may not claim exemption from federal income taxes on their W-4. If you know an employee is not a resident of the United States, you must withhold federal taxes from her paycheck even if she claims an exemption on her W-4. If you believe a nonresident alien is attempting to claim an exemption she is not entitled to, contact your tax attorney to determine how to best handle the situation.
Social Security Taxes
Even if an employee is exempt from income taxes, he is not exempt from paying Social Security or Medicare taxes. Thus, you cannot withhold income taxes from his paycheck, but you should still withhold Social Security and Medicare taxes from each check. As of 2011, each employee must pay Social Security and Medicare taxes of 6.65 percent on each of his paychecks; make sure you withhold this amount even if employees are exempt from federal income taxes.
If the IRS determines that a particular employee chronically claims more exemptions from federal taxes than she is entitled to, including claiming exemption from federal taxes when she is not qualified to do so, it may send you a lock-in letter. The lock-in letter informs you that the employee chronically miscategorizes herself as exempt and tells you what marital status she must use and her maximum number of exemptions. If you receive a lock-in letter from the IRS, you must honor it even if the employee claims to be exempt from federal taxes.
Jack Ori has been a writer since 2009. He has worked with clients in the legal, financial and nonprofit industries, as well as contributed self-help articles to various publications.