In certain circumstances, the IRS allows an employee to withhold zero federal taxes from every paycheck. This is known as being tax exempt. The IRS has very specific rules before a worker can be declared exempt from taxes, and she will still be responsible for Social Security and Medicare taxes. Also, a federal tax exemption does not mean that you are exempt from state or local taxes.
What Does it Mean to Be Tax Exempt?
When you fill out your W-4, you are allowed to claim allowances that impact how much federal income taxes you will have taken from each paycheck. You may take an allowance for yourself, your spouse and each qualifying child or dependent you have. The more allowances you claim, the larger your take-home pay will be each pay period because less taxes are withheld from each paycheck. Alternatively, to have more withheld from your paycheck, you would decrease your allowances or claim “0."
Tax exemption is the opposite of claiming zero allowances on your W-4. But you must meet certain requirements before you have no federal income taxes withheld from your pay. In order to be exempt from federal taxes, first, you must have received a refund of federal taxes withheld because you had no tax obligation for the previous year. Secondly, you must also expect another refund and no tax obligation for the current year, as well. Even if you had as little as $1 in federal tax obligation the previous year, you are disqualified from being tax exempt. For more information on whether or not you can claim an exemption from federal income taxes, read the section on Exemption From Withholding of IRS Publication 505, Tax Withholding and Estimated Tax.
Where Do I Enter an Exemption From Federal Taxes?
The Personal Allowances Worksheet attached to a W-4 helps determine the number of allowances you can claim. Because you are tax exempt, you do not need to work through this worksheet. To claim your tax exemption, on your W-4 you must fill out only lines 1, 2, 3, 4 and 7, then sign the form to validate it. You must file your W-4 by February 15, 2018 in order to claim tax exemption for the 2017 tax year. Submit this form to your employer as soon as you know you are eligible for tax exemption to ensure your status.
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What if I Thought I Was Tax Exempt, but Earned More Income?
Sometimes, you anticipate no tax liability for a current year, but end up making more money than you thought, resulting in a tax obligation. In this case, you could end up owing some money to the IRS. An exception to this is if you are eligible to claim certain refundable tax credits such as the Earned Income Tax Credit or the Child Tax Credit. These tax credits are refundable which means you can keep any portion of this credit, in the form of a refund, after your tax obligation has been reduced to zero. If you find yourself in a situation in which you earned more than you anticipated, consult with a qualified tax professional for guidance.