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IRS sets out Form W-4 rules that reflect Tax Cuts and Jobs Act

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

In a Notice, in light of changes made by the recently enacted Tax Cuts and Jobs Act (TCJA; P.L. 115-97, Dec. 22, 2017), IRS has extended the effective period of Forms W-4, Employee’s Withholding Allowance Certificate, furnished to claim exemption from income tax withholding under Code Sec. 3402(n) for 2017 until Feb. 28, 2018, and permitted employees to claim exemption from withholding for 2018 by temporarily using the 2017 Form W-4. IRS also temporarily suspended the Code Sec. 3402(f)(2)(B) requirement that employees must furnish their employers new Forms W-4 within 10 days of changes in status that reduce the withholding allowances they are entitled to claim, set the optional withholding rate on supplemental wage payments under Reg. § 31.3402(g)-1 at 22% for 2018 through 2025, and provided that withholding under Code Sec. 3405(a)(4) for 2018 on annuities or similar periodic payments when no withholding certificate is in effect is based on treating the payee as a married individual claiming three withholding allowances.

Background—Form W-4. An employee may claim exemption from income tax withholding if the employee certifies on Form W-4 that (1) the employee incurred no liability for income tax for the preceding tax year; and (2) the employee anticipates that he or she will incur no liability for income tax for the current tax year. (Code Sec. 3402(n))

Forms W-4 furnished to the employer claiming exemption from withholding for a tax year are effective up to and including February 15 of the following year, and an employer may continue to rely on employees’ Forms W-4 claiming exemption from withholding until February 16 of the following year. (Reg. § 31.3402(f)(4)-2(c)) Thus, the effective period of Forms W-4 furnished to claim exemption from withholding under Code Sec. 3402(n) for 2017 would, absent this extension, be scheduled to expire on Feb. 15, 2018.

In general, if a change in status occurs that reduces the number of withholding allowances to which employees are entitled, employees must, within 10 days, furnish the employer with a new Form W-4 claiming the proper number of withholding allowances. (Code Sec. 3402(f)(2)(B); Reg. § 31.3402(f)(2)-1(b) )

In certain situations, employers may withhold income tax from supplemental wage payments at an optional flat rate. (Reg. § 31.3402(g)-1) Under pre-TCJA law, the optional flat rate was 25%.

Under Code Sec. 3405, subject to limited exceptions, the payor of certain periodic payments for pensions, annuities, and other deferred income generally is required to withhold from the payments as if they were wages unless an individual elects not to have withholding apply to the periodic payment. The withholding election generally is made using Form W-4P, Withholding Certificate for Pension or Annuity Payments. Before amendment by the TCJA, Code Sec. 3405(a)(4) provided that, in the case of a payee entitled to periodic payments with respect to which a withholding certificate has not been furnished, the amount to be withheld from each such payment “shall be determined by treating the payee as a married individual claiming 3 withholding exemptions.”

Background—TCJA withholding changes. Late in 2017, the TCJA was signed into law, making significant changes to income tax rates, deductions and credits, and withholding. IRS is currently working on revising Form W-4 to reflect these changes, but the new form may not be released until after Feb. 15, 2018.

Among the changes made by the TCJA was the addition to the Code of Code Sec. 1(j), which generally provides that for tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, the optional flat rate is 22%.

The TCJA does not mandate that employees furnish new Forms W-4 for 2018 and expressly permits IRS to administer income tax withholding under Code Sec. 3402 for 2018 without regard to the changes in the withholding rules and the suspension of personal exemptions.

Additionally, the TCJA amended Code Sec. 3405(a)(4) to provide that the withholding rate when no withholding certificate is furnished “shall be determined under rules prescribed by the Secretary.” (TCJA § 11041(c)(2)(G))

Background—new withholding tables. In order to minimize burden on employees and employers, IRS and the Treasury Department designed the 2018 withholding tables to work with the Forms W-4 that employees have already furnished their employers (see Weekly Alert ¶ 32 01/18/18 for more details). The revisions are also aimed at avoiding over- and under-withholding of tax as much as possible.

New guidance. IRS has issued Notice 2018-14 to provide guidance and transition rules with respect to a number of withholding issues affected by the TJCA.

… W-4 effective date extended. IRS extended the effective period of Forms W-4 furnished to claim exemption from income tax withholding for 2017 to Feb. 28, 2018. The 2017 Forms W-4 claiming exemption from withholding for 2017 will not be effective for wages payments made after that date. (Notice 2018-14, Sec. II)

With respect to any claim for exemption from withholding for 2018, regardless of whether it’s a new claim or a renewed claim from 2017, IRS will allow employees to claim exemption using the 2017 Form W-4 until 30 days after the 2018 Form W-4 is released by:

1. modifying the 2017 Form W-4 by striking “2017” in the text on Line 7, entering “2018” in its place, and signing the form in 2018;
2. modifying the 2017 Form W-4 by entering “Exempt 2018” on Line 7 and signing the form in 2018;
3. using the 2017 Form W-4 without modification and signing the form in 2018, provided that the employer establishes and communicates to employees a procedure under which an employee signs and furnishes the 2017 Form W-4 in 2018 to certify both that the employee (i) incurred no income tax liability for 2017, and (ii) anticipates that he or she will incur no income tax liability for 2018 and thus claims exemption from withholding for 2018; or
4. any method substantially similar to (1) through (3) that clearly conveys in writing an employee’s intent to certify his or her exemption from withholding for 2018.

IRS cautioned that alternations or additions other than those described above will cause the altered Form W-4 to be invalid, as will any oral or written statement indicating that the Form W-4 is false made by the employee to the employer on or before the date on which the employee furnishes the Form W-4. (Reg. § 31.3402(f)(2)-1(e))

Employers that have established electronic systems for furnishing withholding allowance certificates under Reg. § 31.3402(f)(5)-1(c) may make alterations to their electronic systems to substantially conform with the above options.

Employees who claimed exemption from withholding for 2017 and are renewing claims for exemption from withholding for 2018 need to furnish their Forms W-4 claiming exemption from withholding for 2018 by Feb. 28, 2018. Employees who claim exemption from withholding for 2018 using the 2017 Form W-4, as permitted by Notice 2018-14, do not need to furnish a 2018 Form W-4 after the 2018 Form W-4 is released.

… 10-day requirement temporarily suspended. IRS also suspended the requirement that employees furnish employers new Forms W-4 within 10 days after a change in status that results in reduced withholding allowances. Instead, the Form W-4 reflecting such a change isn’t required to be furnished until 30 days after the 2018 Form W-4 is released. (Notice 2018-14, Sec. III)

Because the 2018 withholding tables are designed to work with the Forms W-4 that employees have already furnished their employers, employees who have a reduction in the number of withholding allowances solely due to the changes made by the TCJA may, but are not required to, furnish employers new withholding allowance certificates during 2018. Employees who choose to update their withholding may use the 2017 Form W-4 to report changes in withholding allowances, and new hires may claim allowances on the 2017 Form W-4, until 30 days after the 2018 Form W-4 is released. (Notice 2018-14, Sec. III)

… Optional withholding rate. IRS reminded employers that, for tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, under the TCJA, the optional withholding rate for supplemental wages is 22%. Employers and other entities paying supplemental wages should implement the 22% optional flat rate for withholding on supplemental wages as soon as possible, but not later than Feb. 15, 2018. Employers using optional flat rate withholding that withheld at a higher rate than 22% (e.g. at the 25% rate in effect for 2017) may, but are not required to, correct such withholding on supplemental wages paid on or after Jan. 1, 2018, and before Feb. 15, 2018, under the rules applicable to corrections of overcollections of federal income tax. (Reg. § 31.6413(a)-1(b); Reg. § 31.6413(a)-2(c) ) (Notice 2018-14, Sec. IV)

… Withholding on periodic payments. For 2018, the rules for default withholding under Code Sec. 3405(a)(4) parallel the rules for prior years. Accordingly, in the case of a payee entitled to periodic payments with respect to which a withholding certificate has not been furnished, the payee is treated as a married individual claiming three withholding allowances. (Notice 2018-14, Sec. V)

References: For withholding by employers, see FTC 2d/FIN ¶ H-4220 et seq.; United States Tax Reporter ¶ 34,024. Notice 2018-14, 2018-7 IRB

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