Withholding Taxes: Federal
Author: Alice Gilman
- The Social Security Administration (SSA) issues Social Security cards to individuals on which Social Security Numbers (SSNs) are indicated. SSNs are the key identifier of individuals for the SSA and the Internal Revenue Service (IRS). Employers must know when to ask new employees for their SSNs, what to do if a new employee does not have an SSN and how to verify SSNs in order to avoid tax penalties for incorrectly reporting them on Forms W-2, Wage and Tax Statement. See Social Security Numbers.
- Every employee must provide their employer with a completed Form W-4, Employee's Withholding Allowance Certificate, either on paper or electronically. The amount of income taxes an employer withholds from an employee's pay is based on the number of withholding allowances the employee claims on Form W-4. Because the W-4 form is the basis for withholding, an employer must be aware of all the issues associated with it, such as knowing when to request an updated form from an employee, what to do with an invalid form and how to comply with IRS lock-in letters. See Determining Federal Income Tax Withholding.
- An employer is required to withhold federal income tax on all wages paid to an employee. This requires an understanding of the payment types that constitute wages and that are exempt from withholding, the concept of pay periods and the various withholding methods available. Special withholding rules apply to tips, nonresident aliens and supplemental wages. See Federal Income Tax Withholding Methods.
- Certain pension and annuity distributions may be subject to federal income tax withholding. The applicable withholding method and rate depend on the pension payment type, but not all recipients want income taxes withheld from distributions. Pension recipients indicate their withholding preferences on Form W-4P, Withholding Certificate for Pension or Annuity Payments. See Withholding on Pension and Annuity Distributions.
- Cash payments made to an independent contractor are subject to income tax withholding if the contractor is paid at least $600 during a year and fails to provide its Taxpayer Identification Number (TIN) before the first payment. This is called backup withholding. An employer must know when backup withholding is required and what to do if it receives an IRS notice initiating this type of withholding. See Backup Withholding on Nonemployee Payments.
- The Earned Income Credit (EIC) is a refundable tax credit for certain low to moderate income workers. An employee may claim the EIC when filing a personal income tax return. An employer must notify certain employees of their eligibility for the EIC in the proper manner. See Earned Income Credit.
- An employer that withholds income taxes from employees' wages is required to keep a particular set of records for at least four years. No particular storage medium is required, but the IRS must be able to access and examine the records during normal business hours. See Recordkeeping Requirements.
- Employers in most states are required to withhold state income taxes from employees' pay in addition to federal income taxes. Because state requirements vary, an employer should check the law of the states in which it has employees in order to remain compliant. See State Income Tax Withholding.
- Some states have empowered counties, cities, municipalities and other local government units to collect income taxes. An employer with employees in these states must also withhold for these local income taxes. See Local Income Tax Withholding.
- An employer is required to withhold FICA taxes from its employees' pay. FICA taxes consist of two separate taxes with separate tax rates - Social Security tax and Medicare tax. An employer is also required to make matching contributions in the same amount that it withheld from each employee's pay. FICA taxes are withheld at the same time as income taxes. Certain types of payments and jobs are exempt from FICA withholding. An employer must keep the same records for FICA withholding purposes as it does for federal income tax withholding purposes, plus certain additional records. See FICA Tax Withholding.
- Civil and criminal tax penalties apply to an employer that fails to withhold federal income and FICA taxes. However, the IRS will forgive penalties if an employer can prove it had reasonable cause for the failure. See Penalties for Failing to Withhold.
The following states have additional requirements for this topic under applicable state law.
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