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 one, and how to verify SSNs in order to avoid tax penalties for reporting SSNs incorrectly on Forms W-2, Wage and Tax Statement. See Social Security Numbers.
- All employees must provide their employers with a completed Form W-4, Employee's Withholding Allowance Certificate, either on paper or electronically. The amount of income taxes employers withhold from employees' pay is based on the number of withholding allowances employees claim on their Forms W-4. Because the forms are the basis for withholding, employers must be aware of all the issues associated with them, some of which include knowing when to request updated Forms W-4 from employees, what to do with invalid Forms W-4, and how to comply with IRS lock-in letters. See Determining the Amount of Federal Income Tax Withholding.
- Employers must withhold federal income taxes on all wages paid to employees. This requires an understanding of what types of payments constitute wages, what types of payments are exempt from withholding, the concept of pay periods, and the various withholding methods that are 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 withholding method and withholding rate depend on the type of pension payment recipients receive. However, in most cases, recipients may choose to not have 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 independent contractors are subject to income tax withholding if service recipients pay them at least $600 during a year, and the independent contractors fail to provide their Taxpayer Identification Numbers prior to the first payment. This withholding is called backup withholding. Employers need to be aware of when backup withholding is required, and how to proceed if the IRS sends the employer a 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. Employees claim the EIC when they file their personal income tax returns. Employers must know which employees need to be notified of their eligibility for the EIC and how to properly provide such notice. See Earned Income Credit.
- Employers that withhold income taxes from the wages of employees are required to keep a particular set of records for at least four years. No particular storage medium is required, but the IRS has the right to access and examine them during normal business hours. See Recordkeeping Requirements for Federal Income Tax Withholding.
- Employers in most states are required to withhold state income taxes from employees' pay in addition to federal income taxes. Because state requirements may be different, employers should check the law of the states in which they have employees in order to remain compliant. Some states have also empowered counties, cities, municipalities, and other local government units to collect income taxes. Employers with employees in these states must also withhold for these local income taxes. See State Income Tax Withholding; Local Income Tax Withholding.
- Employers must withhold FICA taxes from employees' pay. FICA taxes consist of two separate taxes with separate tax rates - Social Security taxes and Medicare taxes. Employers must also make matching contributions in the same amount that was withheld from employees' pay. FICA taxes are withheld at the same time that income taxes are withheld. Certain types of payments and certain types of jobs are exempt from FICA withholding. Employers must keep the same records for FICA withholding purposes as they do for federal income tax withholding purposes, plus certain additional records. See FICA Tax Withholding.
- Civil and criminal tax penalties apply to employers that fail 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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- Rhode Island
- South Carolina
- New Jersey
- New Mexico
- New York
- District of Columbia
- North Carolina
- West Virginia
- North Dakota