IRS Issues Highly Anticipated Form W-4 Guidance in Wake of Tax Reform

Author: Rena Pirsos, XpertHR Legal Editor

January 29, 2018

The IRS has published Notice 2018-14, which provides employers with much needed guidance regarding IRS Form W-4, due to the significant changes made by the recent tax reform law to personal income tax rates, deductions, credits and federal income tax withholding. Employers use Forms W-4 completed and submitted by employees to determine the amount of income tax to withhold from the employees' pay for the particular tax year.

Exempt Status Expiration Date Extended

The Notice extends until February 28, 2018, the expiration date of Forms W-4 that employers have on file for employees who claimed exempt status in 2017. Without this extension, these forms would expire on February 15, 2018. However, the IRS anticipates that it will not be able to release the 2018 Form W-4, revised to reflect the changes made by the tax reform law, until after February 15. Accordingly, the 2017 Forms W-4 claiming exempt status for 2017 will not be effective for wage payments made after February 28, 2018.

Procedures for Claiming Exempt Status

The Notice also provides four procedures by which employees may claim exempt status for 2018 using the 2017 Form W-4, whether it is a new or renewed claim of exemption. The procedures are effective for up to 30 days after the IRS releases the 2018 Form W-4. Employees who claim exempt status for 2018 using the 2017 Form W-4 as permitted by these procedures will not have to submit a 2018 Form W-4.

An employee may either:

1. Modify the 2017 Form W-4 by striking "2017" in the text on Line 7 of the form and entering "2018" in its place, and signing the form in 2018;
2. Modify the 2017 Form W-4 by entering "Exempt 2018" on Line 7 of the 2017 form, and signing the form in 2018;
3. Use the 2017 Form W-4 without modification and sign it in 2018, provided the employer establishes and communicates to employees a procedure under which employees sign and submit the 2017 form in 2018 to certify both that the employee incurred no income tax liability for 2017 and that the employee anticipates that he or she will incur no income tax liability for 2018 and, thus, claims exempt status for 2018; or
4. Follow any method similar to the first three methods, so long as the employee clearly conveys in writing his or her intent to certify exempt status for 2018.

If option three or four is used, the employer must clearly identify whether 2017 Forms W-4 submitted by employees are claiming exempt status for 2017 or 2018.

Employers that have a system in place by which employees submit completed Forms W-4 to the employer electronically may alter that system to make it substantially conform to any of the four procedures. Employers are required to keep records of all Forms W-4 submitted by employees.

10-Day Requirement Suspended

The Notice also temporarily suspends the requirement that employees provide their employer with a new Form W-4 within 10 days after any change in their tax status that reduces the withholding allowances they are entitled to claim on the form. These employees are not required to submit a new form until 30 days after the IRS releases the 2018 Form W-4.

In addition, because the 2018 income tax withholding tables are designed to work with the 2017 W-4s that employers already have on file, employees who have a reduction in the number of withholding allowances solely due to the changes made by the tax reform law are not required to complete and submit a new form in 2018. However, they may update their withholding at any time.

Supplemental Withholding Rate Reduced

The Notice also confirms that the optional withholding rate on supplemental wage payments (e.g., bonuses, commissions, severance pay) is 22% starting January 1, 2018, through December 31, 2025. The rate was 25% prior to the tax reform law. Employers should implement this rate as soon as possible, but no later than February 15, 2018.

Employers using optional flat rate withholding that withheld at a higher rate than 22% may, but are not required to, correct the withholding on supplemental wages paid on or after January 1, 2018, and before February 15, 2018, under the rules applicable to correcting overcollections of federal income tax.

Withholding On Periodic Payments

In addition, the Notice provides that if an employee who receives periodic payments of pension, annuity and other deferred income has failed to complete and submit a Form W-4, the employer must calculate 2018 withholding on those payments as if the employee is a married individual claiming three withholding allowances. This default rule of withholding parallels the rule applied in prior years.