IRS Redirects Its Approach To Ensure Withholding Compliance

The IRS has released temporary and proposed regulations (REG-162813-04 & TD 9196) under IRC section 3402 modifying employer requirements to furnish copies of Forms W-4, Employee’s Withholding Allowance Certificate, to the IRS. The temporary regulations provide that employers are no longer required to submit copies of questionable Forms W-4 to the IRS unless directed to do so in a written notice to the employer or pursuant to published guidance. The new regulations are effective April 14, 2005.

The existing regulations require employers to submit a copy of the employee’s withholding certificate if the employee claims (1) more than 10 withholding certificates or (2) complete exemption from withholding, if the employer expected the employee’s wages to exceed $200 per week.

The IRS said it plans to continue its enforcement efforts in the withholding compliance area by making more effective use of information reported on Forms W-2, Wage and Tax Statement, to ensure that enough Federal income tax is withheld from employees and to identify potential withholding compliance issues.

According to the temporary regulations, an employer must submit to the IRS a copy of any currently effective withholding certificates as directed in a written notice to the employer or as directed in a revenue procedure or notice published in the Internal Revenue Bulletin. In either situation, the required submission may relate to one or more named employees, employees in reasonably segregable units, or certificates with certain specified criteria. After reviewing the submitted certificate, the IRS may notify the employer to withhold at a different rate after determining that a copy of the employee’s withholding certificate contains a materially incorrect statement or after the employee fails to adequately respond for verification of the statements on the withholding certificate. In addition, if the IRS otherwise determines that an employee is not entitled to a complete exemption or more than a specified number of exemptions, it may notify an employer to allow only a specified number of exemptions for withholding purposes without first obtaining a copy of the employee’s withholding certificate.

If, after the employer receives this notification, the employee provides the employer a new withholding certificate that does not claim complete exemption from withholding or that claims less withholding exemptions than the maximum allowable exemptions specified by the IRS, the employer may withhold based on the new withholding certificate. However, if the employee wishes to claim complete exemption from withholding or claim exemptions in excess of the maximum number specified by the IRS, the employee must now send the new withholding exemption certificate, along with a written statement, directly to the IRS. This is a change from the existing regulations, which require the employee to first submit this information to the employer for submission to the IRS. In this situation, the employer must continue to withhold tax based on the number of exemptions specified in the IRS notice until the IRS notifies the employer to withhold based on the new withholding certificate.

While the temporary regulations relieve the employer from the burden of submitting to the IRS questionable withholding certificates, withholding certificates claiming more than 10 exemptions or complete exemption under certain circumstances, the employer will be responsible for reviewing published guidance requiring submission of certain withholding certificates and searching its employee files to ascertain whether any of its employees’ certificates fit the criteria for a required submission to IRS.