Are You Exempt from Federal Withholding?

Posted by in Taxes | Updated on November 15, 2022
At a Glance: Being tax-exempt means you do not have to pay the same tax as other people. This is because your income is lower than the tax threshold. The W-4 tells your employer how much tax to withhold for tax purposes.

If cash is tight right now, it may seem tempting to file an exemption on your W-4 form so that your employer doesn’t withhold any tax from your paycheck.

If you qualify for tax exemptions, then this is a great strategy! If you earn less than the income tax thresholds laid out by the IRS, you do not owe any tax.

But remember to always be honest when filling out tax documentation. If you are not tax-exempt, you are going to have to pay your taxes eventually, and filing a withholding exemption is not going to change that. If you claim exempt on your Form W-4 without actually being eligible, anticipate a large tax bill and possible penalties after you file your tax return.

So it’s important to determine if you are exempt from federal withholding. Here we look at what being tax-exempt means, whether you are tax-exempt and what to do if you are.  

What Does Filing Exempt on a W-4 Mean?

Being tax-exempt means you are free from tax liability. You do not need to pay the same tax that other people are paying. You are tax-exempt when you do not meet the requirements for paying tax. This usually happens because your income is lower than the tax threshold.  

To make the tax collection process smoother, your employer subtracts the tax you need to pay from your paycheck before you receive it. This is known as withholding tax on your paycheck. You fill out Form W-4 to determine how much your employer should withhold for federal income tax. Your W-4 tells your employer the amount they should withhold from your paycheck for tax purposes.

Exemption from Federal Income Tax

If you are exempt from withholding, you are exempt from federal withholding for income tax. This means you don’t make any federal income tax payments during the year. You need to indicate this on your W-4.

If you are shown as exempt from federal taxes, it means your employer does not withhold any federal tax from your paycheck. Normally, your W-4 does not expire. But if you claim you are exempt from federal income tax, you need to give your employer a new W-4 each year to keep the exemption.

Claiming exempt on W-4 does not mean you are exempt from Social Security and Medicare taxes though. State and local income taxes might also still apply. Check your state and local laws for more information.

Is Filing as Exempt Illegal?

Filing as “exempt” is not illegal. If you meet the criteria for filing as exempt you should file exempt on your W-4. Even if you qualify for a federal tax exemption, your employer will still withhold Social Security and Medicare taxes.

The reason you are cautioned against filing as exempt is not that it is illegal, but because you can get into trouble with the IRS if you do it when you do not qualify. If you should be paying tax, your employer should be withholding this from your paycheck for you. If you withhold too little, you are not making your tax payments to the IRS. You may then owe tax and face a penalty when you file your return.

Filing Exempt on Taxes When You Are Not Eligible

Improperly claiming exempt from federal tax withholding can have major consequences. If you claim to be exempt on your W-4 without actually being eligible, anticipate a large tax bill and possible penalties after you file your tax return.

If the IRS does not think that you are exempt, they will send you a letter detailing the withholding arrangement you should have with your employer instead. You have time to dispute this decision, but if your dispute is inadequate, your employer will start withholding tax based on the IRS recommendation.

Can You Claim Exempt for One Paycheck?

If something changes and you find you are eligible for a tax exemption, you may want to temporarily stop tax withholding from your paycheck. You’ll need to file a new W-4 with your employer. If you are no longer eligible for the tax exemption, remember to file another W-4 to enable your employer to withhold tax from your paycheck again, so that you make all of your tax payments.

Who Should Be Filing Exempt on Taxes?

To be exempt from withholding, you must:

  1. Have owed no federal income tax in the prior tax year
  2. Expect to owe no federal income tax in the current tax year

If your total tax on Form 1040 is less than your refundable credits, you owe no income tax. To qualify for no tax liability, your income must be low enough that you won’t owe income tax.

How Much Income for No Tax Liability?

So, how much income results in no tax liability? In 2021, your annual income has to be lower than:

  • $12,400 (Single or Married Filing Separately)
  • $18,650 (Head of Household)
  • $24,800 (Married Filing Jointly or Qualifying Widow(er).

If you are 65 or older, or if you are blind, different income thresholds may apply to you.

If you need help determining if you are exempt from taxes, consult the IRS Publication 505. The publication has a flow chart and worksheets that can help you determine if you are exempt.  For personalized assistance, find a tax office nearest you.

How to Claim Exempt Status

On your W-4, enter your identifying information, such as your name, address, and Social Security number. Do not complete lines 5 and 6 and write “Exempt” in the box on line 7. Sign and date the form and return it to your employer.

Your employer will stop withholding federal tax after receiving your completed Form W-4. If your situation changes after submitting the form to your employer so that you will owe tax, you must complete a new W-4 within 10 days showing your allowances and additional withholding, if any, and leaving line 7 blank.

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Final Thoughts

Hopefully, these guidelines can help you determine are you exempt from federal withholding.

If you earn less than the income tax thresholds laid out by the IRS, you do not owe any tax. If you do not owe any tax, your employer should not withhold money from your paycheck to pay the IRS on your behalf.

You can stop this withholding by filing for an exemption from withholding on your W-4. It is not illegal to file as exempt if you are eligible. If you lie about your eligibility or taxable income, you can expect a large tax bill and possible penalties from the IRS.

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