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Background

I began at a Company in Maryland, USA as a part-time employee with an expectation of earning a full refund. Since I also received a full refund the previous year, the company HR/Accounting rep advised that I mark 'Exempt' on line 7 of my W-4.

Unexpectedly, I was offered a full-time position 3 months later, which I accepted. I was not given a new offer letter or W-4 to fill out, but I did begin receiving full-time pay and benefits.

About 10 months after accepting the full-time position, I noted to the HR/Accounting rep that Federal and State taxes were not being deducted from my paychecks. She changed the Exemption status for future paychecks, but now that I am doing my taxes I see that I have a significant tax liability from the lingering Exempt status.

Question

I have a couple questions that are closely related and should all fall into the Personal Finance & Money category.

  1. Legally, do I have anything to worry about from having an incorrectly filed W-4?
  2. Is there anything within my rights I can do to get the company to take responsibility for their role in this situation, or is it basically my fault?
  3. Will my (now former) employee be responsible for paying their portion of the taxes that were not withheld during the 9 months I was full-time, tax Exempt?
  4. Finally, and I am not too hopeful on this one, but is there anything I can do to ease this tax burden? I understand that the IRS is owed no matter what.

Thank you!

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Legally, do I have anything to worry about from having an incorrectly filed W-4?

What you did wasn't criminal. When you submitted the form it was correct. Unfortunately as your situation changed you didn't adjust the form, that mistake does have consequences.

Is there anything within my rights I can do to get the company to take responsibility for their role in this situation, or is it basically my fault?

It is basically your fault. The company needs a w-4 for each employee. They will use that W-4 for every paycheck until the government changes the regulation, or your employment ends, or you submit a new form.

Topic 753 - Form W-4 – Employee's Withholding Allowance Certificate

If an employee qualifies, he or she can also use Form W-4 (PDF) to tell you not to deduct any federal income tax from his or her wages. To qualify for this exempt status, the employee must have had no tax liability for the previous year and must expect to have no tax liability for the current year. However, if the employee can be claimed as a dependent on a parent's or another person's tax return, additional limitations may apply; refer to the instructions for Form W-4. A Form W-4 claiming exemption from withholding is valid for only the calendar year in which it is filed with the employer. To continue to be exempt from withholding in the next year, an employee must give you a new Form W-4 claiming exempt status by February 15 of that year. If the employee does not give you a new Form W-4, withhold tax as if he or she is single, with no withholding allowances. However, if you have an earlier Form W-4 (not claiming exempt status) for this employee that is valid, withhold as you did before.

(I highlighted the key part)

Because you were claiming exempt they should have required you to update that form each year. In your case that may not have applied because of the timing of the events.

When do you submit a new form? Anytime your situation changes. Sometimes the change is done to adjust withholding to modify the amount of a refund. Other times failure to update the form can lead to bigger complication: when your marital status changes, or the number of dependents changes. In these situations you could have a significant amount of under-withheld, which could lead to a fine later on.

As a side note this is even more true for the state version of a W-4. Having a whole years worth of income tax withholding done for the wrong state will at a minimum require you to file in multiple states, it could also result in a big surprise if the forgotten state has higher tax rate.

Will my (now former) employee be responsible for paying their portion of the taxes that were not withheld during the 9 months I was full-time, tax Exempt?

For federal and state income taxes they are just a conduit. They take the money from your paycheck, and periodically send it to the IRS and the state capital. Unless you could show that the pay stubs said taxes were being withheld, but the w-2 said otherwise; they have no role in judging the appropriateness of your W-4 with one exception.

Finally, and I am not too hopeful on this one, but is there anything I can do to ease this tax burden? I understand that the IRS is owed no matter what.

You have one way it might workout. For many taxpayers who have a large increase in pay from one year to the next, they can take advantage of a safe-harbor in the tax law. If they had withheld as much money in 2015 as they paid in 2014, they have reached the safe-harbor. They avoid the penalty for under withholding. Note that 2014 number is not what you paid on tax day or what was refunded, but all your income taxes for the entire year.

Because in your case your taxes for the year 2014 were ZERO, that might mean that you automatically reach the safe-harbor for 2015. That makes sense because one of the key requirements of claiming exempt is that you had no liability the year before. It won't save you from paying what you owe but it can help avoid a penalty.

Lessons

  • Always update your federal and state W-4s.
  • always check your pay stubs.
  • Thank you for clarifying the chain of responsibility in tax withholding, mentioning the safe-harbor, and reminding me of the lessons learned. – dreamincerise Mar 12 '16 at 20:08
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The W4 specifies withholding for income taxes, FICA taxes are not impacted. The tax withholding is do that you do not need to make estimated tax payments. Failing to make sufficient quarterly estimated tax payments or withholding a sufficient amount could result in you being hit with under payment penalties but nothing more. The under payment penalties will be figured out as part of you income tax return.

What you should have done when you discovered this was use the extra withholding line on the W4 to further increase your withholding. The nice thing about withholding is that you back load it and the IRS does not care.

The company has no liability here. It is your responsibility to update them when your personal circumstances change. You will be fully responsible for the tax bill.

There is no company paid portion of your income tax so they are not impacted. The company only pays an employer share of FICA and that is not impacted by how you fill out the W4.

First thing to do is figure out how much you owe the IRS. Then determine if you can pay it or if you need to investigate an installment option. In any case make sure to file your return on time.

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