My employer suddenly stopped withholding federal income tax from my paycheck. What should I do?

Question

I started an internship in May and worked full time from then until mid-August. When I filled out the W-4 form I had used the IRS calculator to calculate allowances; the calculator recommended 6. The salary I used for the calculator was based upon working full time for 13 weeks.

However, I'm continuing to work part time at the same company. It will not add substantially to the salary; I'll be making around $160 pre-tax per week.

Today I just got my first paycheck from working part time and noticed that they did not withhold any federal income tax. However, they did withhold Social Security tax, and state taxes.

I don't want to have to pay any penalties because I didn't pay enough federal income tax during the year. What should I do?

Answer 1

By filling out the W-4 you are estimating how much tax you will pay at the end of the year, and they withhold a prorated amount out of each paycheck. The trouble is if you fill out the W-4 "correctly" will not correctly figure your taxes. You will almost always get a large refund or owe a large amount. For low wage earners, the W-4 almost always withholds too much tax, for high wage earners or dual incomes it almost always withholds too little.

If you put Single or Married and 2 exemptions the withholding is correct at zero. Social security and Medicare is simply a percentage of your income so there will always be money withheld for those categories.

More than likely you will receive a refund at the end of the year. With the earned income tax credit low wage earners often receive a "tax refund" in excess of any amount they paid in making it an entitlement program.

One way to be assured of this is filling out last years 1040EZ (if you have nothing but standard deductions) or this years 1040ES with your expected income for this year and the expected withholding. You can then adjust your exemptions accordingly to get as close as possible to zero.

For full disclosure high wage earning couples who fill out their W-4s accurately will owe the IRS in the tens of thousands of dollars because the withholding will be so inaccurate. To further exasperate this they will often have to pay a penalty for owing too much. Crazy huh? Follow the instructions on an IRS form accurately, and you will be penalized. These couples should almost always file M-0, and do additional withholding (line 6) to avoid the penalty.

Answer 2

As Pete said, get this year's 1040ES (PDF available from http://www.irs.gov under Forms&Pubs then search) and do an estimate, even a somewhat rough one, of what your tax liability will be, so that you can either adjust withholding if needed or otherwise save for it.

If your withholding has been too low so far you can adjust it upward anytime before the end of the year (unless your employment ends earlier, because if you don't have wages you don't have withholding) and it is treated as timely even if it wasn't really; if you make estimated payments (direct to the IRS) starting midyear you have to fill out a complicated schedule (2210-AI) to show they are timely.

However, as to the penalty:

• if your withholding is at least the correct tax minus $1000, there is no underpayment penalty

• if your withholding plus any estimated payment(s) is at least 90% of the correct tax, there is no underpayment penalty

• if you did not owe any tax for last year (2015) -- which you don't say in your question, but your unfamiliarity with the process suggests to me you didn't -- and you were a citizen or resident, there is never an underpayment penalty for this year, no matter how short your withholding is

• if you did owe tax for last year, and your withholding plus any estimated payment(s) for this year is at least 100% of last year's tax (for most people, more for high earners, less for farmers and fishermen, see the form), there is no underpayment penalty

Of course even with no penalty, you do need to pay the remainder of the tax by 2017-04-17. So keep that money in your bank account; don't spend it or invest in something illiquid. And welcome to the ranks of people who feel justified complaining when the government you paid for wastes money :-)