Tax Implications of Taking No Income Tax Withholding From Salary

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Your employer calculates federal withholdings from your salary based on the information you provide on Form W-4. If you had no federal tax liability for the previous tax year and expect to have no tax liability for the current filing year, you can claim an exemption from federal withholdings so that no federal tax estimates are deducted from your salary. That situation usually arises if your allowed deductions exceed your annual income. However, if you claim the exemption to avoid federal withholdings but end up owing federal taxes, the Internal Revenue Service may take action against you.

False Claim Penalty

If you deliberately claim incorrect information on your Form W-4 to avoid federal tax withholding, you can be assessed a $500 penalty. If you made a mistake when filling out the W-4, you will not be assessed a penalty, but you will have to file a new Form W-4 with your employer to correct the information.

Criminal Fine or Jail Time

In addition to the $500 for deliberately filing an incorrect Form W-4, you can be tried in criminal court for supplying fraudulent information on a tax form. If you are found guilty of fraud, you can be assessed a fine up to $1,000, required to spend up to one year in jail, or both.

Underpayment Penalty

If you did not have a tax liability for the previous tax year, or your federal taxes due for the current tax year are less than $1,000, the IRS does not assess an underpayment penalty. If you do not meet either of those two qualifications, the IRS assesses an underpayment penalty applied to the underpaid amount. As of 2010, the underpayment penalty rate is four percent. Once the IRS receives your tax filing, a representative calculates the underpayment penalty and issues a bill.

Lock-In Letter

If the IRS determines that your Form W-4 contains incorrect withholding information, it can issue a “lock-in” letter to your employer, directing the employer as to the maximum number of withholding allowances you can claim on your Form W-4.