When you hire an employee, you must have the employee complete a Form W-4 (PDF), Employee's Withholding Allowance Certificate. Form W–4 tells you, as an employer, how many withholding allowances to use when you deduct Federal income tax from the employee's pay. Form W-4 includes detailed instructions, and a worksheet to help the employee figure his or her correct number of withholding allowances. Employees may also want to access the withholding calculator on the IRS website at www.irs.gov/individuals for help in completing Form W-4.

Form W–4 is also used by an employee 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 apply. See the instructions for Form W-4. Employees who claim exemption from withholding must complete a new Form W–4 by February 15th each year (February 16th, 2004) to continue claiming exempt status.

After the employee completes and signs the Form W–4, you should keep it in your files. This form serves as verification that you are withholding federal income tax according to the employee's instructions. Do not send it to the IRS.

However, if you receive a Form W–4 on which the employee claims more than 10 withholding allowances, or claims exemption from withholding and his or her wages would normally be expected to exceed $200 or more a week, you must send a copy of that Form W–4 to the IRS service center with your next Form 941 (PDF). Complete boxes 8 and 10 on each Form W-4 that you submit. If you want to submit the Form W–4 earlier, you can send a copy of the Form W–4 to your IRS service center. If you do so, include a cover letter giving your name, address, EIN, and the number of forms included. Your service center will send you further instructions if it determines that you should not honor any Form W–4.

You should inform your employees of the importance of submitting an accurate Form W–4. An employee may be subject to a $500 penalty if he or she submits, with no reasonable basis, a Form W–4 that results in less tax being withheld than is required. There is no penalty if your employee doesn't claim enough withholding allowances and has too much withheld.

You should keep blank Form W–4's on hand so you can provide them to your current and new employees. An employee may want to change the number of withholding allowances or his or her filing status on Form W–4 for any number of reasons, such as marriage, an increase or decrease in the number of dependents, or an increase or decrease in the amount of itemized deductions or tax credits anticipated for the tax year. Any of these reasons could affect the employee's tax liability. If you receive a revised Form W–4 from an employee, you must put it into effect no later than the start of the first payroll period ending on or after the 30th day from the date you received the revised Form W–4.

If an employee fails to give you a properly completed Form W–4, you must withhold federal income tax from his or her wages, as if he or she were single and claiming no withholding allowances.

For additional information, refer to Publication 15, Circular E, Employer's Tax Guide, Publication 505, Tax Withholding and Estimated Tax, and Publication 919, How Do I Adjust My Tax Withholding ?.