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Prop. Regs Address Federal Income Tax Withholding and Redesigned Form W-4

(Parker Tax Publishing March 2020)

The IRS issued proposed regulations which update the regulations under Code Sec. 3401 and Code Sec. 3402 to conform to changes enacted by the Tax Cuts and Jobs Act of 2017 (TCJA), as well as other legislation enacted since the regulations were last revised. The proposed regulations, which employers may rely on until final regulations are published, are designed to accommodate the redesigned 2020 Form W-4, Employee's Withholding Certificate, and related wage withholding tables and computational procedures established by the IRS and reflected in Publication 15-T, Federal Income Tax Withholding Methods. REG-132741-17.


Before the enactment of the Tax Cuts and Jobs Act of 2017 (TCJA), one withholding exemption was equal to the amount of one personal exemption provided in Code Sec. 151(b), prorated to the payroll period. TCJA enacted Code Sec. 151(d)(5), which reduced the personal exemption amount to zero for the years 2018-2025. TCJA also increased the standard deduction under Code Sec. 63, increased the child tax credit under Code Sec. 24, and created a new credit under Code Sec. 24 for other dependents. TCJA permanently modified the wage withholding rules in Code Sec. 3402(a)(2) and replaced ''withholding exemptions'' with a ''withholding allowance, prorated to the payroll period.'' TCJA also repealed Code Sec. 3401(e), which, before TCJA, provided that the ''number of withholding exemptions claimed'' meant the number of withholding exemptions claimed in a withholding exemption certificate in effect under Code Sec. 3402(f) or in effect under the corresponding section of prior law, except that if no such certificate was in effect, the number of withholding exemptions claimed was considered zero.

TCJA modified Code Sec. 3402(f), and defined a ''withholding allowance,'' on the basis of factors listed in Code Sec. 3402(f)(1). TCJA further changed the list of factors on which the withholding allowance is based and added that the withholding allowance is determined based on rules determined by the Secretary of Treasury. This change to Code Sec. 3402(f)(1) revised Code Sec. 3402(f)(1)(C), entitling an employee to take into account the number of individuals for which the employee expects to take an income tax credit under Code Sec. 24 instead of the number of individuals with respect to whom the employee reasonably expects to claim a deduction under Code Sec. 151. Code Sec. 3402(f)(1)(D) also changed an employee's entitlement to take into account the standard deduction from an amount generally equal to one withholding exemption to the standard deduction allowable to such employee (one-half of the standard deduction in the case of an employee who is married and whose spouse is an employee receiving wages subject to withholding).

TCJA added Code Sec. 3402(f)(1)(F), which provides that the employee's withholding allowance also takes into account ''whether the employee has withholding allowance certificates in effect with respect to more than one employer.''

TCJA also added the Code Sec. 199A deduction to the list of deductions in Code Sec. 3402(m)(1) that an employee may take into account in determining the additional withholding allowance that the employee is entitled to claim on Form W-4, and struck the reference to Code Sec. 62(a)(10) with respect to certain payments made under divorce or separation instruments previously described in Code Sec. 62(a)(10).

Proposed Regulations

In mid-February, the IRS issued proposed regulations incorporating the TCJA changes to Code Sec. 3401 and Code Sec. 3402. According to the IRS, the proposed regulations provide flexible and administrable rules for income tax withholding from wages that work with both the 2020 Form W-4 and its related tables and computational procedures described in Publication 15-T, and Forms W-4 and related tables and computational procedures provided in 2019 and earlier years. Because the ultimate goal of income tax withholding is to achieve withholding from employee's wages that accurately reflects the income tax provisions applicable to wages and the period wages are paid, the IRS determined that the mechanical details of income tax withholding should be provided in forms, instructions, publications, and other guidance, so that these materials can be quickly updated as needed (for legislative changes or other reasons) to give payroll processors adequate time to program their systems to withhold the proper amount of income tax from employees' pay.

The IRS stated that the proposed regulations are generally compatible with the income tax withholding system in effect for 2019, as well as the system in effect for 2020, and may be relied upon by employers for withholding until final regulations are published.

The IRS noted that the changes made by TCJA to Code Sec. 3405(a) (i.e., withholding on pensions, annuities, and certain other deferred income) were addressed in Notice 2018-14 and Notice 2018 - 92 for the 2018 and 2019 calendar years, respectively. The proposed regulations do not address withholding under Code Sec. 3405(a); instead, Notice 2020-3 describes the withholding rules under Code Sec. 3405(a) for the 2020 calendar year.

Revised Form W-4 for 2020

To address the limitations of the prior Form W-4, the IRS said that the 2020 Form W-4 uses the same underlying information as the 2019 Form W-4, but replaces complex worksheets with more straightforward questions. The form has been renamed from the "Employee's Withholding Allowance Certificate" to the "Employee's Withholding Certificate." The final 2020 Form W-4 was released on December 4, 2019, and then was rereleased on December 31, 2019, to reflect a change in the medical expense deduction threshold under Code Sec. 213 for 2020 made by the Further Consolidated Appropriations Act, 2020, that was signed into law on December 20, 2019.

The 2020 Form W-4 does not use withholding allowances. An employee checks a filing status (single, married filing separately, head of household, married filing jointly, or qualifying widow(er)) on the Form W-4 and, as a result, will generally have the basic standard deduction corresponding to the employee's anticipated filing status on his or her income tax return taken into account in determining the amount of tax withheld from the employee's pay, in accordance with Code Sec. 3402(f)(1)(E). In addition, the 2020 Form W-4 streamlines the multiple jobs procedures and gives employees three options to account for a working spouse or multiple jobs held concurrently in accordance with Code Sec. 3402(f)(1)(B), (E), and (F): (1) Employees may use the Tax Withholding Estimator to achieve accurate withholding; (2) employees may complete the Multiple Jobs Worksheet and enter an additional amount to withhold from the employee's pay for each pay period; or (3) employees may check the box in Step 2(c) on the 2020 Form W-4 to request withholding using higher withholding rate tables. For married taxpayers filing jointly with two jobs held concurrently, the effect of checking the box in Step 2(c) is similar to selecting ''Married, but withhold at higher Single rate'' on a Form W-4 from 2019 or earlier.

The 2020 Form W-4 also allows an employee to enter dollar amounts for tax credits, other income, and deductions the employee expects to claim on his or her income tax return to reflect the permitted allowance under Code Sec. 3402(f)(1)(C) and Code Sec. 3402(f)(1)(D) and the increase in the amount of withholding under Code Sec. 3402(i).

Observation: According to the IRS, the Tax Withholding Estimator is expected to provide instructions on how to complete Form W-4 to take into account an employee's personal tax circumstances in a manner that helps protect the employee's privacy by limiting the entries the employee is required to make on the 2020 Form W-4. The IRS said it will continue to update the Tax Withholding Estimator based on user feedback and to enhance accuracy, privacy, and the employee experience.

For a discussion of the rules on withholding allowances, see Parker Tax ¶212,115. For a discussion of Form W-4, see Parker Tax ¶212,120.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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