The IRS recently issued guidance to employers regarding the amount of federal income tax to withhold from employees’ wages. The final regulations on tax withholding (T.D. 9924) implement changes made to the Internal Revenue Code (IRC) Sections 3401 and 3402 by the Tax Cuts and Jobs Act (TCJA). The regulations also reflect the redesigned 2020 Form W-4, Employee’s Withholding Certificate, and the related wage withholding tables and computational procedures published in IRS Publication 15-T, Federal Income Tax Withholding Methods.
Impact of the TCJA and Changes to the Form W-4
The TCJA introduced several changes such as eliminating withholding allowances from 2020 through 2025 that were used on a Form W-4 to help employers determine federal income tax withholding for employees. As a result, the IRS redesigned Form W-4, which was issued for use beginning in 2020. The new Form W-4 no longer includes withholding allowances and contains a five-step process for individuals to complete. Employers also use new Publication 15-T, Federal Income Tax Withholding Methods, to determine federal income tax withholding.
TCJA and IRS Lock-in Letters
If an employer receives an IRS Letter 2800C, Withholding Compliance Lock-In Letter to Employer, this indicates that the IRS believes an employee filed an incorrect Form W-4. Typically, an employer should begin withholding federal income tax from the employee’s wages as specified in the letter. It generally takes effect 60 days from the letter’s date.
Prior to the TCJA, IRS lock-in letters instructed an employer to withhold federal income tax from the employee as if the employee has claimed a single filing status with zero withholding allowances. However, since the TCJA has eliminated withholding allowances from 2020 through 2025, employees can no longer claim these allowances on any completed 2020 or later Form W-4. Therefore, it was necessary for the IRS to redesign its lock-in letters to reflect the changes.
In March 2020, the IRS announced redesigning the following two lock-in letters: 2800C and 2808C, Withholding Compliance Modified Lock-In Letter. Instead of providing employers with the number of allowances by which withholding would be reduced, the lock-in letters provided employers with the withholding status, withholding rate, and any annual reductions to withholding or additional amount to withhold per pay period as a dollar value.Use this detailed guide to help you understand your tax responsibilities and ensure compliance with tax regulations that constantly change and vary by location and industry.
Modifications of Tax Withholding Rules
Among other changes, the final regulations on tax withholding address concerns about an employer’s requirement to maintain two systems to determine withholding as well as the issuance of lock-in letters related to pre-2020 Forms W-4.
Computational Bridge Entries
As the TCJA did not require employees to furnish new Forms W-4 to conform to the TCJA changes to the tax withholding rules, in some cases employers have to continue withholding according to outdated Forms W-4. To address this, the final regulations contain optional computational bridge entries to allow employers to continue earlier Forms W-4 in effect as if the employees had furnished redesigned Forms W-4.
Computational bridge entries allow employers to use the computational procedures and data fields for the redesigned Form W-4 to get an equivalent amount of withholding for an employee that would have applied using the computational procedures for a 2019 or earlier Form W-4. Regulations provide a detailed preview of the four specific adjustments that employers may make to implement the computational bridge entries, so they do not have to maintain two withholding systems.
To facilitate the use of the computational bridge entries, the IRS will no longer index the pre-TCJA withholding allowance to reflect cost-of-living adjustments, starting in 2021. Thus, the withholding allowance will be fixed at $4,300. Also, the use of the computational bridge entries is optional. Therefore, employers may continue using computational procedures for pre-2020 Forms W-4, since the IRS will continue to publish tax withholding tables and procedures for employers who choose to do so.
Lock-In Letters Related to Pre-2020 Forms W-4
The final regulations on tax withholding inform employers that a lock-in letter or modification notice does not cease to be effective because of changes resulting from the redesigned Form W-4 and related withholding procedures. Unless the employee furnishes the employer a Form W-4 that results in more withholding than that required by the lock-in letter or modification notice, the employer must continue to withhold as instructed by the IRS until the IRS releases the employee from the program. An employer is permitted to use the optional computation bridge entries to administer the withholding instructions of a lock-in letter or modification notice related to pre-2020 Forms W-4.
Preparing for Tax Withholding Changes
To ensure compliance with constantly changing IRS regulations, both employers and employees need to pay close attention to changes introduced with the new guidance. As this creates additional challenges, many businesses outsource payroll tax management to handle computing payroll taxes, withholding them from employees’ paychecks, remitting payroll taxes to the government, and filing employment tax returns.
While this doesn’t relieve employers of their obligations to the government, the advantages of outsourcing payroll for both small and large companies are numerous. In addition to cost and time savings, filing of reports, and avoiding potential issues, businesses get to comply with complex payroll requirements that are difficult to keep track of.