Final regulations govern income tax withholding rules after the TCJA

Editor: Sally P. Schreiber, J.D.

The IRS issued guidance to employers regarding the amount of federal income tax to withhold from employees’ wages (T.D. 9924). The final regulations implement changes enacted in the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, and reflect the redesigned Form W-4, Employee’s Withholding Certificate, that the IRS has already issued and updated guidance the IRS has provided in other of its publications.

Among other changes, the TCJA modified the wage withholding rules found in Sec. 3402(a)(2) and replaced the former concept of “withholding exemptions” with a “withholding allowance, prorated to the payroll period.” A withholding allowance is determined based on the factors listed in Sec. 3402(f)(1).

The IRS has addressed the TCJA withholding changes in earlier subregulatory guidance, including in revised Forms W-4 starting in 2018, in Notice 2018-92, and in IRS Publication 15-T, Federal Income Tax Withholding Methods, as well as in proposed regulations (REG-132741-17) issued in February 2020. The proposed regulations are finalized, with some changes, in T.D. 9924.

The regulations provide two withholding methods: a percentage method and a wage bracket method. An employer applies the applicable percentage method or wage bracket method withholding tables corresponding to the marital status or filing status that the employee selects on a valid Form W-4. An employee will be treated as single unless the employee selects head-of-household or married-filing-jointly filing status on a valid Form W-4.

Computational bridge entries

One issue raised by commenters was that the TCJA did not require employees to furnish new Forms W-4 to conform to the TCJA changes to the withholding rules, so in some cases employers have to continue withholding according to outdated Forms W-4.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 2019 or earlier Forms W-4 in effect as if the employees had furnished redesigned Forms W-4. Starting in 2021, Publication 15-T will contain these optional computational bridge entries.

To facilitate the use of the computational bridge entries, starting in 2021 the IRS will no longer index the withholding allowance to reflect cost-of-living adjustments to what would have been the value of a personal or dependency exemption in Sec. 151(b) prior to the enactment of the TCJA. The withholding allowance will be fixed at $4,300 in 2021.

Lock-in letters

The final regulations follow the proposed regulations and do not require the IRS to reissue lock-in letters or modification notices solely because of the redesign of the Form W-4. Lock-in letters inform an employer in writing that an employee is not entitled to claim exemption from withholding or is not entitled to the withholding allowance claimed on the employee’s Form W-4, and prescribes the withholding allowance the employer must use to figure withholding.

Under the final regulations, unless the employee furnishes the employer a Form W-4 that results in more withholding than under the lock-in letter or modification notice, the employer must continue following any lock-in letter or modification notice until the IRS releases the employee from the program.

The final regulations are effective on Oct. 6, 2020.