Am I Exempt From Federal Withholding? Do I Still Get a Refund?

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Starting in January 2020, there’s a new design for Form W-4. The IRS explained that the redesign will reduce confusion for filers and enhance the transparency of the tax withholding system. Luckily, current employees who have completed a W-4 before 2020 do not need to fill out a new one.

Form W-4 is an IRS tax form completed by an employee to indicate their current tax situation. You usually complete a Form W-4 when you start a new job or your financial situation changes. This form helps you estimate your total income and the total amount of your deductions and certain tax credits to let your employer know how much federal income tax to withhold from each paycheck.

According to the IRS, if you had no income tax liability last year and expect the same for this year, you can claim exemption from income tax — but not Social Security or Medicare tax — withholding. But what does this exemption mean, and how do you know if you qualify?

Find Out: What Are the 2020-2021 Federal Tax Brackets and Tax Rates?

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How Do I Know If I Am Exempt From Federal Withholding?

Every time you fill out a W-4, you might be wondering, “Am I exempt from federal withholding?” To claim exemption, you must meet a set of criteria.

“If your income can be canceled out by allowable tax deductions leaving you with no tax liability, you can elect to be exempt from federal withholding,” said Ben Watson, a certified public accountant and personal finance expert at DollarSprout. “However, if you had even $1 of tax liability in the prior year, you cannot claim an exemption in the following year.”

If you cannot claim exemption from withholding, you can still reduce the amount withheld from every paycheck by entering the dollar amount of your deductions and claiming your dependents and dependent-related tax credits on Form W-4. As you add deductions and credits, your tax withholding will decrease and your take-home pay will increase. When you claim fewer deductions and credits, your tax withholding increases and you see less in your paycheck.

This is often a delicate balance. You don’t want to claim too many adjustments to your income, as your employer will not withhold enough tax based on your filing status. This could leave you with a big tax bill come April 15 (May 17 in 2021). But not claiming all the adjustments you’re entitled to means you’ll have to wait for your tax refund to get your overpayment back.

Please note that The IRS has announced that the federal income tax deadline for individuals is May 17, 2021 for the 2020 tax year. State deadlines have not changed, however, so make sure to confirm your state’s due date before you file. 

Learn More: What Are Tax Allowances and How Many Should You Claim?

What Does It Mean To Be Exempt From Federal Withholding?

Being exempt from federal withholding means your employer will not withhold federal income tax from your paycheck. When you claim certain deductions, they get subtracted from your annual gross income. This causes your taxable income to decrease as well.

If you file as single on your taxes for 2020, the standard deduction is $12,400. The standard deduction is $24,800 for individuals who are married and filing jointly. If your yearly income is less than this deduction, you would be classified as exempt — and you do not have to pay taxes. However, if you claim exemption from withholding and earn more than that this year, you will be penalized.

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Who Is Exempt From Federal Income Tax?

“(Exemption) is most common with individuals who earn less than the standard deduction or receive assistance in their living, such as children, dependents or those with handicaps limiting their ability to work,” Watson said.

You might be able to claim an exemption if you have the following exceptions:

  • Student: You are not automatically exempt as a student. If you are a seasonal or part-time worker, you may qualify for this exemption.
  • Age 65 or older: If Social Security is your only source of income, then you do not need to file a tax return. Social Security is not included in gross income. Fun fact: The IRS considers you age 65 the day before your actual birthday.
  • Visually impaired: Due to cost of living, there is a higher standard deduction for those who are blind. This includes individuals who cannot see 20/200 with glasses or contacts or their field of vision is 20 degrees or less.

Unsurprisingly, most of these exceptions are based on level of income.

“Typically, people with lower income are the ones who qualify for the exemption from federal income tax,” said Paul T. Joseph, president at Joseph & Joseph, LLC. “However, there may be situations where higher-income people have suffered some other sort of loss in the previous year and expect that loss to continue and can file for the exemption.”

If you are a low-income filer, you may be eligible for various tax credits and deductions. However, keep in mind that this exemption does not apply to Social Security or Medicare tax.

“The employer is still required to withhold FICA (Federal Insurance Contributions Act) and Medicare, as well as state and local withholding,” said Mike Savage, CPA and CEO of 1-800Accountant. “If the employee claims exemption from state and local taxes, there would be a separate state and local form comparable to a federal W-4 form to complete.”

It’s also important to note that exemptions expire every year. If you claim an exemption but your situation changes at a later time, you must file a new Form W-4 within 10 days after the change. This exemption is only good for one year, and you must file by Feb. 15 of each year to continue your exemption.

Related: Can I Claim My Boyfriend or Girlfriend as a Dependent?

Do You Still Get a Refund If You’re Exempt From Federal Withholding?

Taxpayers don’t love the confusion of filing taxes, but the anticipation of a large refund is always a nice reward. The IRS will issue tax refunds when you have overpaid. You receive this money only because you have paid more than what you owe. When you file for an exemption from withholding, you are not making any tax payments throughout the year. And since you are not paying any taxes, you typically will not qualify for a tax refund. However, there are exceptions.

“Without paying tax, you could potentially still obtain a refund if you qualify to claim a refundable tax credit, such as the earned income credit,” Savage said. “Unless you qualify for one of these credits, you would typically not get any refund because nothing was paid in by you.”

The earned income tax credit benefits low- to moderate-income people and reduces the amount of taxes you owe. Another tax credit is the American opportunity tax credit, which gives students a partial refund on qualifying education expenses that reduce the student’s tax liability to an amount less than $0.

With tax season around the corner, it’s important to stay informed when it comes to tax withholding. If you are unsure whether you qualify for an exemption or a tax credit, please visit the IRS website for more details.

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Daria Uhlig contributed to the reporting for this article. 

Last updated: Mar. 18, 2021

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