The Meaning of "Exempt" in Taxes on a W2

Exemptions permit a taxpayer to retain more earnings.

Tax exemptions under Internal Revenue Service regulations refer to something that is not taxable. On a Form W-2, "exempt" may refer to the taxpayer's wages or salary.

Identification

When a new employee fills out a Form W-4, the employer has the needed information to withhold the proper amount of taxes and fill out Form W-2 at the end of the year.

Significance

If a taxpayer's earnings are approximately the same from one year to the next and the taxpayer did not have to pay taxes in a prior year, then he may elect to claim exemption on the W-4. He assumes he will not be required to pay taxes in the current year either.

Function

The Form W-4, retained by the employer, details what to withhold. Although an individual may be "exempt from federal taxes," Social Security and Medicare taxes must still be withheld and paid to the appropriate agencies.

Considerations

Under IRS statutes, a claim of exemption is "valid for only one calendar year." Therefore, a new W-4 must be completed at the beginning of each year. Otherwise, the employer is instructed by the IRS to withhold at the highest rate.

References

• IRS: Circular E, Employer's Tax Guide