[Federal Register Volume 72, Number 134 (Friday, July 13, 2007)]
[Rules and Regulations]
[Pages 38478-38484]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-13492]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 31

[TD 9337]
RIN 1545-BE21


Withholding Exemptions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations providing guidance 
under section 3402(f) of the Internal Revenue Code (Code) for employers 
and employees relating to the Form W-4, ``Employee's Withholding 
Allowance Certificate.'' The regulations provide rules for income tax 
withholding when the IRS notifies the employer and the employee of the 
maximum number of withholding exemptions permitted. The regulations 
also provide rules for the use of substitute forms and preserve the 
IRS's ability to require the submission of certain copies of 
withholding exemption certificates. The regulations primarily affect 
taxpayers who are employers and employees.

DATES: Effective Date: These regulations are effective July 13, 2007.
    Applicability Date: Except as provided in section 31.3402(f)(2)-
1(g)(5), section 31.3402(f)(2)-1(g) applies on April 14, 2005. Section 
31.3402(f)(2)-1(g)(2)(iii)(A), (B), and (C) and section 31.3402(f)(2)-
1(g)(2)(ix) apply on October 11, 2007, except taxpayers may rely on 
such paragraphs for notices issued prior to such date. Section 
31.3402(f)(5)-1(a)(1) applies on April 14, 2005. Section 31.3402(f)(5)-
1(a)(2) applies October 11, 2007.

FOR FURTHER INFORMATION CONTACT: Ilya Enkishev, (202) 622-0047 (not a 
toll-free call).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    These regulations do not impose any new information collection. The 
Office of Management and Budget (OMB) previously approved the 
information collection requirements concerning Form W-4 contained in 
the regulations under section 6001 (Sec.  31.6001-5; OMB Control No. 
1545-0798) and in the regulations under section 3402 (Sec.  
31.3402(f)(2)-1; OMB Control No. 1545-0010) under the provisions of the 
Paperwork Reduction Act, 44 U.S.C. 3501 et seq. Books or records 
relating to a collection of information must be retained as long as 
their contents may become material in the administration of any 
internal revenue law. Generally, tax returns and tax return information 
are confidential, as required by 26 U.S.C. 6103.

Background

    Under section 3402(f)(2)(A) of the Internal Revenue Code, every 
employee is required to furnish his or her employer with a signed 
withholding exemption certificate on or before commencing employment. 
The regulations prescribe the form of the certificate as the Form W-4. 
The maximum number of withholding exemptions to which an employee is 
entitled depends upon the employee's marital status, the employee's 
filing status, the number of the employee's dependents, the number of 
exemptions claimed by the employee's spouse (if any) on a Form W-4, and 
the amount of the employee's estimated itemized deductions, tax 
credits, and certain other deductions from income.
    For many years, the regulations under section 3402(f) required 
employers to submit to the IRS a copy of each Form W-4 on which an 
employee claimed more than a certain number of withholding exemptions. 
Employers had to also submit a copy of each Form W-4 on which the 
employee claimed a complete exemption from withholding for the taxable 
year if the employer reasonably expected, when the Form W-4 was 
received, that the employee's wages from that employer would usually be 
$200 or more per week. The regulations also provided that the IRS could 
notify an employer that a named employee was not entitled to claim a 
complete exemption from withholding and was not entitled to claim more 
withholding exemptions than the number specified by the IRS in the 
notice. The IRS issued this notice (often called a ``lock-in letter'') 
if the IRS found that the withholding exemption certificate contained a 
materially incorrect statement or if the IRS found, after written 
request to the employee for verification of the statements on the 
certificate, that the IRS lacked sufficient information to determine if 
the certificate was correct. In these cases, the employer was required 
to withhold tax based on the number of withholding exemptions specified 
in the notice from the IRS unless otherwise notified by the IRS.
    On April 14, 2005, the Department of Treasury published temporary 
regulations (TD 9196) in the Federal Register (70 FR 19694) under 
section 3402(f) modifying the rules relating to the submission of Forms 
W-4 and relating to the IRS' notification of the number of withholding 
exemptions permitted. The Department of Treasury also published a 
notice of proposed rulemaking (REG-162813-04) cross-referencing the 
temporary regulations in the Federal Register on the same day.
    Effective when published, the temporary regulations changed the 
procedures for submitting copies of Forms W-4 to the IRS. Specifically, 
under the temporary regulations employers were no longer routinely 
required to submit a copy of any Form W-4 on which an employee claimed 
more than 10 withholding exemptions. In addition, employers were no 
longer routinely required to submit a copy of any Form W-4 on which an 
employee claimed complete exemption from withholding for the taxable 
year if the employer reasonably expected, when the Form W-4 was 
received, that the employee's wages from that employer would usually be 
$200 or more per week. Rather, the temporary regulations provided that 
employers must submit copies of Forms W-4 only if instructed to do so 
in published guidance or in a written notice to the employer from the 
IRS. At this time, the IRS has not issued any published guidance 
requiring the submission of Forms W-4 to the IRS.

[[Page 38479]]

    The temporary regulations authorized the IRS to issue a notice to 
an employer specifying the maximum withholding exemptions permitted to 
be claimed by the employee without first obtaining a copy of the 
withholding exemption certificate from the employer. Under the 
temporary regulations, the IRS issued this notice to the employer with 
a copy for the employee. The IRS also sent another copy to the employee 
at the employee's last known address. The temporary regulations 
provided that the employer must withhold tax in accordance with the 
notice as of the date specified in the notice, which was required to be 
at least 45 calendar days after the date of the notice. If the employee 
wanted to claim complete exemption from withholding or claim more 
withholding exemptions than the number specified by the IRS in the 
notice, the employee must contact the IRS to provide information to 
support the claim. The previous, and now obsolete, regulations 
permitted the employee to send this information to the employer to 
forward to the IRS. To reduce burdens on employers and to facilitate 
efficient responses to the employee, the temporary regulations required 
the employee to contact the IRS directly.
    Finally, the temporary regulations also permitted employers to give 
their employees a substitute withholding exemption certificate, if the 
employers also gave them the worksheets contained in the Form W-4 in 
effect at that time. The temporary regulations also authorized 
employers to refuse to accept a substitute form developed by an 
employee.
    The proposed regulations were identical to the temporary 
regulations described in the Preamble. The publication of the proposed 
and temporary regulations followed a comprehensive review of 
withholding compliance, which found that withholding noncompliance 
remained a problem with some employees. In connection with the 
publication of the proposed and temporary regulations, the IRS 
developed a process to use information already reported on Forms W-2, 
Wage and Tax Statements, to more effectively identify and address 
employees with withholding compliance problems.
    A public hearing on the proposed regulations was held on July 26, 
2005. Written and electronic comments responding to the notice of 
proposed rulemaking were received. After consideration of all the 
comments, the Department of Treasury adopts the proposed regulations, 
as modified herein, as final regulations, and removes the corresponding 
temporary regulations.

Summary of Comments and Explanation of Provisions

    The publication of this Treasury decision follows the 
implementation of the IRS's new process for using information already 
reported on Forms W-2 to more effectively identify employees with 
withholding compliance problems. The modifications to the proposed 
regulations that are included in these final regulations reflect both 
consideration of the comments submitted by taxpayers and changes needed 
following the implementation of the new process.
    The comments received were generally favorable to the changes 
proposed by the proposed regulations and implemented by the temporary 
regulations. Commentators observed that the regulations reduced burdens 
on employers by eliminating the requirement that employers submit 
questionable Forms W-4 to the IRS and the requirement that employers 
transmit communications from the employee to the IRS. One commentator 
recommended that, as an alternative to the withholding compliance 
program, the problem of underwithholding should be addressed by 
increasing the employee's estimated tax penalty if insufficient taxes 
are withheld and otherwise paid by the employee for the year. While tax 
penalties do deter some employees from submitting Forms W-4 claiming 
excessive withholding exemptions, the IRS has concluded that the 
withholding compliance program implemented under the temporary 
regulations is a more efficient and effective manner of deterring 
serious underwithholding.

Submission of Withholding Exemption Certificates

    Under the temporary regulations, employers were no longer routinely 
required to submit copies of Forms W-4 that met the previously 
established criteria, often referred to as ``Questionable W-4s''. 
Rather, the temporary regulations provided that an employer must submit 
a copy of any currently effective Form W-4 only if directed to do so in 
a written notice to the employer from the IRS or if directed to do so 
under any published guidance.
    Some commentators observed that requiring employers to submit 
questionable Forms W-4 to the IRS may have deterred employees from 
furnishing a Form W-4 claiming excessive withholding exemptions. Some 
employers have expressed the concern that eliminating the submission 
requirement will result in more employees submitting Forms W-4 claiming 
excessive withholding allowances. While the Department of Treasury and 
the IRS acknowledge the possible deterrent effect of a requirement to 
submit certain Forms W-4 to the IRS, they have concluded that the final 
regulations are a more efficient and effective manner of deterring 
withholding compliance problems. Accordingly, the final regulations do 
not require the routine submission of Forms W-4, but permit the IRS to 
require submission of Forms W-4 under specific criteria either by 
written notice or by future published guidance. The final regulations 
do not change an employee's obligations to provide an accurate Form W-4 
to an employer and to satisfy his or her tax obligations on a timely 
basis. Thus, employees may be subject to penalties if they claim 
excessive withholding exemptions on Forms W-4 or fail to file their tax 
returns and pay their full tax liabilities on a timely basis.
    Some commentators have suggested that if the IRS requires an 
employer to submit certain Forms W-4 by a written notice or published 
guidance, the employer should have the ability to provide the requested 
Forms W-4 by electronic means. The final regulations do not address 
this comment as the available and appropriate means for submission can 
be determined by the IRS in specific cases or in the context of any 
future published guidance requiring the submission of Forms W-4.

Valid and Invalid Withholding Exemption Certificates

    In the Preamble to the proposed and temporary regulations, the 
Department of Treasury and IRS requested comments specifically with 
regard to the criteria for identifying a valid withholding exemption 
certificate contained in Sec.  31.3402(f)(5)-1(a)(1) of the Employment 
Tax Regulations. While a few comments were received, they were not 
likely to provide significant assistance to employers or the IRS in 
identifying potentially invalid withholding exemption certificates. 
Accordingly, these final regulations do not change the existing rules 
on when to treat a withholding exemption certificate as invalid.

Effect of Notice Specifying the Maximum Withholding Exemptions 
Permitted

    The final regulations, like the temporary regulations, authorize 
the IRS to issue a notice to an employer specifying the maximum number 
of

[[Page 38480]]

withholding exemptions permitted for a specific employee. The IRS may 
issue such a notice after it determines an employee is not entitled to 
claim exemption from withholding or more than a specified number of 
withholding exemptions based on IRS records, without first obtaining a 
copy of the withholding exemption certificate from the employer. 
Alternatively, the IRS may issue such notice after it reviews a 
particular withholding exemption certificate and determines that the 
withholding exemption certificate contains a materially incorrect 
statement or determines, after a request to the employee for 
verification of the statements on the certificate, that the IRS lacks 
sufficient information to determine if the certificate is correct.
    The IRS will send the notice both to the employer (with a copy for 
the employee) and to the employee directly. The final regulations 
provide a period during which the employee can address the pending 
withholding adjustment by contacting the IRS. The final regulations 
provide that the earliest the notice may be effective is 45 calendar 
days after the date of the notice. The notice may specify a later 
effective date.
    One commentator expressed a concern held by some employers 
regarding the need to ``warehouse'' the notice for the 45-day period 
and suggested that instead the IRS either (1) send the notice first to 
the employee before involving the employer or (2) not require the 
employer to implement the notice until a subsequent ``final'' notice is 
sent to the employer. The final regulations retain the approach of the 
proposed and temporary regulations, including a delay period, to 
balance the need to ensure that the employee receives the notice and to 
provide time for the employee to discuss the appropriate withholding 
with the IRS. Consistent with the intent to ensure that the employee 
receives the notice, the final regulations also provide that if the IRS 
is unable to determine a last known address for the employee, the IRS 
will use other available information as appropriate to provide the 
notice to the employee.
    The final regulations also clarify that the notice to an employer 
specifying the maximum withholding exemptions permitted for a specific 
employee will also specify the marital status for purposes of 
calculating the required withholding under the notice. Accordingly, the 
employer must use the maximum number of withholding exemptions 
permitted and marital status specified in the notice for calculating 
income tax withholding, unless a new withholding exemption certificate 
is submitted by the employee that must be honored under these final 
regulations. Specifically, if, at any time, the employee furnishes a 
withholding exemption certificate that claims a marital status, a 
number of withholding exemptions, and any additional withholding that 
results in more withholding than would result from applying the marital 
status and number of withholding exemptions permitted in the notice, 
the employer must withhold tax based on that certificate. The IRS may 
also issue a modification notice to the employer that the employer must 
implement as of the date in the notice. This notice may change the 
marital status and/or the maximum number of withholding exemptions 
permitted.
    Although this issue was not raised in the comments, in the course 
of conducting the withholding compliance program, the IRS has received 
questions from taxpayers asking about the implications of receiving a 
notice specifying the maximum number of withholding exemptions 
permitted and marital status when possible exclusions from withholding 
apply. Receipt of an IRS notice does not impose a requirement to 
withhold income taxes where one does not already exist. For example, 
under section 3401(a)(8)(A)(i) of the Code, employers do not have to 
withhold income taxes from payments made to employees who are United 
States citizens working in foreign countries if the employer reasonably 
believes that the payments are excluded from taxation under section 911 
of the Code. Issuance of an IRS notice to an employer properly relying 
on this exclusion does not impose a withholding requirement on amounts 
covered by the exclusion. However, if withholding is required, such as 
on wages paid in excess of the amount excludable under section 911, or 
if the exclusion ceases to apply to amounts paid by the employer to the 
employee, the employer must withhold on the basis of the marital status 
and maximum number of withholding exemptions set forth in the IRS 
notice. An example has been added to the regulations to illustrate this 
point.

Employer Furnishing IRS Notice to Employee

    The final regulations provide that, if the employee is still 
employed by the employer, the employer must furnish the notice of 
maximum number of withholding exemptions permitted to the employee 
within 10 business days of receipt. Commentators questioned whether 
they may furnish the employee's copy electronically. The final 
regulations clarify that the employer may furnish the copy of the IRS 
notice to the employee within the 10 required business days using any 
reasonable business practice. For example, an employer might provide 
the employee with a paper copy of the notice or might transmit a copy 
using a secure and reliable electronic means of communication.

Terminated, Rehired, and Seasonal Employees

    The proposed and temporary regulations provided that the employer 
is not required to furnish the IRS employee notice to the employee if 
the employee is no longer employed by the employer. In such a case, the 
employer must send a written response to the IRS office designated in 
the notice indicating that the employee is no longer employed by the 
employer. Some commentators have expressed concerns over application of 
the regulations to employees who are not currently performing services, 
but may resume employment in the future, such as seasonal employees or 
rehired employees. Specifically, the comments requested assistance in 
determining when an employee is ``no longer employed,'' and asked 
whether an employer is required to retain an IRS notice for future 
implementation should an employee be rehired or resume performance of 
services. One commentator recommended that the employer be required to 
retain the notice no later than the end of the calendar year in which 
the employee terminates, or one year after termination.
    After consideration of these comments, the final regulations modify 
the proposed regulations to clarify that the determination of whether 
the employee is employed is made as of the date of the notice, and is 
based on all the facts and circumstances, including whether the 
employer has treated the employment relationship as terminated for 
other purposes. The final regulations also specifically state that an 
employee who is not currently performing services is nevertheless 
employed for purposes of this rule if on the date of the notice (a) The 
employer pays wages subject to income tax withholding to the employee 
with respect to prior employment on or after the date specified in the 
notice, (b) the employer reasonably expects the employee to resume the 
performance of services for the employer within twelve months of the 
date of the notice, or (c) the employee is on a bona fide leave of 
absence if the period of such leave does not exceed twelve months or if 
the individual retains a right to reemployment with the employer by

[[Page 38481]]

contract or under an applicable statute, such as the Family Medical 
Leave Act.
    If the employer must furnish the notice under these final 
regulations, the employer must withhold based on the notice as of the 
date specified in the notice unless one of the regulatory exceptions 
applies. Specifically, the employer must withhold based on the notice 
unless (a) the employer receives a modification notice, (b) the 
employee has provided or provides a new Form W-4 that results in more 
withholding than would result based on the notice, (c) the employer is 
required to furnish the notice only because the employer reasonably 
expects the employee to resume the performance of services within 
twelve months of the date of the notice but the employee does not 
resume the performance of services until after such time, or (d) the 
employment relationship is terminated for more than twelve months. The 
regulations include examples to illustrate these requirements.

Notices to Other Employers

    One commentator questioned whether an employer has any obligation 
with respect to an IRS notice issued to another employer, such as a 
related entity or an employer using the same entity as its ``payroll 
agent,'' with respect to the same employee. The commentator also 
proposed that an employer be able to rely on any subsequent notices 
provided by the IRS with regard to an employee (for example, modifying 
the maximum number of withholding exemptions permitted) while the 
employee was employed by another employer.
    The final regulations do not adopt these proposals. Other than when 
an employer qualifies as a ``successor employer'' within the meaning of 
section 3121(a)(1) of the Code and Sec.  31.3121(a)(1)-1(b) of the 
Employment Tax Regulations and uses the alternate procedure described 
in Rev. Proc. 2004-53, 2004-34 I.R.B. 320, an employer's liability for 
withholding under section 3402 is determined separately with regard to 
that employer. Rev. Proc. 2004-53 provides that, under the alternative 
procedure, the predecessor employer must transfer to the successor 
employer all current Forms W-4 that were provided to the predecessor by 
the acquired employees and any written notices received from the IRS 
under Sec.  31.3402(f)(2)-1(g). The revenue procedure also provides 
that the successor employer must withhold amounts from the employees on 
the basis of the maximum number of withholding exemptions specified in 
any written notices from the IRS under Sec.  31.3402(f)(2)-1(g). 
Accordingly, the provision of an IRS notice or a subsequent IRS notice 
to another employer is not relevant in determining the employer's 
obligation to withhold income taxes under these final regulations.

Substitute Forms W-4

    Some commentators have suggested that employers must refuse to 
accept substitute Forms W-4 developed by employees. After consideration 
of this comment, the final regulations provide that employers may not 
accept a substitute form developed by an employee, and the employee 
submitting such form will be treated as failing to furnish a 
withholding exemption certificate.

Effective Date

    The final regulations are generally effective on April 14, 2005, 
the date the temporary regulations were published in the Federal 
Register. However, the new provisions in the final regulations that (a) 
specify when an employee who is not currently performing services is 
employed for purposes of the requirements to furnish the employee 
notice and withhold based on the notice, (b) require the employer to 
withhold based on the notice if a terminated employment relationship is 
resumed within 12 months, and (c) require employers to refuse to accept 
substitute withholding exemption certificates developed by employees 
apply on October 11, 2007. However, taxpayers may rely on such 
provisions for notices issued prior to such date.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations, and because the 
regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, the notice of proposed 
rulemaking that preceded these regulations was submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.

Drafting Information

    The principal author of these regulations is Ilya Enkishev, Office 
of the Division Counsel/Associate Chief Counsel (Tax Exempt and 
Government Entities). However, other personnel from the IRS and the 
Department of Treasury participated in their development.

List of Subjects in 26 CFR Part 31

    Employment taxes, Income taxes, Penalties, Pensions, Railroad 
retirement, Reporting and recordkeeping requirements, Social security, 
Unemployment compensation.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 31 is amended as follows:

PART 31--EMPLOYMENT TAXES AND COLLECTION OF INCOME TAX AT THE 
SOURCE

0
Paragraph 1. The authority citation for part 31 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 2. Section 31.3402(f)(2)-1 is amended by revising paragraph (g) to 
read as follows:


Sec.  31.3402(f)(2)-1  Withholding exemption certificates.

* * * * *
    (g) Submission of certain withholding exemption certificates and 
notice of the maximum number of withholding exemptions permitted--(1) 
Submission of certain withholding exemption certificates--(i) In 
general. An employer must submit to the Internal Revenue Service (IRS) 
a copy of any currently effective withholding exemption certificate as 
directed in a written notice to the employer from the IRS or as 
directed in published guidance.
    (A) Notice to submit withholding exemption certificates. A notice 
to the employer to submit withholding exemption certificates may relate 
either to one or more named employees, to one or more reasonably 
segregable units of the employer, or to withholding exemption 
certificates under certain specified criteria. The notice will 
designate the IRS office where the copies of the withholding exemption 
certificates must be submitted. Alternatively, upon notice from the 
IRS, the employer must make available for inspection by an IRS employee 
withholding exemption certificates received from one or more named 
employees, from one or more reasonably segregable units of the 
employer, or from employees who have furnished withholding exemption 
certificates under certain specified criteria.
    (B) Published guidance. Employers may also be required to submit 
copies of withholding exemption certificates

[[Page 38482]]

under certain specified criteria when directed to do so by the IRS in 
published guidance. For purposes of the preceding sentence, the term 
published guidance means a revenue procedure or notice published in the 
Internal Revenue Bulletin (see Sec.  601.601(d)(2) of this chapter).
    (ii) Withholding after submission of withholding exemption 
certificate. After a copy of a withholding exemption certificate has 
been submitted to the IRS under this paragraph (g)(1), the employer 
must withhold tax on the basis of the withholding exemption 
certificate, if the withholding exemption certificate meets the 
requirements of Sec.  31.3402(f)(5)-1. However, the employer may not 
withhold on the basis of the withholding exemption certificate if the 
certificate must be disregarded based on a notice of the maximum number 
of withholding exemptions permitted under the provisions of paragraph 
(g)(2) of this section.
    (2) Notice of the maximum number of withholding exemptions 
permitted--(i) Notice to employer. The IRS may notify the employer in 
writing that the employee is not entitled to claim a complete exemption 
from withholding or more than the maximum number of withholding 
exemptions specified by the IRS in the written notice. The notice will 
also specify the applicable marital status for purposes of calculating 
the required amount of withholding. The notice will specify the IRS 
office to be contacted for further information. The notice of maximum 
number of withholding exemptions permitted may be issued if--
    (A) The IRS determines that a copy of a withholding exemption 
certificate submitted under paragraph (g)(1) of this section or 
otherwise provided to the IRS contains a materially incorrect statement 
or determines, after a request to the employee for verification of the 
statements on the certificate, that the IRS lacks sufficient 
information to determine if the certificate is correct.
    (B) The IRS otherwise determines that the employee is not entitled 
to claim a complete exemption from withholding and is not entitled to 
claim more than a specified number of withholding exemptions.
    (ii) Notice to employee. If the IRS provides a notice to the 
employer under this paragraph (g)(2), the IRS will also provide the 
employer with a similar notice for the employee (employee notice) that 
identifies the maximum number of withholding exemptions permitted and 
specifies the marital status to be used for calculating the required 
amount of withholding. The employee notice will also indicate the 
process by which the employee can provide additional information to the 
IRS for purposes of determining the appropriate number of withholding 
exemptions and/or modifying the specified marital status. The IRS will 
also mail a similar notice to the employee's last known address. For 
further guidance regarding the definition of last known address, see 
Sec.  301.6212-2 of this chapter. If the IRS is unable to determine a 
last known address for the employee, the IRS will use other available 
information as appropriate to mail the notice to the employee.
    (iii) Requirement to furnish. If the employee is employed by the 
employer as of the date of the notice, the employer must furnish the 
employee notice to the employee within 10 business days of receipt. The 
employer may follow any reasonable business practice to furnish the 
copy of the notice to the employee. For purposes of this paragraph 
(g)(2)(iii), the determination of whether an employee is employed as of 
the date of the notice is based on all the facts and circumstances, 
including whether the employer has treated the employment relationship 
as terminated for other purposes. An employee that is not performing 
services for the employer as of the date of the notice is employed by 
the employer as of the date of the notice for purposes of this 
paragraph (g)(2)(iii) if--
    (A) The employer pays wages with respect to prior employment to the 
employee subject to income tax withholding on or after the date 
specified in the notice;
    (B) The employer reasonably expects the employee to resume the 
performance of services for the employer within twelve months of the 
date of the notice; or
    (C) The employee is on a bona fide leave of absence if the period 
of such leave does not exceed twelve months or the employee retains a 
right to reemployment with the employer under an applicable statute or 
by contract.
    (iv) Requirement to notify the IRS. If the employer is not required 
to furnish the notice to the employee under paragraph (g)(2)(iii) of 
this section, the employer must send a written response to the IRS 
office designated in the notice indicating that the employee is not 
employed by the employer.
    (v) Requirement to withhold based on the notice. If the employer is 
required to furnish the employee notice to the employee under paragraph 
(g)(2)(iii), then the employer must withhold tax on the basis of the 
maximum number of withholding exemptions and the marital status 
specified in the notice for any wages paid after the date specified in 
the notice, except as provided in paragraphs (g)(2)(vi), (vii), (viii), 
(ix), and (x) of this section. The employer must withhold tax in 
accordance with the notice as of the date specified in the notice, 
which shall be no earlier than 45 calendar days after the date of the 
notice.
    (vi) Employment resumes after twelve months. If the employer is 
required to furnish the employee notice to the employee only pursuant 
to paragraph (g)(2)(iii)(B) of this section and the employee resumes 
the performance of services for the employer more than 12 months after 
the date of the notice, then the employer is not required to withhold 
based on the notice.
    (vii) Requirement to withhold based on an existing Form W-4. If a 
withholding exemption certificate is in effect with respect to the 
employee before the employer receives a notice of the maximum number of 
withholding exemptions permitted under this paragraph (g)(2), the 
employer must continue to withhold tax in accordance with the existing 
withholding exemption certificate, rather than on the basis of the 
notice, if the existing withholding exemption certificate does not 
claim complete exemption from withholding and claims a marital status, 
a number of withholding exemptions, and any additional withholding that 
results in more withholding than would result from applying the marital 
status and number of withholding exemptions specified in the notice.
    (viii) Modification notice. After issuing the notice specifying the 
maximum number of withholding exemptions permitted and the marital 
status, the IRS may issue a subsequent notice that modifies the 
original notice (modification notice). The modification notice may 
change the marital status and/or the number of withholding exemptions 
permitted. The employer must withhold based on the modification notice 
as of the date specified in the modification notice.
    (ix) Requirement to withhold after termination of employment. If 
the employee is employed as of the date of the notice under paragraph 
(g)(2)(iii) of this section but the employer or employee terminates the 
employment relationship after the date of the notice, the employer must 
continue to withhold based on the maximum number of withholding 
exemptions and the marital status specified in the notice or a 
modification notice if any wages subject to income tax withholding are 
paid with respect to the prior employment after such date. Furthermore, 
the employer must withhold based on the notice or

[[Page 38483]]

modification notice if the employee resumes an employment relationship 
with the employer within 12 months after the termination of the 
employment relationship. Whether the employment relationship is 
terminated is based on all the facts and circumstances.
    (x) Requirement to withhold based on new Form W-4. The employee may 
furnish a new withholding exemption certificate after the employer 
receives a notice or modification notice from the IRS of the maximum 
number of withholding exemptions permitted under this paragraph (g)(2).
    (A) Employee requests more withholding. If the employee furnishes a 
new withholding exemption certificate after the employer receives the 
notice or modification notice, the employer must withhold tax on the 
basis of that new certificate only if the new certificate does not 
claim complete exemption from withholding and claims a marital status, 
a number of withholding exemptions, and any additional withholding that 
results in more withholding than would result under the notice or 
modification notice.
    (B) Employee requests less withholding. If the employee furnishes a 
new withholding exemption certificate after the employer receives the 
notice or modification notice, the employer must disregard the new 
certificate and withhold on the basis of the notice or modification 
notice if the employee claims complete exemption from withholding or 
claims a marital status, a number of withholding exemptions, and any 
additional withholding that results in less withholding than would 
result under the notice or modification notice. If the employee wants 
to put a new certificate into effect that results in less withholding 
than that required under the notice or modification notice, the 
employee must contact the IRS. The employer must withhold on the basis 
of the notice or modification notice unless the IRS subsequently 
notifies the employer to withhold based on the new certificate.
    (3) Definition of employer. For purposes of this paragraph (g), the 
term employer includes any person authorized by the employer to receive 
withholding exemption certificates, to make withholding computations, 
or to make payroll distributions.
    (4) Examples. The following examples illustrate the rules of this 
section.

    Example 1. Employer U receives a notice from the IRS that 
identifies the maximum number of withholding exemptions permitted 
and specifies the marital status for Employee A. Employee A is not 
currently performing any services for Employer U. However, Employer 
U is continuing to make certain wage payments to Employee A. 
Employer U must furnish the employee notice to Employee A within 10 
business days of receipt and must withhold based on the notice on 
any wages paid to Employee A on or after the date specified in the 
notice.
    Example 2. Employer V receives a notice in October of Year 1 
from the IRS that identifies the maximum number of withholding 
exemptions permitted and specifies the marital status for Employee 
B. Employee B has not performed services for Employer V since August 
of Year 1. However, since Employee B has performed services for 
Employer V for several years on a seasonal basis, Employer V 
reasonably expects Employee B to resume the performance of services 
for Employer V in June of Year 2, a date that is within 12 months of 
the date of the notice. Employer V is required to furnish the notice 
to Employee B within 10 business days of receipt. Employee B does 
not resume the performance of services until June of Year 3. 
Employer V is not required to withhold based on the notice.
    Example 3. Employer W receives a notice from the IRS that 
identifies the maximum number of withholding exemptions permitted 
and specifies the marital status for Employee C. Employee C began a 
4-month unpaid maternity leave of absence three weeks before 
Employer W received the notice. Employer W must furnish the employee 
notice to Employee C within 10 business days of receipt. When 
Employee C resumes performing services when her maternity leave 
ends, Employer W must withhold based on the notice.
    Example 4. Employer X receives a notice from the IRS in Year 1 
that identifies the maximum number of withholding exemptions 
permitted and specifies the marital status for Employee D. Employer 
X must furnish the employee notice to Employee D within 10 business 
days of receipt and withhold based on the notice. In Year 2, 
Employee D terminates the employment relationship. Employee D 
applies for a different position with Employer X and resumes 
employment 10 months after having left her previous position with 
Employer X. Since Employer X rehired Employee D within 12 months 
after the termination of employment, Employer X must withhold based 
on the notice.
    Example 5. Employer Y receives a notice from the IRS that 
identifies the maximum number of withholding exemptions permitted 
and specifies the marital status for Employee E. Employer Y must 
furnish the employee notice to Employee E within 10 business days of 
receipt. After receipt of this notice, Employee E contacts the IRS 
and establishes that he is entitled to claim a higher number of 
withholding exemptions. Employer Y receives a modification notice 
from the IRS that changes the maximum number of withholding 
exemptions permitted for Employee E. Employer Y must withhold tax 
based on the modification notice as of the date specified in such 
notice.
    Example 6. Employer Z pays remuneration to Employee F, a United 
States citizen, for services performed in Country M. Employer Z 
receives a notice from the IRS in Year 1 that identifies the maximum 
number of withholding exemptions permitted and specifies the marital 
status for Employee F. Employer Z must furnish the employee notice 
to Employee F within 10 business days of receipt. Employer Z 
reasonably believes all the remuneration paid to Employee F in Year 
1 is excluded from Employee F's gross income under section 911 of 
the Internal Revenue Code. Since section 3401(a)(8)(B) excludes such 
remuneration from wages for income tax withholding purposes, 
Employer X does not have to withhold on such remuneration, 
notwithstanding the maximum number of exemptions permitted and 
marital status specified in the notice. In Year 2, Employee F 
returns to the United States to perform services. Employer Z does 
not reasonably believe any part of Employee F's remuneration paid in 
Year 2 is excluded from Employee F's gross income under section 911. 
Rather, Employer Z reasonably believes that remuneration paid to 
Employee F in Year 2 is subject to income tax withholding. Employer 
Z must withhold on the remuneration paid to Employee F based on the 
notice.
    (5) Effective/applicability date. Except as provided in this 
paragraph (g)(5), paragraph (g) applies on April 14, 2005. Paragraphs 
(g)(2)(iii)(A), (B), and (C) and paragraph (g)(2)(ix) apply on October 
11, 2007, except taxpayers may rely on such paragraphs for notices 
issued prior to such date.


Sec.  31.3402(f)(2)-1T  [Removed]

0
Par. 3. Section 31.3402(f)(2)-1T is removed.

0
Par. 4. Section 31.3402(f)(5)-1 is amended by revising paragraph (a) to 
read as follows:


Sec.  31.3402(f)(5)-1  Form and contents of withholding exemption 
certificates.

    (a)(1) Form W-4. Form W-4, ``Employee's Withholding Allowance 
Certificate,'' is the form prescribed for the withholding exemption 
certificate required to be furnished under section 3402(f)(2). A 
withholding exemption certificate must be prepared in accordance with 
the instructions and regulations applicable thereto, and must set forth 
fully and clearly the data that is called for therein. Blank copies of 
paper Forms W-4 will be supplied to employers upon request to the 
Internal Revenue Service (IRS). An employer may also download and print 
Form W-4 from the IRS Internet site at www.irs.gov. In lieu of the 
prescribed form, employers may prepare and use a form the provisions of 
which are identical with those of the prescribed form, but only if 
employers also provide employees with all the tables, instructions, and 
worksheets contained in the Form W-4 in effect at that time, and only 
if employers comply with all revenue procedures relating to substitute 
forms in effect at that time.

[[Page 38484]]

    (2) Employers are prohibited from accepting a substitute form 
developed by an employee, and the employee submitting such form will be 
treated as failing to furnish a withholding exemption certificate. For 
further guidance regarding the employer's obligations when an employee 
is treated as failing to furnish a withholding exemption certificate, 
see Sec.  31.3402(f)(2)-1.
    (3) Effective/applicability date. Paragraph (a)(1) applies on April 
14, 2005. Paragraph (a)(2) applies to any substitute withholding 
exemption certificate furnished to an employer on or after October 11, 
2007.
* * * * *


Sec.  31.3402(f)(5)-1T  [Removed]

0
Par. 5. Section 31.3402(f)(5)-1T is removed.

Kevin Brown,
Deputy Commissioner for Services and Enforcement.
    Approved: July 2, 2007.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
 [FR Doc. E7-13492 Filed 7-12-07; 8:45 am]
BILLING CODE 4830-01-P