With the 2015 tax filing deadline now closed, employers can expect to see an uptake in the volume of requests to change federal and state income tax withholding certificates. Thanks in large part to the lack of consistency in federal and state income tax laws, this taxpayer "spring cleaning" can present a number of challenges for employers that are not necessarily met with automated Form W-4 collection systems.

There are many Form W-4 processing considerations, particularly at the state and local level, that are not necessarily addressed by automated Form W-4 collection systems.

State income tax withholding audits are increasing in volume and scope, making it important that payroll departments take some time to review their policies and procedures for processing and implementing withholding allowances certificates keeping in my mind some key compliance areas frequently overlooked.

Here are two examples.

1. Know how to compute income tax withholding when there is no withholding allowance certificate on file. The IRS and state taxing authorities encourage employees to provide a timely Form W-4 (or state equivalent) to their employers by mandating income tax withholding at an assumed higher rate of tax when there is no form on file.

For federal income tax withholding purposes, when there is no valid Form W-4 on file, the employer is required to assume that the employee filed a certificate as single with zero allowances. The result of this rule is a higher amount of federal income tax withholding than applies when claiming married or when claiming personal allowances. (Section 31.3402(f)(2)-1; IRS Publication 15 (rev. 2016).)

The state rules vary considerably.

For instance, if an Arizona employee has failed to provide a Form A-4, the employer is required to withhold at 2.7% of the employee's gross taxable wages. (Arizona Department of Revenue, Withholding Tax.)

To avoid underwithholding penalties, payroll policies and procedures should include the state and local income tax withholding instructions in the case of a missing withholding allowance certificate, and these procedures should be updated at least once a year.

2. File certain copies of withholding allowance certificates with the state taxing authority. Once upon a time (prior to 2005), employers were required to submit copies of all Forms W-4 to the IRS on a quarterly basis in cases where the employee (1) claimed more than 10 personal allowances or (2) claimed to be exempt from withholding and normally earned more than $200 per week. The IRS no longer requires the routine filing of Forms W-4. However, employers must submit copies of Forms W-4 for certain employees when the IRS requests them. When submitting copies of Forms W-4 to the IRS, you generally should complete boxes 8 and 10.

Despite the IRS resending the requirement to routinely submit copies of certain Forms W-4, there are 26 state income tax authorities (including the District of Columbia) that continue to impose a filing rule, the triggering events variable by state. (See the 2016 state Form W-4 survey in our special report for the 26 states with Form W-4 filing requirements.)

Payroll departments should be familiar with these state rules and if they outsource employment tax filing to a third party, confirm the extent to which they are assisted in complying with these filing requirements.

These as well as other Form W-4 compliance tips are available in the Ernst & Young LLP's 2016 edition of its annual report, Federal and state Form W-4 compliance. The special report includes the 2016 survey of state Form W-4 requirements.

Download the special report here.

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