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Contributions to Trump accounts will be treated as completed gifts that are not future interests in property and the gift tax annual exclusion amount will apply under a safe harbor for certain donors making contributions to Trump accounts created under Code Sec. 530A.

Contributions to Trump accounts will be treated as completed gifts that are not future interests in property and the gift tax annual exclusion amount will apply under a safe harbor for certain donors making contributions to Trump accounts created under Code Sec. 530A.

Pursuant to the rules of Code Sec. 530A, distributions from Trump accounts are limited during the growth period, which is the period ending on January 1 of the year in which the account beneficiary attains age 18. During the growth period, annual contributions are limited to $5,000 per year, as adjusted for inflation after 2027. Gifts of future interests in property are not eligible for the annual gift tax exclusion and must be reported on a federal gift tax return.

The safe harbor applies for a particular year if the following requirements of section 4.02 are met:

• The taxpayer is an individual;
• The only taxable gifts made by the taxpayer during the calendar year are cash contributions to one or more Trump accounts, each made before the calendar year in which the account beneficiary attains age 18;
• The taxpayer's total gifts during the calendar year to each individual who is an account beneficiary, including contributions to that individual beneficiary's Trump account, do not exceed the Code Sec. 2503(b) annual exclusion;
• Such contributions to Trump accounts during the calendar year do not generate for that year either a gift or generation-skipping transfer (GST) tax liability after application of the taxpayer's remaining applicable credit amount against the gift tax or remaining GST exemption; and
• Disregarding the Trump account contributions described in section 4.02(2) of the revenue procedure, a gift tax return is not required to be filed, and no gift tax return is otherwise filed for that calendar year by or on behalf of the taxpayer for any other purposes.

If these requirements are satisfied, each Trump account contribution made by the taxpayer during the calendar year will be treated as a completed gift to the account beneficiary that is not a future interest in property and to which the annual exclusion applies for purposes of gift and GST tax reporting. As a result, taxpayers within the scope of the safe harbor will not be required to file a gift tax return reporting the such contributions.

Rev. Proc. 2026-25

IR 2026-80

The IRS has issued final regulations identifying certain Charitable Remainder Annuity Trust (CRAT) transactions and substantially similar transactions as listed transactions subject to the reportable transaction disclosure rules. The regulations require participants and material advisors to disclose these transactions to the IRS while clarifying that charitable organizations whose only interest is as charitable remaindermen are not treated as participants or parties to prohibited tax shelter transactions. The regulations are effective July 9, 2026.

The IRS has issued final regulations identifying certain Charitable Remainder Annuity Trust (CRAT) transactions and substantially similar transactions as listed transactions subject to the reportable transaction disclosure rules. The regulations require participants and material advisors to disclose these transactions to the IRS while clarifying that charitable organizations whose only interest is as charitable remaindermen are not treated as participants or parties to prohibited tax shelter transactions. The regulations are effective July 9, 2026.

Under Code Secs. 6011 and 6707A, the IRS may identify transactions with tax avoidance potential as listed transactions. The final regulations add Reg. §1.6011-15, identifying transactions in which appreciated property is contributed to a purported CRAT, sold by the trust, and the sale proceeds are used to purchase an annuity, with the beneficiary improperly treating the annuity payments under Code Sec. 72 instead of applying the distribution ordering rules of Code Sec. 664(b).

Although participants and material advisors remain subject to the applicable disclosure requirements, organizations described in Code Sec. 170(c) that merely receive the charitable remainder interest are excluded from participant status and are not treated as parties to prohibited tax shelter transactions under Code Sec. 4965 solely because of that interest. The IRS finalized the regulations without substantive changes from the proposed regulations issued in 2024.

T.D. 10051

IR 2026-82

A portion of litigation settlement proceeds consisting of attorney’s fees and costs was includible in the gross income of two individuals (taxpayers). Said portion was not deductible under Code Sec. 62(a)(20). The Fair Credit Reporting Act’s (FCRA) (P.L. 91-508) fee-shifting provisions were inapplicable in this case.

A portion of litigation settlement proceeds consisting of attorney’s fees and costs was includible in the gross income of two individuals (taxpayers). Said portion was not deductible under Code Sec. 62(a)(20). The Fair Credit Reporting Act’s (FCRA) (P.L. 91-508) fee-shifting provisions were inapplicable in this case.

Background

The taxpayers sued multiple credit reporting agencies under FCRA provisions. They eventually settled with each agency. In all relevant Forms 1099–MISC the settlement amounts were reflected without the attorney’s fees and costs.

Civil Rights Interpretation for FCRA Claims Denied

The taxpayers’ FCRA claims of unlawful discrimination did not fall under Code Sec. 62(e)(18)(i). Said claims were based on fair and accurate credit reporting and not consumer privacy. Particularly, the taxpayers’ concerns did not fall under “highly sensitive” and “intimate personal information” categories.

J.W. Eiler, 167 T.C. No. 3, Dec. 62,865

The IRS has reminded taxpayers that major life events can affect tax filing requirements, eligibility for tax benefits and the amount of tax withheld from paychecks. The agency explained that changes such as marriage, the birth or adoption of a child, divorce or the death of a loved one may require updates to tax information and a review of filing status.

The IRS has reminded taxpayers that major life events can affect tax filing requirements, eligibility for tax benefits and the amount of tax withheld from paychecks. The agency explained that changes such as marriage, the birth or adoption of a child, divorce or the death of a loved one may require updates to tax information and a review of filing status. A name change following marriage should be reported to the Social Security Administration so the updated name matches Social Security records. An address change should be reported to the IRS by filing Form 8822, Change of Address, and employers, financial institutions and the U.S. Postal Service should also be notified. Marriage may also require submission of a new Form W-4, Employee's Withholding Certificate, to ensure the correct amount of tax is withheld.

Additionally, the IRS noted that the birth or adoption of a child may make a taxpayer eligible for valuable tax benefits, including the Child Tax Credit, Adoption Credit and Child and Dependent Care Credit, if applicable requirements are satisfied. Divorce or the death of a spouse may also affect filing status, tax withholding and eligibility for certain tax benefits. The IRS encouraged prompt updates to tax records, careful evaluation of changes affecting tax obligations and use of available IRS resources to better understand the tax consequences of major life events. Early action can help avoid filing issues, support accurate tax reporting, maximize available tax benefits and improve preparation for the next tax filing season.

IRS Tax Tip 2026-55

The Internal Revenue Service received and processed less returns during 2026, according to the Treasury Inspector General for Tax Administration.

The Internal Revenue Service received and processed less returns during 2026, according to the Treasury Inspector General for Tax Administration.

In a recently released report, TIGTA stated that from March 1, 2025, through February 28, 2026, the IRS received 51.5 million tax returns, down from 52. 4 million in the previous year, though it did see a significant drop in paper returns received from 1.2 million in 2025 to 618,000 in 2026. Of the returns received in 2026, the agency processed 50.9 million returns, down from 51.8 million.

From the beginning of the 2026 tax filing season to the end of February 2026, TIGTA reported that the inventory backlog in key tax return processing programs increased from 1.9 million to 2.4 million. Additionally, nearly 75 percent of the amended return inventory is over-aged during the 2026 tax filing season.

“Generally, inventories increase during the filing season as the IRS balances efforts to answer phone calls and reduce inventories,” TIGTA stated in the report. “However, with the reduction in staff, increases in key inventories could become a concern.”

The number of refunds dipped to 36.5 million from 36.9 million, although there was a $360 increase in the average refund from $3,382 in 2025 to $3,742.

TIGTA also reported that the IRS did not meet its hiring goals for the 2026 tax filing season. The agency had been approved to hire 1,900 employees for submission processing (these workers process original and amended returns and resolve tax return errors) but only onboarded 800 individuals. Likewise, it was approved to hire 3,500 account management employees (handlers of taxpayer contacts through telephone and mail and process adjustments) but brought 2,300 on board.

Submission processing management said it would be onboarding new hires throughout the tax season, while account management leadership had no plans to hire new employees and would only be onboarding those who previously received offers but had delays in the hiring process.

In a positive from the 2026 season, TIGTA reported that the new and modified “e-file business rules associated with the child tax Credit, state and local tax deduction, and adoption credit are working as intended.”

Taxpayer Assistance Centers offered incorrect tax guidance during nearly half of unannounced visits by Treasury Inspector General for Tax Administration staff.

Taxpayer Assistance Centers offered incorrect tax guidance during nearly half of unannounced visits by Treasury Inspector General for Tax Administration staff.

According to a recent TIGTA report, during the 2025 tax filing season, the Treasury watchdog made 91 unannounced visits to TACs nationwide at various time (regular and extended hours), at the 61 visits where TIGTA staff did receive assistance, “TAC employees did not provide the correct tax law guidance during 28 of those visits (46 percent).”

TAC employees were presented with questions across one of the three areas – injured spouse, selling your main home, and American Opportunity Tax Credit. The report notes that for questions related to tax law topics, “TAC employees must use the Interactive Tax Law Assistant ITLA) tool to respond to taxpayers. The ITLA tool asks a series of questions, then generates accurate and complete responses based on the taxpayer’s situation. The tool is designed for TAC employees and is intended to improve operational performance in the areas of quality, efficiency, customers satisfaction, and employee satisfaction.”

TIGTA noted that during the 2025 filing season, “managers counseled several TAC employees for not using the ITLA tool during taxpayer interactions. During our site visits, we also observed that TAC employees did not always the ITLA tool to answer our tax law questions.”

Additionally, of those 91 visits, TIGTA “did not receive full assistance during 30 of our 91 visits due to incomplete or inaccurate responses to tax law questions, denial of entry by security or unexpected TAC closures.”

Gross income is taxed to the person who earns it by performing services, or who owns the property that generates the income. Under the assignment of income doctrine, a taxpayer cannot avoid tax liability by assigning a right to income to someone else. The doctrine is invoked, for example, for assignments to creditors, family members, charities, and controlled entities. Thus, the income is taxable to the person who earned it, even if the person assigns the income to another and never personally receives the income. The doctrine can apply to both individuals and corporations.

Gross income is taxed to the person who earns it by performing services, or who owns the property that generates the income. Under the assignment of income doctrine, a taxpayer cannot avoid tax liability by assigning a right to income to someone else. The doctrine is invoked, for example, for assignments to creditors, family members, charities, and controlled entities. Thus, the income is taxable to the person who earned it, even if the person assigns the income to another and never personally receives the income. The doctrine can apply to both individuals and corporations.

A taxpayer cannot assign income that has already accrued from the property the taxpayer owns, and cannot avoid liability for tax on that income by assigning it to another person or entity. This result often applies to interest, dividends, rent, royalties, and trust income. The doctrine applies when the taxpayer's right to income has ripened so that the receipt of income is practically certain to occur. Once a right to receive income has ripened, the taxpayer who earned it or otherwise created that right will be taxed on the income.

Similarly, under the anticipatory assignment of income doctrine, a taxpayer cannot shift tax liability by transferring property that is a fixed right to income. However, a taxpayer can assign future income by making an assignment of property for value or a bona fide gift of the underlying property.

The doctrine does not apply if a right to income is sold or exchanged for value. If a gift of income-producing property is made, income earned after the date of the gift is taxed to the donee of the gift. If a taxpayer assigns a claim to income that is contingent or uncertain, the assignee of the right is taxable on income that the assignee collects on the claim. If a taxpayer transfers appreciated property prior to a sale or exchange, the appreciation is income to the person owning the property at the time of the sale or exchange.

The mortgage interest deduction is widely used by the majority of individuals who itemize their deductions. In fact, the size of the average mortgage interest deduction alone persuades many taxpayers to itemize their deductions. It is not without cause, therefore, that two recent developments impacting the mortgage interest deserve being highlighted. These developments involve new reporting requirements designed to catch false or inflated deductions; and a case that effectively doubles the size of the mortgage interest deduction available to joint homeowners. But first, some basics.

The mortgage interest deduction is widely used by the majority of individuals who itemize their deductions. In fact, the size of the average mortgage interest deduction alone persuades many taxpayers to itemize their deductions. It is not without cause, therefore, that two recent developments impacting the mortgage interest deserve being highlighted. These developments involve new reporting requirements designed to catch false or inflated deductions; and a case that effectively doubles the size of the mortgage interest deduction available to joint homeowners. But first, some basics.

Mortgage Interest Deduction Ground Rules

Mortgage interest — or "qualified residence interest" — is deductible by individual homeowners. Qualified residence interest generally includes interest paid or accrued during the tax year on debt secured by either the taxpayer's principal residence or a second dwelling unit of the taxpayer to the extent it is considered to be used as a residence (a "qualified residence").

Qualified residence interest comprises amounts paid or incurred on acquisition indebtedness and home equity indebtedness. Acquisition indebtedness is debt that is both:

1. secured by a qualified residence, and
2. incurred in acquiring, constructing or substantially improving the residence.

Home equity indebtedness is any debt secured by a qualified residence that is not acquisition indebtedness to the extent of the difference between the amount of outstanding acquisition indebtedness and the fair market value of the qualified residence.

A qualified residence for purposes of the home mortgage interest deduction can be the principal residence of the taxpayer, and one other residence selected by the taxpayer. In other words, the deduction is limited to interest payments on two homes.

Qualified residence interest is subject to several dollar limitations:

• The total acquisition indebtedness (principal) on which qualified residence interest is deductible is limited to $1 million ($500,000 in the case of married individuals filing separately).
• The total amount of home equity indebtedness (principal) taken into account in calculating deductible qualified residence interest may not exceed $100,000 ($50,000 in the case of married individuals filing separately).

Information reporting. Mortgage service providers have been required to report only the following information to the IRS annually with respect to individual borrower:

• the name and address of the borrower;
• the amount of interest received for the calendar year of the report; and
• the amount of points received for the calendar year and whether the points were paid directly by the borrower.

The amount of interest received by a mortgage service provider is reported on Form 1098, Mortgage Interest Statement, to the IRS. Form 1098 must also be furnished by the mortgage service provider to the payor on or before January 31 of the year following the calendar year in which the mortgage interest is received.

More Detailed Form 1098 Coming

The 2015 Surface Transportation Act (aka the Highway bill), which was signed into law on July 31, 2015, will require that Form 1098, Mortgage Interest Statement, filed with the IRS and provided to homeowners, include information on:

1. the amount of outstanding principal of the mortgage as of the beginning of the calendar year,
2. the address of the property securing the mortgage, and
3. the loan origination date.

These items are in addition to the information that parties were already required to provide to the IRS and payors under existing law.

The Government Accountability Office (GAO) had expressed concern that the information reported on Form 1098 is insufficient to allow the IRS to enforce compliance with the deductibility requirements for qualified residence interest. This criticism has included in particular, but not limited to, the dollar limitations imposed on acquisition indebtedness and home equity indebtedness.

While the modifications are intended to boost compliance with the deductibility requirements for qualified residence interest, they also impose a new burden on mortgage service providers. To give mortgage service providers time to reprogram their systems, the additional reporting requirements apply to returns and statements required to be furnished after December 31, 2016.

Joint Ownership

Another major development impacting on some homeowners’ mortgage interest deduction also took place this summer. Reversing the Tax Court, a panel of the Court of Appeals for the Ninth Circuit has found that when multiple unmarried taxpayers co-own a qualifying residence, the debt limit provisions apply per taxpayer and not per residence (Voss, CA-9, August 7, 2015). The question was one of first impression in the Ninth Circuit, the court observed.

Background. The taxpayers, registered domestic partners, obtained a mortgage to purchase a house (the Rancho Mirage property). In 2002, the taxpayer refinanced and obtained a new mortgage. That same year, the taxpayers purchased another house (the Beverly Hills property) with a mortgage, which they subsequently refinanced and obtained a home equity line of credit totaling $300,000. The total average balance of the two mortgages and the line of credit during the tax years at issue was approximately $2.7 million.

Both taxpayers filed separate income tax returns. Each individual claimed home mortgage interest deductions for interest paid on the two mortgages and the home equity line of credit. The IRS calculated each taxpayer’s mortgage interest deduction by applying a limitation ratio to the total amount of mortgage interest that each petitioner paid in each taxable year. The limitation ratio was the same for both: $1.1 million ($1 million of home acquisition debt plus $100,000 of home equity debt) over the entire average balance, for each tax year, on the Beverly Hills mortgage, the Beverly Hills home equity line of credit, and the Rancho Mirage mortgage. The taxpayers challenged the IRS’s calculations but the Tax Court ruled in favor of the agency.

Court’s analysis. Code Sec. 163(h)(3), the court found, provides that interest on a qualified residence, by a special carve-out, is not considered "personal interest," which would otherwise be nondeductible by taxpayers who are not corporations. A qualified residence is the taxpayer’s principal residence and one other residence of the taxpayer which is selected by the taxpayer for the tax year and which is used by the taxpayer as a residence.

The court further found the Tax Code limits the aggregate amount treated as acquisition indebtedness for any period to $1 million and the aggregate amount treated as home equity indebtedness for any period to $100,000. In the case of a married individual filing a separate return, the debt limits are reduced to $500,000 and $50,000.

Looking at the language of the Tax code, the court found that the debt limit provisions apply per taxpayer and not per residence. There was no reason not to extend this treatment to unmarried co-owners, the court concluded. Thus, each of the homeowners were entitled to the $1 million limit.

Whether this holding will hold up in jurisdictions other than the Ninth Circuit (California and other western states, including Hawaii), and whether it will apply to joint ownership situations for vacation homes, for example, remains to be tested.

If you have any questions regarding how best to maximize your mortgage interest deduction, please do not hesitate to contact this office.

Many federal income taxes are paid from amounts that are withheld from payments to the taxpayer. For instance, amounts roughly equal to an employee's estimated tax liability are generally withheld from the employee's wages and paid over to the government by the employer. In contrast, estimated taxes are taxes that are paid throughout the year on income that is not subject to withholding. Individuals must make estimated tax payments if they are self-employed or their income derives from interest, dividends, investment gains, rents, alimony, or other funds that are not subject to withholding.

Many federal income taxes are paid from amounts that are withheld from payments to the taxpayer. For instance, amounts roughly equal to an employee's estimated tax liability are generally withheld from the employee's wages and paid over to the government by the employer. In contrast, estimated taxes are taxes that are paid throughout the year on income that is not subject to withholding. Individuals must make estimated tax payments if they are self-employed or their income derives from interest, dividends, investment gains, rents, alimony, or other funds that are not subject to withholding.

Estimated income tax payments are required from taxpayers who:

1. expect to owe at least $1,000 in tax for the year, after subtracting taxes that were paid through withholding and tax credits; and
2. expect that the amount of taxes to be paid during the year through other means will be less than the smaller of—

• 90% of the tax shown on the current year's tax return, or
• 100% of the tax shown on the previous year's return (the previous year's return must cover all 12 months). This 100-percent test increases to 110 percent if the taxpayer's AGI for the previous year exceeds $150,000.

U.S. citizens who have no tax liability for the current year are not required to make estimated tax payments.

Form 1040-ES. Taxpayers use Form 1040-ES to calculate, report and pay their estimated tax. The annual liability may be paid in quarterly installments that are due based upon the taxpayer's tax year. However, no payments are required until the taxpayer has income upon which tax will be owed. Taxpayers may also credit their overpayments from one year against the next year's estimated tax liability, rather than having them refunded.

Generally, the required installment is 25 percent of the required annual payment. However, a taxpayer who receives taxable income unevenly throughout the year can elect to pay either the required installment or an annualized income installment. The use of the annualized income installment method, provided on a worksheet contained in the instructions to Form 2210, Underpayment of Estimated Tax by Individuals and Fiduciaries, may reduce or eliminate any penalty for underpaid taxes.

Due Dates. For most individual taxpayers, the quarterly due dates for estimated tax payments are:

Penalties. A penalty generally applies when a taxpayer fails to make estimated tax payments, pays less than the required installment amount, or makes late payments. However, the IRS may waive the penalty if the underpayment was due to casualty, disaster or other unusual circumstances.

A business operated by two or more owners can elect to be taxed as a partnership by filing Form 8832, the Entity Classification Election form. A business is eligible to elect partnership status if it has two or more members and:

A business operated by two or more owners can elect to be taxed as a partnership by filing Form 8832, the Entity Classification Election form. A business is eligible to elect partnership status if it has two or more members and:

• is not registered as anything under state law,
• is a partnership, limited partnership, or limited liability partnership, or
• is a limited liability company.

Publicly traded businesses cannot elect to be treated as partnerships. They are automatically taxed as corporations.

Form 8832 allows a business to select its classification for tax purposes by checking the box on the form: partnership, corporation, or disregarded. If no check-the-box form is filed, the IRS will assume that the entity should be taxed as a partnership or disregarded as a separate entity. An LLC that makes no federal election will be taxed as a partnership if it has more than one member and disregarded if it has only one member. An LLC must make an affirmative election to be taxed as a corporation. The IRS language on Form 8832 uses the term "association" to describe an LLC taxed as a corporation.

Form 8832 has no particular due date. There is a space on the form (line 4) for the entity to note what date the election should take effect. The date named can be no earlier than 75 days before the form is filed, and no later than 12 months after the form is filed. It is most important to file Form 8832 within the first few months of operations if the entity desires a tax treatment that differs from the tax status the IRS will apply by default if no election is made.

A few businesses do not qualify to be partnerships for federal tax purposes. These are:

1. a business that is a corporation under state law,
2. a joint stock company (a corporation without limited liability),
3. an insurance company,
4. most banks,
5. an organization owned by a state or local government,
6. a tax-exempt organization
7. a real estate investment trust, or
8. a trust.

Although these businesses cannot be partnerships, they can be partners in a partnership (they can join together to form a partnership).

Of course, whether your business is best operated as a partnership, as a corporation or as another type of entity should not only be driven by short-term tax considerations. How you envision your business will develop over time, whether your business is asset or service intensive, and what personal financial stake you plan to take, among other factors, are all additional factors that should be considered.

The IRS expects to receive more than 150 million individual income tax returns this year and issue billions of dollars in refunds. That huge pool of refunds drives scam artists and criminals to steal taxpayer identities and claim fraudulent refunds. The IRS has many protections in place to discover false returns and refund claims, but taxpayers still need to be proactive.

The IRS expects to receive more than 150 million individual income tax returns this year and issue billions of dollars in refunds. That huge pool of refunds drives scam artists and criminals to steal taxpayer identities and claim fraudulent refunds. The IRS has many protections in place to discover false returns and refund claims, but taxpayers still need to be proactive.

Tax-related identity theft

Tax-related identity theft most often occurs when a criminal uses a stolen Social Security number to file a tax return claiming a fraudulent refund. Often, criminals will claim bogus tax credits or deductions to generate large refunds. Fraud is particularly prevalent for the earned income tax credit, residential energy credits and others. In many cases, the victims of tax-related identity theft only discover the crime when they file their genuine return with the IRS. By this time, all the taxpayer can do is to take steps to prevent a recurrence.

Being proactive

However, there are steps taxpayers can take to reduce the likelihood of being a victim of tax-related identity theft. Personal information must be kept confidential. This includes not only an individual's Social Security number (SSN) but other identification materials, such as bank and other financial account numbers, credit and debit card numbers, and medical and insurance information. Paper documents, including old tax returns if they were filed on paper returns, should be kept in a secure location. Documents that are no longer needed should be shredded.

Online information is especially vulnerable and should be protected by using firewalls, anti-spam/virus software, updating security patches and changing passwords frequently. Identity thieves are very skilled at leveraging whatever information they can find online to create a false tax return.

Impersonators

Criminals do not only steal a taxpayer's identity from documents. Telephone tax scams soared during the 2015 filing season. Indeed, a government watchdog reported that this year was a record high for telephone tax scams. These criminals impersonate IRS officials and threaten legal action unless a taxpayer immediately pays a purported tax debt. These criminals sound convincing when they call and use fake names and bogus IRS identification badge numbers. One sure sign of a telephone tax scam is a demand for payment by prepaid debit card. The IRS never demands payment using a prepaid debit card, nor does the IRS ask for credit or debit card numbers over the phone.

The IRS, the Treasury Inspector General for Tax Administration (TIGTA) and the Federal Tax Commission (FTC) are investigating telephone tax fraud. Individuals who have received these types of calls should alert the IRS, TIGTA or the FTC, even if they have not been victimized.

Tax-related identity theft is a time consuming process for victims so the best defense is a good offense. Please contact our office if you have any questions about tax-related identity theft.

An employer must withhold income taxes from compensation paid to common-law employees (but not from compensation paid to independent contractors). The amount withheld from an employee's wages is determined in part by the number of withholding exemptions and allowances the employee claims. Note that although the Tax Code and regulations distinguish between withholding exemptions and withholding allowances, the terms are interchangeable. The amount of reduction attributable to one withholding allowance is the same as that attributable to one withholding exemption. Form W-4 and most informal IRS publications refer to both as withholding allowances, probably to avoid confusion with the complete exemption from withholding for employees with no tax liability.

An employer must withhold income taxes from compensation paid to common-law employees (but not from compensation paid to independent contractors). The amount withheld from an employee's wages is determined in part by the number of withholding exemptions and allowances the employee claims. Note that although the Tax Code and regulations distinguish between "withholding exemptions" and "withholding allowances," the terms are interchangeable. The amount of reduction attributable to one withholding allowance is the same as that attributable to one withholding exemption. Form W-4 and most informal IRS publications refer to both as withholding allowances, probably to avoid confusion with the complete exemption from withholding for employees with no tax liability.

An employee may change the number of withholding exemptions and/or allowances she claims on Form W-4, Employee's Withholding Allowance Certificate. It is generally advisable for an employee to change his or her withholding so that it matches his or her projected federal tax liability as closely as possible. If an employer overwithholds through Form W-4 instructions, then the employee has essentially provided the IRS with an interest-free loan. If, on the other hand, the employer underwithholds, the employee could be liable for a large income tax bill at the end of the year, as well as interest and potential penalties.

How allowances affect withholding

For each exemption or allowance claimed, an amount equal to one personal exemption, prorated to the payroll period, is subtracted from the total amount of wages paid. This reduced amount, rather than the total wage amount, is subject to withholding. In other words, the personal exemption amount is $4,000 for 2015, meaning the prorated exemption amount for an employee receiving a biweekly paycheck is $153.85 ($4,000 divided by 26 paychecks per year) for 2015.

In addition, if an employee's expected income when offset by deductions and credits is low enough so that the employee will not have any income tax liability for the year, the employee may be able to claim a complete exemption from withholding.

Changing the amount withheld

Taxpayers may change the number of withholding allowances they claim based on their estimated and anticipated deductions, credits, and losses for the year.  For example, an employee who anticipates claiming a large number of itemized deductions and tax credits may wish to claim additional withholding allowances if the current number of withholding exemptions he is currently claiming for the year is too low and would result in overwithholding.

Withholding allowances are claimed on Form W-4, Employee's Withholding Allowance Certificate, with the withholding exemptions. An employer should have a Form W-4 on file for each employee. New employees generally must complete Form W-4 for their employer. Existing employees may update that Form W-4 at any time during the year, and should be encouraged to do so as early as possible in 2015 if they either owed significant taxes or received a large refund when filing their 2014 tax return.

The IRS provides an IRS Withholding Calculator at www.irs.gov/individuals that can help individuals to determine how many withholding allowances to claim on their Forms-W-4. In the alternative, employees can use the worksheets and tables that accompany the Form W-4 to compute the appropriate number of allowances.

Employers should note that a Form W-4 remains in effect until an employee provides a new one. If an employee does update her Form W-4, the employer should not adjust withholding for pay periods before the effective date of the new form. If an employee provides the employer with a Form W-4 that replaces an existing Form W-4, the employer should begin to withhold in accordance with the new Form W-4 no later than the start of the first payroll period ending on or after the 30th day from the date on which the employer received the replacement Form W-4.