Key Takeaways

  • Filing exempt means no federal income tax is withheld from your paycheck. Your eligibility depends on having no tax liability in the previous year and not expecting any for the current year.

  • To remain exempt, you must claim your exemption status on Form W-4 from the IRS and submit it each year by February 15th. 

  • State-specific tax exemptions may vary; some states have no income tax, while others require separate forms to claim exemptions.

  • Filing exempt when you do not qualify can result in fines, additional taxes, and big tax bills when you file your return.

  • Students and seasonal workers must check if their income and circumstances are eligible for exemption.

  • A dependent or non-wage income might impact your exemption filing status and tax liability.

  • Post a job on UpCounsel to find a tax attorney to help determine if you qualify for exemption. 

If you are filing exempt for tax purposes, you will need to indicate this on the Internal Revenue Service (IRS) Form W-4, which will estimate the amount that should be withheld from your paycheck depending on certain tax information that you provide. 

However, even if you only made $10 the prior year, you cannot claim an exemption on your federal tax withholding. 

With that being said, someone who makes very little can still claim what is called “allowances” on their W-4, thereby reducing the amount withheld for tax purposes.  

Such allowances are based on your specific status, the number of dependents, and other itemized deductions, such as property taxes and medical expenses.

What Does It Mean to File Exempt on Federal Taxes?

Generally, the IRS will issue a tax refund when you pay more than what is owed in that tax year.  

When you file an exemption with your employer, however, this means you will not make any tax payments whatsoever throughout the tax year. Therefore, you will not qualify for a tax refund unless you are issued a refundable tax credit.  

If you file as exempt, no federal income tax is withheld from your paycheck. To file as exempt, you must have owed no federal income tax in the previous year and expect to owe no federal income tax in the current year. 

During tax season, your employer will provide you with Form W-2, which identifies the total amount of taxes withheld throughout the year.  

If your tax liability is less than the amount withheld, the IRS will issue you a tax refund for the difference. 

However, if you incorrectly file as exempt, you could owe back taxes and fines during tax season. Remember, even if you are exempt from federal withholding, you will still have Social Security and Medicare taxes (FICA taxes) taken from your paycheck.

How to Determine If You Are Eligible for Exemption

The following two criteria must be met for you to claim an exemption on your W-4: 

#1

The prior year, you received a refund of ALL federal income tax withheld or had no federal income tax liability. This means you didn’t owe anything or didn’t have to file a tax return because your income level was low enough that you were not required to file.

#2

For the current year, you anticipate a refund of all federal income tax that was withheld because you assume you have no tax liability. 

This means that, based on your current income and tax situation, you do not expect to pay federal income tax.  

Carefully assess your financial situation, income sources, and any tax credits or deductions to determine if you qualify for an exemption.  

If you make the wrong decision, you may need to pay the tax you should have paid, plus penalties when you file your income tax return. 

Review your financial position regularly across the year, particularly if your income or other financial circumstances change and you move away from the minimum exemption threshold.

Examples of Eligible Situations

There are a wide variety of circumstances under which a person may qualify for an exemption from federal income tax withholding: 

  • Students: Earned income that does not exceed the minimum income for tax purposes may qualify for exempt status, provided eligibility requirements are met.

  • Low-Income Workers: If your yearly earned income remains low enough, you could qualify for an exemption. 

  • Part-Time Workers: If you work part-time or only have temporary jobs, your yearly earned income could be low enough to qualify for an exemption.

  • People Who Receive Earned Income Credits: If you qualify for refundable tax credits (the Earned Income Tax Credit, or EITC, is the most common one) that wipe out your tax liability, you might be able to file for exemption.

  • Retirees with Low Income: Retirees who live on Social Security or other nontaxable sources can have no federal tax liability and can file exempt.

Impact of Dependents, Income, and Other Factors

When people claim dependents on their taxes, it could affect whether they file exempt or not. 

That’s because dependents often result in tax credits and deductions that reduce the amount of your taxable income and, possibly, your tax liability to zero.  

You can have dependents, but simply claiming them doesn’t make you exempt – you have to look at how they affect the rest of your tax liability. You must look at your qualifying income and deductions and see how they affect you. 

Dependent Children or Other Dependents: You might be able to reduce your taxable income and increase your chances of no tax at all if you have dependents.  

However, dependents don’t eliminate your taxes alone: you must still meet both the income and the tax tests. 

Sources of Income: You’re getting income from capital gains, rental property, or a side business, and you expect it to increase your tax liability. 

Other Deductions and Credits: Some people qualify for specific deductions or credits.  

Examples include:  

  • Education-related deductions

  • Child tax credits

  • Retirement savings credits 

You might qualify for an exemption if these deductions and credits bring your tax liability to zero. 

Remember that if you file as exempt when you are not, you will owe a large tax bill when you file your return. So, make sure your income, credits, deductions, and other factors are correct before claiming tax exemption.

State-Specific Tax Exemptions: What You Need to Know

FEDERAL: Only federal exemptions apply to your federal income tax withholding. 

STATE: Only state exemptions apply to your state income tax.  

Note that claiming exemption from federal withholding does not necessarily exempt you from state tax.  

Each state has different rules and requirements. Some states permit exemptions similar to federal exemptions, while others have their own criteria and filing forms. 

Federal tax exemption is based primarily on your federal tax liability, determined by your income, deductions, and credits.  

State income taxes vary by state income tax laws, which may be non-existent, meaning your state has no income tax or by the different credits and deductions that may be available.

List of States with No State Income Tax

Here are the states where there is currently no state income tax: 

  • Alaska

  • Florida

  • Nevada

  • South Dakota

  • Texas

  • Washington

  • Wyoming

  • Tennessee (taxes only interest and dividend income, not wages)

  • New Hampshire (taxes only interest and dividend income, not wages) 

You’ll have to file for state-specific exemptions from income tax withholding in these states because no state income tax is withheld. However, you might be subject to other taxes, such as sales and property taxes.

How to File for State-Specific Exemptions

Exemptions can be filed in various ways for states with income taxes.  

Some states use a process similar to the federal W-4 process, while others have their own forms and requirements. 

Double-Check Your State’s Forms: All states have a state version of the W-4 form, but it might have different lines for entering exemptions or allowances.  

In some states, like California or New York, you must also submit a state form (in California’s case, it would be called a DE-4) to claim exemption from state income tax withholding. 

Qualification Requirements: To qualify for a state exemption, you generally have to meet the requirements as you would for the federal exemption – meaning you did not owe state tax in the prior year and do not expect to owe tax this year.  

In some cases, a state might require that you meet other criteria to qualify for the exemption – such as residency, the source of income, or whether you work in more than one state. 

Cross-State Workers: If you live in one state but work in another, you might have to file forms in both states, depending on reciprocal agreements between the states that affect tax withholding.  

For instance, you can file to be exempt from New Jersey state taxes if you live in Pennsylvania but work in New Jersey. 

Filing for a state exemption is a bit like filing for a federal exemption, except you need to pay attention to the nuances of your state’s particular exemption rules.  

Call your state’s Department of Revenue or tax authority to determine if you qualify and what forms you complete.

Understanding Refundable Tax Credits

Refundable tax credits are designed to benefit taxpayers by directly reducing the amount of taxes they owe. The taxpayer is refunded the excess if the credit exceeds the taxes owed.

Here are some common examples: 

How These Credits Affect Tax Liability and Refunds

Refundable tax credits reduce or eliminate your tax liability.  

One of the big benefits of refundable tax credits is they can generate a tax refund for a taxpayer with no federal tax liability. It is no surprise refundable credits are especially valuable to low-income workers.  

A refundable tax credit can provide a lifeline for many taxpayers, especially at the lower end of the income spectrum. Check to see if you qualify. 

How Long Can You Go Exempt Without Being Penalized?

You are entitled to claim exemption from federal income tax withholding for a calendar year on Form W-4 if you meet any of the following requirements: 

  • You owed no federal income tax in the prior tax year.

  • You expect to owe no federal income tax in the current year. 

If you satisfy these criteria, you can claim an exemption for that calendar year. However, you must file another Form W-4 by February 15th of the next year if you want to continue your exempt status.  

If you do not submit a new W-4, your employer will withhold it as if you were single or married and filing separately, without any other checkboxes. 

If you claim to be tax-exempt when you are not, you could be penalized when the IRS reviews your tax return.

Circumstances When You Can't Claim Exempt

  • Employees who claim dependents on the tax return can’t claim tax exemption.

  • If an employee plans to itemize deductions, they can’t claim exemption.

  • If you are 65 or older or blind, you must look at IRS Worksheet 1-3 or 1-4 to verify if you are exempt.

Conclusion: Final Thoughts on Filing Exempt and Tax Exempt Status

Determining your eligibility for tax exemptions is complex, and this process demands extensive research and a good understanding of tax laws. 

Post a job on UpCounsel to find a lawyer in your state specializing in tax-related issues to determine if you can file exempt.  

With their help, you can ensure compliance with federal and state laws and take advantage of any relevant exemptions. 

UpCounsel accepts only the top 5% of lawyers on its site.  

Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.

Frequently Asked Questions

I’m exempt, now what?

If you are, in fact, exempt, you will leave Box 5 on the W-4 Form blank. Box 7 will include the term “EXEMPT.”

What if I claim exempt but am not eligible?

If you incorrectly indicate that you are exempt on the W-4, you will likely face a high tax bill after filing your return and tax penalties for claiming exempt when you are otherwise not allowed to do so.  

However, if you receive a monetary penalty, try speaking to an IRS representative or even a tax attorney, indicating that you made an honest mistake and are seeking help.

I’m a student/seasonal part-time employee. Can I claim exempt?

Not necessarily. If you are a student, however, you are exempt from FICA taxes, also called payroll taxes (i.e., Social Security taxes and Medicare taxes), as long as you are enrolled as a part-time or full-time student.

What makes someone tax-exempt?

You have to satisfy two primary conditions: you did not owe any federal tax the prior year, and you anticipate no federal tax liability this year.