U.S. employers use Internal Revenue Service Form W-4 to calculate how much federal income tax employers should take out of employees' pay, if any. At their election, taxpayers can an claim exemption from withholding by simply writing "Exempt" on line 7 of the W-4 form, allowing them to pay no federal tax on their income. Only those who meet the exempt status requirements should exercise this option, however.
The IRS states that individuals should only claim an exemption if they meet both of the following conditions: The claimant had zero federal tax liability for his income the previous tax year and he anticipates the same situation this year.
As of 2010, even a taxpayer who meets the IRS conditions for an exemption cannot claim the exempt status if her overall income exceeds $950, more than $300 of which came from sources classified as "unearned income" and someone else can claim her as a dependent on his tax return. Examples of unearned income include pensions, interest and dividends, Social Security and unemployment benefits, alimony and child support.
Exemption v. Personal Allowances
Exempt status disqualifies employees from claiming on their Form W-4 any tax credits, deductions or other allowances to which they might otherwise be entitled to that year, the IRS says.
Duration and Renewal
Exempt status remains in force for a year and expires February 15. An employee wishing to extend the exemption into the next year has to submit a new W-4 form before February 15 of that year.
The IRS can fine a taxpayer who claims an exemption without having a reason to think he qualifies for it. Attempting to do so knowingly can also lead to criminal liability.