- 1 When Does the IRS Issue a Lock-in Letter?
- 2 Facts & Procedural History
- 3 The IRS’s Withholding Compliance Program and the IRS Incorrect W4 Letter
- 4 What Triggers an IRS Lock-in Letter?
- 5 How Long Does a Federal Lock-in Letter Last?
- 6 How Do I Get Out of the Withholding Compliance Program?
- 7 Responding to the IRS’s Letters – Where to Send W4 Form
- 8 Experienced Tax Attorney – Help With Filing Status Letters
When Does the IRS Issue a Lock-in Letter?
Many taxpayers get behind in paying the IRS as a result of IRS audits. Others have tax balances as they are self-employed or contractors and they simply do not make estimated payments. There are others who owe tax as they instruct their employers to withhold too little income tax from their paychecks. The Internal Revenue Service does not like a withholding rate that results in no taxes being withheld.
The IRS has methods for identifying and dealing with each of these no-tax withholding rate situations. The last situation with under-withholding by employees can be the most challenging to deal with. The IRS does have the ability to force the taxpayer’s employer to make additional withholding. Once the IRS does this, it can be difficult to get the IRS to modify or withdraw the order for increased tax withholding. This is a very common type of payroll tax dispute.
The recent Cooper v. United States, No. 2021-1627 (Fed. Cir. 2021) case provides an opportunity to consider these rules. In the Cooper case, a taxpayer was forced to file a lawsuit in order to persuade the IRS to modify or release its increased tax withholding.
Facts & Procedural History
The taxpayer owed the IRS back taxes. The IRS issued a “lock-in” letter to his employer. The letter instructed the employer to withhold Federal income tax based on no exemptions and single marital filing status. As a result, more income tax was withheld from his paychecks. This is as low a withholding rate as there ever could be.
The IRS informed the taxpayer that he could contact the agency to have the withholding reviewed. Rather than asking the IRS to reconsider its decision, the taxpayer filed a lawsuit in the Court of Federal Claims. The taxpayer requested a ruling that the withholding violated several Federal laws, including the Fair Debt Collection Practices Act.
The trial court determined that the IRS had the authority to compel the taxpayer’s employer to increase income tax withholding. The appeals court upheld the lower court’s decision.
The reason we recite the facts here is not to critique the court’s reasoning or the outcome. The facts are presented here to provide context for understanding how to deal with lock-in letters and how they relate to the taxpayer’s filing status.
The IRS’s Withholding Compliance Program and the IRS Incorrect W4 Letter
The IRS’s Withholding Compliance Program is part of the IRS’s Small Business/Self-Employed (“SB/SE”) Division. It is one of several programs in the IRS’s SB/SE Division’s collection group.
The IRS’s Withholding Compliance Program is responsible for sending out withholding compliance notices and interacting with taxpayers and employers.
The IRS’s Withholding Compliance Program begins with the issuance of Letters 2801C or 2802C. These letters are based on the employee’s Social Security Number and are often referred to as “filing status letters.”
The 2801C letter and 2802C letter request that the taxpayer correct their Federal income tax withholding. If the taxpayer does not respond or instruct his employer to adjust his withholding, the IRS will send the employer a lock-in letter. Letter 2808C is the lock-in letter. The lock-in letter requires the employer to withhold additional income tax from the taxpayer’s wages. (Note: this differs from the IRS notices sent to employers for failing to withhold from contractors–there is also a withholding tax for contractors).
The IRS may also issue a Letter 4243C to request additional information. This information is typically used to determine whether the lock-in letter should be modified. As explained below, the IRS may make a modification to the lock.
The employer will also receive a letter. It is the Letter 2800C. The 2800C letter notifies the employer to start making backup withholding.
This is why we usually see the IRS withholding compliance program when the employer did not have the employee fill out a Form W-4.
What Triggers an IRS Lock-in Letter?
The IRS does not disclose its methods for what triggers a lock-in letter. And the IRS’s methods change over time.
The fact pattern above is common. What you can glean from this is that having withholdings set to zero is one of the triggers. That plus earning higher than average wages, having a tax due for one or more years, and having higher deductions that is inconsistent with their tax filing status for consecutive years are all triggers. This makes sense since the IRS’s goal is to increase the withholding rate. This is especially true if no taxes are withheld from checks issued in the most recent pay period.
This is consistent with our experience. Most clients who ask us about lock-in letters have had taxes due for more than one year, but still have their withholdings set at zero. These are no doubt what triggers the IRS’s computer system to issue lock-in letters.
How Long Does a Federal Lock-in Letter Last?
Once issued, the IRS lock-in letter lasts indefinitely. It does not expire after a certain number of days from the date of the letter.
This means that the employer must comply with the letter for any future wage payments made to the taxpayer. This is true even if the taxpayer changes their deductions or filing status.
Naturally, the lock-in letter has little effect if the employer does not make future payments to the employee. Employers sometimes do terminate employees when these letters are received.
How Do I Get Out of the Withholding Compliance Program?
Once the lock-in letter is issued, the IRS will usually only modify the Federal income tax withholding when the taxpayer has complied with the withholding for a period of three years.
This is the textbook answer to how to deal with the IRS’s lock-in letter.
For many taxpayers, the employer takes action first. Just the receipt of a copy of the letter may prompt the employer to terminate the taxpayer’s job.
In other cases, the taxpayer may be forced to change jobs or start a business and work as a self-employed business owner or contractor. This is especially true in difficult situations where the taxpayer cannot afford to have additional taxes withheld. For lower-income taxpayers who live paycheck to paycheck, this can be a legitimate issue.
Responding to the IRS’s Letters – Where to Send W4 Form
The IRS’s initial letters provide the taxpayer with 30 days to contact the IRS or to ask for a redetermination.
The redetermination request is simply a letter and is usually accompanied by a new Form W-4 and support for the change. There is no format for providing this information. The taxpayer should just follow the instructions provided in the IRS’s letter. This information can be faxed to the IRS. The IRS is even able to take notes on the phone and count the notes as support for modifying the lock-in letter. You can find the IRS’s number on the IRS website.
The IRS will often agree to these changes if the circumstances warrant it. This is particularly true if the taxpayer’s circumstances have changed. The IRS will review the taxpayer’s circumstances at the time the taxpayer contacts the IRS. A change in circumstances can warrant a change in the lock-in letter.
There are other circumstances where the IRS has been willing to change lock-in letters. Natural disasters are an example. Here in Houston, Texas, the IRS modified lock-in letters following the Hurricane Harvey storms. This provided much-needed funds for Houstonians who suffered economic losses due to the storms.
Other more common circumstances include a change to overall income, an increase in itemized deductions, and even marital and family relationship or status changes. The IRS may even remove a lock-in letter if the taxpayer files bankruptcy or has an offer-in-compromise accepted.
Experienced Tax Attorney – Help With Filing Status Letters
If you received a lock-in letter from the IRS, you should provide a copy of the letter to an experienced tax attorney.
An experienced tax attorney may be able to review the copy of the letter and help you get the IRS to modify or remove the lock-in letter.