All employees, including household employees, use the Form W-4 to direct the employer on how to calculate Federal income tax deductions from their paycheck. The responsibility for the accuracy of this form rests with the nanny or other employee.
Let's first start out by saying that Household Employers are the ONLY U.S. employers who are not legally obligated to deduct or withhold Federal income taxes from an employee's pay. This special rule was written into law for two reasons. First, it makes the compliance with payroll taxes easier for the employer. Secondly, many household employees work multiple jobs - a house cleaner may work alternate weeks for you, two times a week for another family, weekly for a third family, and on and on - and the Form W-4 is of little or no practical utility in determining the taxes she owes from multiple employers over the course of a year. Ultimately, the household employer is legally obligated for payroll taxes (Social Security, Medicare, Unemployment) and the household employee is responsible for her income taxes.
So you hired a nanny and you volunteer to withhold her income taxes (HWS clients find this easy to do, as HWS does all the calculations for you!). When she turns in her W-4 form, she has claimed exempt and you worry this isn't correct.
In a nutshell, EXEMPT status applies when the worker had no income tax obligation in the prior year, and does not anticipate having an income tax obligation in the current year. This often applies to low wage workers who benefit from generous tax credits. Remember, at the end of the day the employee is the one responsible for the accuracy of the W-4 form*. You simply keep it on file, and follow the instructions.
*Years ago an employer was required to notify the IRS when an employee claimed 10 or more allowances on a W-4 form - this requirement no longer exists.