Early 2014 IRS Released New Revisions of the Four Most Important Tax Resolution Forms

Early 2014 IRS Released New Revisions of the Four Most Important Tax Resolution Forms 

IRS releases updates to the four fundamental IRS Forms regularly used in resolving delinquent taxpayers’ accounts. These are: Form 433-A (OIC), Form 433-B (OIC), Form 656 and Form 9465.

1. Form 433-A (OIC), Collection Information Statement for Wage Earners and Self-Employed Individuals, Rev. January 2014:

• For employed individuals it is now required to indicate if taxpayer(s) have an interest in their employers’ business. 
• The form now clearly allows the $1,000 adjustment to the individual bank accounts equity. However, there is no mention of reduction of bank account equity by allowable monthly living expenses.  
• On the form, it is now required to indicate the purchase date and date of final payment for real estate properties. 
• In the Vehicles section, disclosing the creditor's name, purchase date and date of final payment is required. 
• The form now clearly allows a $3,450 deduction from the vehicle value, and if a joint offer is filed, an additional $3,450 for a second vehicle. Vehicles don't have to be used for work, the production of income or the welfare of the taxpayer's family in order to qualify for the deduction. 
• Under the Personal Assets Information, it is now required to include interest in a company or business that is not publicly traded. 
• Self-Employed sections are to be completed not only for Schedule C filers, but for Schedule E and F filers as well. 

2. Form 433-B (OIC), Collection Information Statement for Businesses, Rev. January 2014:

• The Quick Sale Value of 80% is now clearly indicated for business investments, real estate assets and business vehicles. In prior revisions those calculated values were subject to guesswork. 
• The name of creditor and date of final payment are now required for real estate assets and business vehicles. 
• The IRS exemption amount for professional books and tools of trade increased from $4,290 to $4,470. 

3. Form 656, Offer in Compromise, Rev. January 2014

• The application fee for Offer in Compromise increased from $150 to $186, effective January 1, 2014. 
• The form added a question as to whether or not the taxpayer used the Pre-Qualifier tool located on OIC Pre-Qualifier prior to filling out the form. 
• Low Income Certification guidelines have increased slightly for all states and D.C. 
• Offer amount should now be rounded to whole dollars only; no cents please. 
• The loophole for Lump Sum Cash offers has been closed, as it is now clearly states that Lump Sum Cash offers must be paid within 5 or fewer months from the date of acceptance. In prior revisions the verbiage was in 5 or fewer payments, which allowed it to be paid over a period of 24 months. 
• Payment schedule for Lump Sum Cash offers no longer require specifying the ‘day of the month’ payments will be made; just the month suffices. 
• A Correction Agreement has been added to the Offer Terms section which indicates that the taxpayer authorizes the IRS to correct any typographical or clerical errors or make minor modifications to Form 656. 

4. Form 9465, Installment Agreement Request, Rev. December 2013:

• The Installment Agreement fee for non-direct-debit agreements and payroll deduction agreements increased from $105 to $120, effective January 1, 2014. 
• Form 9465 can now be filed by individuals who owe employment or unemployment taxes for businesses that are no longer operating. In such cases the name of business and EIN is required. 
• Foreign address fields have been added for those taxpayers who currently reside outside of the US. 
• The total amount owed is now to be divided by 72 months to see if the proposed installment amount is greater than or equal to this value. If it's less, Form 433-F is required for submission. If the amount is equal or greater, but the total amount owed is between $25,000 and $50,000, then direct debit from checking account or payroll deduction is required, unless submitted with Form 433-F. If the amount owed is over $50,000, then Form 433-F is always required. 
• Part II has been added to the newly revised form which is required to be completed by taxpayers who have either defaulted on an installment agreement within the past 12 months, or who owe (in total IRS debt) more than $25,000 but less than $50,000 and can pay the debt in full within 72 months. Part II questions mimic those on Form 9465-FS, which probably will drop out of circulation with the introduction of this newly revised Form 9465.

Reference: Lawrence M. Lawler, CPA, CTRS, EA - National Director - American Society of Tax Problem Solvers (ASTPS) thanks to PitBullTax Software

20 tax tips for small businesses

20 tax tips for small businesses
The Internal Revenue Service sent letters to thousands of small-business owners recently, questioning whether they underpaid their taxes last year. 

Titled “Notification of Possible Income Under Reporting,” the letters were mailed to small employers this summer requesting that they review and confirm that they accurately reported their income on their 2012 tax returns.

In response to this action by the IRS, American University professors Donald Williamson and David Kautter have created a list of “Tax Best Practices for Small Businesses,” a checklist designed to help small business entrepreneurs stay up to date on all tax-related issues, and away from the scrutiny of 
the IRS. 

Here’s what Williamson & Kautter recommend small-business owners should do: 

1. Keep good records about who is an “employee” and who is an “independent contractor.” 
2. Keep track of places where you may have "nexus" (“physical presence”) (even unknowingly), to properly comply with state rules governing sales and income tax collection. 
3. Invest in a good software accounting system — to track your records and regularly provide updates to new IRS rules. 
4. Hire a tax accountant who has experience in your type of business, whether it’s a coffee shop or a construction business. 
5. Keep good records on how much was paid and the date placed in service, for any equipment, vehicles or other business assets. 
6. Avoid using funds from employee payroll tax withholding (or any taxes, for that matter) as a short-term loan to tide your business over during a shortfall in your cash flow. 
7. One of the biggest traps for small-business taxpayers is estimated taxes — pay quarterlies on time, calculate quarterlies correctly, and know the safe harbors that can protect you against underpayments.  Miscalculating any of these steps can be a major headache, so small-business owners should speak with someone, most likely a tax accountant or enrolled agent, who knows the rules cold. 
8. If you are the owner, and your spouse, child, mother-in-law, or other close relative works in your business, you should make sure your relative abides by the same employment rules as your unrelated employees. When someone pays you in cash, it doesn’t mean that payment is nontaxable.
9. Select a “tax year” for your business that reflects the natural ebb and flow of your business’ receipts and disbursements. This way, you won’t get caught in a cash crunch when tax time comes. 
10. You (or your accountant) should retain all relevant tax records for at least three years, and if your records relate to property and depreciation, you should keep the records until the property is disposed of, plus an additional three years. 
11. Keep detailed records on how you use your personal or business-owned vehicle for business versus personal purposes. 
12. Hire a reputable third-party administrator (such as Fidelity or Vanguard) to manage your 401(k) plan and other tax-favored employee benefits. 
13. Make sure you (and your tax accountant) are familiar with the tax rules, including the favorable tax credits and deductions that are unique to your business. 
14. If it becomes necessary for your small business to open a foreign bank account in order to pay vendors or others in a foreign country, make sure you (and your tax accountant) are vigilant in following the new rules on foreign bank accounts enacted in the Foreign Account Tax Compliance Act, or FATCA. (FBAR reporting)
15. If your hope is that your business will continue after you die, under the leadership of another family member or designated heir, you should take steps to protect the business against a forced sale in order to pay inheritance taxes. 
16. Don’t become foolishly emboldened into thinking the IRS will have to “prove” you have done something contrary to the tax law. The "burden of proof" is always on the taxpayer, not the IRS. 
17. Become familiar with the tax rules surrounding starting, running, selling and shutting down a business. Determine whether you should operate as a Partnership, Corporation, S-Corp, LLC, or Sole Proprietorship. Your tax accountant should be closely familiar with these rules. 
18. Have a one-on-one conversation with your accountant about the Affordable Care Act. 
19. If you can’t pay the taxes you owe the IRS, or other tax agency, you should contact your accountant right away. The situation won’t get any better by ignoring it.
20. When someone pays you in cash, it doesn’t mean that the payment is nontaxable. The IRS has state-of-the-art statistical technology and models based on spending habits and bank accounts to build a case against alleged tax scofflaws.

Courtesy:  accounting today | October 2013 accountingtoday.com

Donald Williamson & David Kautter

Payroll Taxes - IRS Unveils Key Penalty Findings

Payroll Taxes - IRS Unveils Key Penalty Findings 

Courtesy: Robert W. Wood 

I keep noting how bad IRS payroll tax penalties can be.  See When Payroll Taxes Go Criminal.  Although any tax dispute is bad, payroll tax disputes are especially bad.  How does the IRS build a case against you?  An IRS internal  memorandum provides guidance to IRS employees how to document cases against employers.

If you’re in business you must withhold tax money from employee pay.  Then you must account for it and send it promptly to the IRS.  Failing to pay not only makes the business responsible—you are personally on the hook. When you withhold tax but fail to remit it the IRS will come after you. The IRS views it as trust fund money.

In a cash-strapped business, keeping the lights on or the warehouse stocked can seem more important.  You may think you can pay the IRS later.  But these problems have a way of snowballing, so keep payroll taxes current at all times.

Business owners and other “responsible persons” have personal liability. The IRS can assess a Trust Fund Recovery Assessment—also known as a 100% penalty—against every “responsible person.”  Under Section 6672, the penalty equals the entire amount of trust fund taxes. The IRS can seek to collect 100% from the business and 100% from each responsible person. The IRS often makes an assessment against every officer, watching them turn on each other.  One person may get stuck while others get off scot-free.

The new IRS memorandum says revenue officers should determine case-by-case how much documentation will support a penalty.  Key issues are the “responsibility” and “willfulness” factors. In determining “willfulness,” courts focus on whether you had knowledge of the non-payment of taxes or showed reckless disregard whether they were being paid.

But a person need not actually perform the withholding and payment functions to be considered “responsible.”  If you have signature authority (whether or not you exercised it) while other (non-IRS) payments are being made, that can be enough to result in liability. Most of the time, here’s what the IRS will collect to sink you:

1. “Form 4180” interviews: Form 4180 is the form that is used by the IRS to conduct interviews with each potentially responsible person;
2. Articles of incorporation;
3. Bank signature authority cards or electronic PINS/passwords; and
4. Copies of cancelled checks (or electronic payments or debits) demonstrating payment to other creditors (not the IRS).  If the IRS can’t get the records easily from the business, the IRS will issue a summons to the business, the bank or both.

Individual factors will influence the amount of documentation needed to support a penalty. IRS revenue officers are directed to exercise judgment whether they need more.  Often, though, these key elements will be enough to impose and support the penalty so be careful.

For more, see:

Supreme Court Deaf To Payroll Tax Woes

Don’t Cross The IRS On Payroll Taxes
Fail To Pay Payroll Tax: Go To Jail
Robert W. Wood practices law with Wood LLP, in San Francisco.  The author of more than 30 books, including Taxation of Damage Awards & Settlement Payments (4th Ed. 2009, Tax Institute), he can be reached at Wood@WoodLLP.com.  This discussion is not intended as legal advice, and cannot be relied upon for any purpose without the services of a qualified professional.

Steps When Leaving a Company

Steps When Leaving a Company
Financial Issues When Leaving a Company
There are often many financial choices to make when leaving a company, especially if you are contemplating a retirement or "early retirement" situation.  Frequently there are trade-offs that must be made, and you are only given a short time, a "window of opportunity" to make choices before they are made for you.

The choices for this type of termination incentive involve present and future benefits which require tax and financial planning decisions.  Thus, the purpose here is to give you a general look at the most commonly-offered choices you may be asked to make.

Continued Medical Benefits
While today's law requires your company to allow you to pay for continued medical insurance for a period of 18 months after separation (COBRA provision), a frequent "bribe" to induce you to leave the company involves allowing you to stay in the plan until you are eligible for Medicare (age 65 currently).  Another inducement provides that the company will pay all or a portion of your medical coverage until age 65, or until your death.

We all know how expensive medical coverage can be, especially as one grows older.  This benefit can end up being a very valuable option.  However, if you have a spouse who is also covered under a family plan, you may not need this option, so you can trade it off for another one instead.

Pension/Profit Sharing Payouts
This is a very important issue.  If you are "Vested," that is you have rights to accumulated pension/profit sharing/savings plan monies, you may be given a choice on how to get the funds.

In addition, the company may offer to "accelerate" your pension calculation to give you more money than that to which you ordinarily would be entitled.  As an example, if you normally would be given full benefits at age 65, but are being "retired" at age 55, the company may alter the age/service requirements to allow you full retirement benefits.  This is an attractive inducement. 

A growing trend in companies is to allow a "lump sum" payout instead of annuitizing the payout over a projected life span.  This may be an important negotiating point for you.  The tax treatments will vary according to how it is handled.  If it is annuitized over your life, or over the joint life of you and your spouse (which is the most common method), you will receive a periodic check.  The taxable portion is the annuitized amount of company contributions, and "pre-tax" contributions you have made plus all accumulated earnings within the plan.  You pay tax in the year you receive the payments, so if you will be receiving monthly checks, you will pay tax each year.

For a lump sum payout, you get just that–one lump sum and you pay tax in the year it is received.  However, you have several options here to reduce or defer the taxes.  If it is a qualified singular payout from a qualified plan, and if you meet certain criteria, you may be eligible for special lump sum averaging in which the tax is calculated using a special averaging method.  The tax savings here compared to paying regular tax on the lump sum can be enormous.

You may be eligible to "roll over" this lump sum into a special IRA and pay no tax until you start withdrawing it from the IRA.  At that point, you would pay tax based on your ordinary income tax rates at the time of withdrawal.

Which way should you go?  Take a monthly annuitized check?  Take a lump sum and pay regular tax?  Take a lump sum and do special averaging?  Take a lump sum and roll it into an IRA?  Each of these issues requires some serious calculations of both your present tax bracket, your expected future tax bracket, your present needs for the cash, and possible estate tax considerations as well.  There is no easy one-shot answer.  It may require careful analysis and some "what if" scenarios.

Statistics show that approximately half of the people elect lump sum.  If you were planning to start your own business, for instance, you may elect to take a lump sum because you may need the cash for the business.  Also, if you think you could invest the money at better yields than you would be getting with an annuitization calculation or monthly pension check, a lump sum is attractive.

These decisions may be the most important of all the early retirement choices.  They also may be the most complicated because they involve making detailed projections about such items as future tax brackets and tax laws, future cash needs, and rates of returns on investments.  If the amount of money in question is considerable, you may need a coordinated effort among your tax adviser, a lawyer, a financial planner, a broker, and an estate planner.  In this area, proper planning can make a tremendous overall difference in your after-tax analysis.

Life & Disability Insurance
If you are being covered by company-paid life and disability insurance, this is a good negotiating area, especially if you are over 45 or not in excellent health.  If you have to re-apply for coverages on your own, it could be much more expensive, or even impossible to get.  Although most company plans in this area will not allow for continuance after separation, you may wish to negotiate for the extra dollars it will cost you to implement similar plans on your own.

Extra Severance or Cash Incentives
This is a common company offer to get you to leave on a date most suitable to them.  Extra lump sum pay is given based on the years you have been with the company.  A popular variation is an extra week's pay for every year of service.  This is a totally taxable payout, so you may want to try to time the payout most favorably according to your tax bracket (Regular and Social Security) for the current year vs the following year.  How the tax will be withheld is also important.  Is it being taxed at your regular rate, or is it being "flat" taxed?  It's important to get good tax advice here!

Social Security Supplemental Pay
For people who will be near retirement age, but not eligible for maximum Social Security benefits yet, a possible offer is to "make you whole." The calculation is the difference between what you will get from Social Security now, and what you would get at maximum retirement age.  You get this in a monthly check from the company.  Unlike Social Security, however, this company check will be fully taxable, so a good negotiating ploy here is to ask for an extra check to cover the added-tax you will be paying.  This is called negotiating for a "Gross-up" allowance.

Release of any Non-Compete Clauses
For workers who have signed a company non-compete clause(can apply to managers, technical workers, software applications, designers, etc.), a good "fringe" is to have this eliminated so you can find another job in your field immediately and/or in your same general work area.  Since non-compete clauses are not very common in most fields, many termination incentive packages do not account for this automatically.  You should bring this up if you fall under such a clause.

Use of Company Facilities after Separation
This can be a very valuable, "tax-free" fringe to have.  You would get the use of their facilities and/or so-called outplacement services in order to help you find another job.  You are provided with an office, support help (typing, copying, etc.), free use of company phones, postage, and mailing services.  In looking for a job, these items can add up to thousands of dollars, so don't ignore this possible option.

Becoming a Temporary "Subcontractor"
Sometimes a company will release you as an employee, but retain you for a temporary basis as an Independent Contractor.  This gets you off their pension and benefits roles, and passes the full tax burden onto you.

While this may be an excellent way for you to get more money from the company, and possibly new and extra tax write-offs (since you may qualify as a self-employed taxpayer), there is a big caveat here.  If you are contemplating a lump sum payout of your pension/profit sharing monies, and if you are eligible for special "lump sum" averaging, the continuance as an Independent may jeopardize your rights to this tax saving method under certain IRS rules.

In effect, in their eyes you haven't truly left the job, so you become ineligible for the special averaging.  You must be very careful in this regard.  You may need good tax advice, and maybe some good legal advice as well.

Timing Considerations
Basically, this involves timing the receipt of various taxable incentives according to the most favorable tax bracket.  If you expect to be in a much lower tax bracket the year following your separation, you might want to try to defer some of the taxable package into the next year.  This could be a sizable savings in taxes.

For instance, if you are planning to go into your own business, and don't expect to have much taxable income for the following year, you would try to defer some of the company payouts into that year to reduce your tax liabilities.

As was mentioned earlier, if you are eligible for extra sub-contractor work from your company, the timing of when you will do this, and when you will get paid can have significant tax savings, especially as it applies to Social Security and Medicare taxes.

Collecting unemployment has timing considerations also since each state has its own interpretation of "severance" pay as it relates to when you can collect your unemployment.  A similar issue develops for those who will be applying for Social Security, since the amount of outside earnings you can make directly affect how much Social Security you can collect until you reach age 70.

Conclusion
As you can see, there may be numerous choices and decisions to be made when you leave a company. With all the downsizing that is going on throughout the country, the probabilities of needing to consider these issues is much higher for a worker than in years past.

Further, since a lot of these choices fall under the "non-qualified" sections of IRS codes on benefits and fringes, it means you may have room to negotiate.  But you must first be aware of your choices before you can make suggestions.  Hopefully, this little synopsis gives you room for present – and future – possibilities in this regard.

Reference: Practice Enhancers, Able & Co.

Fringe Benefit Write-Offs

Fringe Benefit Write-Offs
A LOOK AT FRINGE BENEFITS
From a tax savings perspective, fringe benefit planning can achieve considerable results.  The business would be able to deduct the cost of these qualified benefits to save on taxes; yet the recipient would not have to pay current taxes on the value of the benefits received.  A "two for one savings" results, especially for an owner who is also a qualified employee.  So a business owner should have an overview of some of the options in regard to fringe benefits, and potential limitations or caveats.

By definition, a fringe benefit is a form of compensation–other than cash–given to a qualified recipient.  Generally speaking, the bulk of the tax-free fringe benefits can be granted to a qualified recipient who is an employee or to an owner who can also be set up as a qualified employee.

An Overview Of The Possible Fringe Benefit Options
While there are limitations, compliance issues, and non-discrimination rules that can vary according to the particular fringe benefits being set up and the type of business structure you have, it's important to get an idea of the major fringe benefits that may be available.  The following list gives a brief synopsis of the main ones:

Health & Accident Insurance: The cost of this tax-free benefit for employees, their spouses and dependents may be deducted by the business.  If provided, employer generally must also follow COBRA rules upon employee termination.

Life Insurance: Group-term up to $50,000 in coverage for employee, and up to $2,000 coverage for employee spouse or dependents is a tax free benefit.  Beyond that limit, a portion of premium cost may be taxable, but usually at far lower rates than if privately obtained.  Certain other types of life insurance arrangements (such as split dollar) may be set up with some limited tax-free or tax-deferred benefits.

Disability Insurance: The premiums paid by the business for the policy are a tax-free benefit to employee.

Conditional Meals & Lodging: If meals provided to employee on business premises, and lodging provided as a condition of employment–both for the employer's convenience–these are tax-free to the employee.  Business deducts the full cost of lodging, and 50% of the cost of meals.   

Day Care Services: Up to $5,000 per year of cost of these services may be tax-free to employee.  Must be either provided by employer, or paid to a qualified outside day care provider.

Qualified Retirement Plan: Contributions made by employer and/or employee may be deducted.  Various limitations on amount of contributions depending on type of plans and participation percentages.  Examples of such plan: SEP, Sar-SEP, SIMPLE, Keogh, 401(k), Customized Defined Benefits and/or Defined Contribution plans.

Working Condition Fringes: If primarily for benefit of employment conditions, tax-free to employee.  Examples: parking costs, professional association dues, business publications, business equipment (including computers, telephones, etc.) for required use at home, entertainment and travel/transportation expenses, convention expenses, required qualified office in home expense reimbursement, etc.

Vehicle Expenses: Cost of vehicle used for business purposes and/or as required by employer for business use may be tax-free to employee and deductible by business.

Transportation Benefits: Qualified commuter transportation expense, transit passes, commuter parking costs may be tax-free to recipient.

On-premises facilities: Eating facilities, daycare facilities, and athletic facilities available to all employees can be provided tax-free.

De Minimus Benefits: Occasional personal use of business equipment such as copiers, faxes, phones are tax free to employee, and fully deductible by business.  Similar rules for such things as coffee, doughnuts, soda, occasional tickets to shows, office parties and picnics, small gifts to employees.

Outplacement Assistance: This can be a very valuable fringe to a terminated employee.  Costs associated with finding another job may be fully tax-free: secretarial services, use of business facilities, counselling and resume services, etc.

Moving Expense Reimbursements: Subject to various dollar cost limitations, certain costs associated with a qualified job-related move would be tax-free to employee and tax-deductible by the business.

Achievement Awards: Tax-free up to certain dollar limitations ($400 for non-qualified plans; $1,600 for qualified plans) for actual gift or cash award instead.

Spousal Travel Costs: If the business requires an employee's spouse to travel with the employee for business purposes, these costs can be paid by the business and not taxable to employee.

Educational Costs: Up to $5,250 of educational costs for graduate level work is tax-free.  Other types of education costs to meet continuing job requirements are tax-free to employee and deductible by business.

Interest Rate Advantaged Loans: If set up properly, employee can get lower rate loans (in some cases NO interest charges) than on the outside without paying taxes on the differential costs.

Various Stock Options: Depending on the types, and employee status, the value of these options may be tax-free, or tax-deferred.  Overall goal of these options is to create opportunity to buy stock at a price lower than its actual worth.  

• Incentive Stock Options: Employee buys at reduced value, benefit not normally taxable when exercised, but when stock is sold.  
• Restricted Stock Option: Given subject to forfeiture rules if employee leaves prematurely.  Not taxable until forfeiture period elapses, then taxed at fair market value.  Provides possible capital gains tax savings. 
• Non-qualified Option: Taxable when exercised.

Stock Grants: Business grants employee actual stock, not just options.  The fair market value of the stock is taxable to employee.  But if stock appreciates this hidden value is tax deferred, and may be taxable at reduced capital gains rates later on when sold.  This can be a substantial tax benefit to people in high tax brackets.

Deferred Compensation Plans: Allows business to defer paying an employee for current work until a future date.  Can be a good tax saving tool in situations where the expectation exists that the tax bracket for the recipient will be lower at the future date vs the current date and/or vice versa for the business paying it.  This is primarily a tax-deferring benefit, and the business takes the deduction for the paid compensation at the future date as well.

Cafeteria Plans: A benefit plan in which the employee has a choice of either receiving cash or two or more qualified benefits in lieu of cash.  The allowable benefits that can be included in this plan are: disability, accident, health, dental insurance premiums, medical costs not covered by insurance, dependent care costs, and qualified 401(k) pension plans.

In addition, under Code Section 125, a special flexible spending account can be set up for the employee to directly pay for dependent care or various health care costs.  Up to $5,000 per year of this benefit cost can be deducted "off the top" of the employee's compensation.  This FSA provision has two main caveats for an employee.  First, the cost for these qualified expenses must be established in advance and paid for currently, not after the fact.  Second, if the employee fails to use up the pledged amount of expenses for the stated purposes, the unused portion cannot be given back.  It is a "use it or lose it" restriction.

The Cafeteria-type plans thus allow employees to be able to customize their benefits package and/or coordinate it with a working spouse's benefits to maximize the tax-free/tax-deferred benefits.

This can be ideal for smaller businesses that can't pay for the total cost of these benefits, but still want to offer employees some tax advantages.  The flexible spending account arrangement benefit can do this.

Compliance & Qualifying Issue #1: Type Of Business Entity
To be deductible by the business and tax-free/tax-deferred by the recipient, most fringe benefits must meet certain compliance and qualifying requirements.  These requirements fall into two main categories for this purpose: 1) The type of business entity, and 2) the so-called highly compensated/non-discriminatory tests.

In regard to category #1, the type of business entity may limit which fringe benefits are allowable from a qualified position.  For this form of limitation, the four types of business entities are: Sole Proprietorship, Partnership, C Corporation, and Subchapter S Corporation.  Certain qualified fringe benefit plans may not be allowed for the owners/controllers of some of these business types, but allowed for other employees.

In this regard, sole proprietors, owners of partnerships, and employee/shareholders who own more than 2% of a Subchapter-S corporation do not usually get to share in all of the potential tax free benefits available.  There are some that they cannot get 100% tax free, most specifically for the current year: health insurance, group term life insurance, death-benefit exclusion, and employer-furnished meals and lodging for on premises containment.

There is a tax-deductible allowance for health insurance, in that the taxable premiums may be deducted by these individuals on their own tax returns. 

The bulk of the other fringe benefits that may not be allowed for the owners or controllers of the business entity types are summarized as follows:

Sole Proprietors: Cannot get tax-free status in on-premise facilities, outplacement assistance, deferred compensation, disability insurance, death benefits, achievement awards, transportation benefits, moving expense, cafeteria plans, interest rate advantaged loans, stock options, stock grants.   

Partner/owners: Cannot get tax-free status in outplacement services, cafeteria plans, deferred compensation, disability insurance, stock options, stock grants, interest rate advantaged loans.

2% owner/shareholders of Sub Chapter S Corporation: Cannot get full tax-free/tax-deferred status in disability insurance, and cafeteria plans.

Be advised that these restrictions mostly apply to owners or controllers of these business entities.  They usually do not restrict general employees from the tax-free/tax-deferred status of the above-mentioned fringe benefits.

Compliance & Qualifying Issue #2: Tests To Pass
The IRS attempts to reduce possible discriminatory use of certain fringe benefits so that businesses can't show favoritism among different levels of employees.  In effect, the intent of these compliance tests is to prevent the "stacking of fringe benefits" in favor of owners and key personnel at the expense of other employees.

Two areas of qualification must be dealt with for setting up some of the tax-free/tax deferred fringe benefits.  First, if a business wishes to EXCLUDE certain employees, it can only do so based on a limited number of parameters such as: full-time vs part-time status, age of employee, seasonal nature of the job, vesting periods, citizenship/residency status, and collective bargaining coverage.

Thus, many of the fringe benefits can be set up in such a way as to exclude part-timers vs full-timers, employees under age 21, seasonal jobs that last less than 12 months, employees who have worked for you less than 1-3 years, non-resident aliens, and employees covered under certain collective bargaining agreements.  So if your business has employees that fit into these categories, or you have a very high turnover rate of employees, you may be able to set up various fringe benefit plans to selectively cover certain people or groups.  This could result in maximizing your own fringe benefits and minimizing the business expense of covering others.

The second area of qualification to deal with involves meeting the IRS tests for "highly compensated" individuals.  In a nutshell, the purpose of this test is to insure that the dollar value of contribution amounts or benefit amounts do not discriminate in favor of highly compensated individuals.  It's not always enough to cover all the employees with a particular benefit.  The dollar value of the benefit must also be spread out in such a way that the "lower compensated" employees are given a calculated fair share portion of the overall benefit according to IRS guidelines.

What is the IRS definition of a "highly compensated" individual?  It can get quite complicated from a calculation standpoint.  Normally, however, it is an owner, a shareholder(with 2%-5% or more of the holdings), an officer, or a key employee–or spouse or dependent of said individuals–whose earnings are such that they are in the top 20 percentile for the company.

Further, these tests can vary according to the particular type of fringe benefit plan, and can be very complicated in some instances, especially for fringes such as 401(k) plans, stock options and grants, cafeteria plans and qualified customized retirement plans.  A benefits specialist is often used in the planning, implementation, and calculation of the benefit deductibility amounts when a question of this qualification test comes into the picture.

Now, what happens if the business doesn't meet this "highly compensated" test?  It means part, or all of the particular fringe benefit may become taxable(or not available) to these highly compensated individuals.  If this is a possibility, the options for the business owner are:

1. Rearrange the fringe benefit amounts so it does qualify
2. Don't make that particular fringe benefit available
3. Accept the consequences of not realizing the full amount of the potential tax savings for the highly compensated group so the other employees can still benefit.

Reporting Requirements
With few exceptions (such as a SEP plan) most fringe benefit plans require some form of reporting to appropriate government agencies, such as the IRS or Department Of Labor.  This falls under the auspices of the Employee Retirement Income Security Act Of 1974, commonly abbreviated "ERISA." Failure to file timely and/or properly may result in civil or criminal penalties if willful failure to file is proven.

The two major categories of benefit plans to which most of this ERISA reporting applies are Employee Pension Plans, and Employee Welfare Plans.

The Welfare Plans refer to other than pension plans, so they may run the gamut from insurance to cafeteria plans.  The Pension Plans comprise the obvious: tax-qualified retirement plans such as Keoghs, 401(k) plans, etc.

The reporting requirements can be quite simple, or quite complex depending on the type and nature of the fringe benefit plan, whether or not the "highly compensated" test is required, how many employees are being covered, and whether any allowable discrimination restrictions are in place, to name a few.

There are a few common denominators among the various reporting requirements.  Most of these plans must be written, and a Summary Plan Description must be distributed to all covered employees.  This Summary must contain a number of specific disclosures, and be filed with the Department Of Labor.  An annual report or return (Form 5500) is usually required to be filed with the IRS.  Any modifications to existing plans must also be filed in the year these changes occur.

If your business uses a professional benefit plan specialist (such as an insurance company, brokerage house, or mutual fund company), most of these reporting/filing/disclosure requirements are taken care of for you.

Conclusion
Fringe benefits can be a very valuable aspect of a business.  First, the potential tax-savings can be substantial.  The business may be able to deduct the entire cost of these benefits, yet the recipients (business owner, employees) may be able to enjoy these fringes tax-free.  Second, offering fringe benefits can help to attract better employees, and reduce employee turnover.  This can save a business a considerable amount of money since employee turnover is so expensive to deal with, and higher quality employees usually translate into higher business profits.

But it may require some advance planning for some of the potential fringe benefits, especially if there is any possibility of a problem meeting the highly compensated/non-discrimination tests for certain fringe benefits.

Finally, the administration and reporting requirements make some of the fringes a chore to maintain, while for others it is relatively simple.  So an analysis of the risk to rewards in this area is always recommended before plunging in.  Nevertheless, the business environment in regard to providing fringe benefits is getting more and more commonplace.  So it is an area in which you, the business owner, should at least have a rough idea of the options and pitfalls.

Reference: Practice Enhancers, Able & Co.

Family Members on Payroll

Family Members on Payroll
HIRING FAMILY MEMBERS
Putting family members on your business payroll can create some significant tax savings.  Naturally, the IRS expects these family members to perform services for the business to justify the tax deductions.  But the various IRS and state laws governing employees and tax obligations are much more liberal when you employ family members as opposed to outsiders, especially for certain forms of business organizations.

Is it possible you could employ your 12 year old child to help you clean up your office, do filing, etc. and write off this as a tax deduction in your unincorporated business?  Yes.  If you were to pay that child $4,300 for the year, and your marginal federal/state tax bracket (including self-employment tax) were 28%, that could translate into a tax savings to you of $1,204  per year.

If you have a corporation, could you hire your spouse, include the spouse in various fringe benefit and pension plans, and take a tax write-off for these business expenses?  The answer again is Yes.

These are some of the possibilities that exist for a business owner.  Properly handled, the hiring of family members can greatly reduce taxes in your business.  Naturally, there are some variables that must be considered to determine overall tax saving possibilities.  The three main ones are:  the type of business entity you have; the relationship and/or age of the potential family member employee; and, whether or not certain types of business deductions are being used.

Type Of Business Entities
For the most part, the two main business types that have the most impact on the possible benefits of employing family members are sole proprietorships and corporations.

Sole Proprietorship
A sole proprietorship–that is, an unincorporated business–can create some interesting tax-saving opportunities in the case where the business owner has children who could help out.  In order to understand the possible tax savings, you should first know several "loopholes" that exist on the federal level in this regard.

Basically, a sole proprietor is allowed to hire his or her children even if the children are not of "legal" working age.  In other words, is it possible you could hire your 9 year old to help out if it were feasible?  According to federal law, it would be perfectly acceptable.  Second, the law also states that the sole proprietor does not have to pay social security taxes on his/her children's wages if the children are under 18 years old–nor do the children have to pay it either.

Let's see how this could save you some significant tax dollars.  Let's assume Business Owner A is currently paying income taxes at the rate of 28%.  In addition, a sole proprietor must pay self-employment taxes on the profits as well.  For the current year, that rate is 15.3% before adjustments–and approximately 14% in round numbers after adjustments. Thus, the overall marginal federal tax bracket in this case is 42%.  That means 42 cents of taxes are being paid for every additional dollar being earned.  From a tax write-off standpoint, it also means 42 cents of taxes would be saved for every additional dollar of deductions.

Thus, if Business Owner A were to hire his/her child for the year, and pay that child a reasonable wage, the savings could be as high as 42 cents on every dollar paid out.  Let's assume the child was paid $2,000 for the year.  The savings would be $840. per year, every year the child was paid.

Will the child have to pay taxes on the money?  It depends on how much the child is paid, and how much other income the child has for the year.  Current tax law allows the dependent child to earn up to at least $4,400 without paying tax.  Thus, for this scenario, the child will not have to pay any federal taxes on the money.  For other situations, the child's tax bracket would probably still be significantly lower than the sole proprietor, so there would still be sizeable potential tax savings.

Will this technique also work for a sole proprietor's spouse?  The answer is no, for two reasons.  First, the exception regarding not paying self employment taxes does not apply for a spouse.  Second, the spouse's marginal tax bracket is normally the same as that of the sole proprietor since a joint tax return is usually filed, so there would be no tax savings here either.

Does that mean there is no tax saving benefit to employing a spouse in a sole proprietorship?  Not necessarily.  There may be some ways to save taxes using other possible angles.  Here are some possible tax savings scenarios if a spouse is hired:

Possible 6.2% tax savings on social security taxes:  If the spouse of a sole proprietor is already paying the maximum in social security tax from other earnings, and the sole proprietor is not paying the maximum, then a possible tax savings exists here.  The sole proprietor would be able to deduct the spouse's wages, and save the self-employment tax on the deduction amount. Since the spouse has already "maxed out" on paying social security from another source of earnings, no extra social security tax would be due.  Hence, a possible 6.2% tax savings.

Possible 100% medical insurance/reimbursement plan write-offs:  Sole proprietors are normally not allowed to write-off 100% of their health insurance like certain "C-type" corporations are; they are also not allowed to set up a medical reimbursement plan for themselves to write-off the medical expenses that their insurance company won't cover.

However, if the sole proprietor hires his/her spouse properly, both of these write-offs could be achieved.  Under federal rules for employee benefit programs, a spouse does qualify under health insurance coverage and deductions for said coverage.  Thus, the sole proprietor could hire the spouse, cover the spouse under a "family plan" health insurance policy (instead of having a sole proprietor coverage plan), and take a full deduction for it.  In effect, the sole proprietor has now covered everyone in the family, and gets a full tax write-off for the cost of the insurance.

Increasing your deductible retirement plan contributions:  Employing a spouse can result in extra retirement plan deductions which results in extra tax savings.  Under certain conditions, the spouse could be eligible to participate in various pension plans, such as IRAs in which more money could be put away than before.  If the sole proprietor is already putting away the maximum $2000 into a "working spouse" IRA, there is a possible scenario where the hired spouse could set up his/her own "working spouse" IRA, resulting in an additional $2000 IRA deduction yearly.

While much too complicated to go into here, the same kind of techniques may be possible for other types of retirement plans, especially customized types a sole proprietor may use in the business.

Creating a deductible office in home write-off:  This is viewed by the IRS as a bit aggressive, but it survives challenge if done properly.  The sole proprietor hires the spouse to do all the recordkeeping for the business.  The spouse then uses a portion of the residence to perform these duties on an "exclusive and regular" basis.  This could then qualify for office in home deductions where it previously didn't qualify under the current IRS rules for deducting a home office.  The tax savings here would revolve around deductions for writing off a portion of the utilities, maintenance, and depreciation of the residence, or a portion of the rent being paid.  This could save a considerable amount of taxes.

Similarly, under federal employee guidelines, a spouse as an employee can be covered under a medical reimbursement plan.  This allows the employer–in this case the sole proprietor–to pay for (and deduct) the medical costs that the health insurance won't pay for.  So if the health insurance had a high deductible, or if there were medical or dental expenses not being covered under the plan, a properly set-up medical reimbursement plan could result in large tax write-off for a sole proprietor.  Like all "fringe benefit" planning, a number of other issues have to be considered, such as other employees, reporting requirements, and tax brackets, but the use of a hired spouse does create interesting tax write-off possibilities in this area.

There are other fringe benefit plans that could be set up for a spouse/employee to generate significant tax deductions and tax free or tax favored benefits, including such things as life insurance, pre-tax savings plans, and the use of a vehicle, to name a few.

Corporation
There are both similarities and differences in employing family members in a corporate structure compared to a sole proprietorship.  A corporation cannot exclude children under 18 from social security/medicare taxes.  Consequently, there would be no savings on social security/medicare tax like there would be with a sole proprietorship.

However, the other options generally exist.  Children could still be paid up to $5,950 without any federal income tax liability, so this could save the corporation and owner/employees.  

When Are Kids Required To File a Tax Return?
Generally, children who can be claimed on another person's taxes must file their own return if:
• They have wages of $5,950 or higher (this is the standard deduction amount for 2012, the amount for 2011 was $5,800)
• They have unearned income (investment income from interest, dividends, etc.) of $950 in 2012 ($950 in 2011)
• They have total income (both earned and unearned) greater than the larger of $950 or their earned income plus $300.

The child's tax bracket would probably be lower, so money paid in this way could save significant corporate taxes.  A spouse could also be hired to take advantage of various fringe benefits and retirement plans(providing the highly compensated tests are met), and might qualify for the home office write-off as well.

Another benefit to hiring family members is to avoid IRS challenge on excess compensation or accumulated earnings issues.  Believe it or not, a corporation is not supposed to retain its earnings over certain acceptable levels or it could be hit with an IRS accumulated earnings tax penalty.  In effect, the IRS wants the corporation to distribute these earnings in the form of dividends instead of retaining them.  This is not a tremendous tax saving option.  The corporation cannot deduct dividend distributions, but the recipients must pay tax on them.  It is a form of double taxation, since the corporation already paid income tax on the original earnings.

Now, if a corporation facing this problem of excess accumulated earnings can justify hiring family members, it is a way of getting the money out in other than dividend distributions–a sizeable tax savings and a way of avoiding the double taxation issue.

Similarly, certain corporations can be penalized for paying out excess compensation to the owner/employee.  The IRS can take the position it is excessive and/or a form of a disguised dividend.  Thus, putting family members on the payroll may help to defend this type of IRS challenge.

Conclusion
Hiring family members can result in dramatic tax savings for a business.  First, the deduction itself may save certain types of taxes, especially for sole proprietors.  Second, if there is a significant tax-bracket differential between the family member and the business or business owner, this can also be used as an important tax-saving device.

Family members can benefit from various tax favored fringe benefits which the business can deduct.  On the corporate level, they can be employed to alleviate certain IRS threats regarding excessive compensation or earnings, and save on taxes as well.  All in all, there can be a number of attractive options in this area.

Reference: Practice Enhancers, Able & Co.

Payroll Issue Basics

Payroll Issue Basics
EMPLOYER PAYROLL ISSUES
It's important to have a basic understanding of your tax obligations as an employer since Federal and State laws have numerous requirements that must be met from both a legal and a tax standpoint.

Keep in mind that most of these laws also apply to the business owner if the owner is set up as an employee of a corporation.  If the business is a sole proprietorship or partnership, legal owners do not register as employees.  However, for purposes of the following discourse, an owner is the same as an employee.

A Quick Overview Of Some Labor Law Guidelines
As of the present year, federal labor laws revolve around 15 main Congressional Acts; the most prevalent one is the Federal Fair Labor Standards Act (FLSA).  Not all employers must meet all the provisions of these Acts, and not all employees of covered employers must necessarily be included.  However, employees may also be covered under numerous state labor laws which tend to mirror many of the federal laws.  Therefore, a working knowledge of the main requirements from a tax standpoint are in order.

Exempt vs Non-exempt employees:  The Federal and State labor laws tend to vary in some areas between these two classes of employees. Exempt employees are those who do not have to be covered under different provisions such as overtime pay.  An exempt employee falls under the "laws of exception" so it is always important to get a ruling if there is any doubt about the exemption status.  Generally, exempt employees are as follows:

♦ Managerial types such as executives, professionals, outside sales people, other highly compensated individuals.

♦ Certain employees in retail, seasonal, farming, domestic help, and transportation fields.

These exemptions can vary between the Federal and State levels and are based on criteria such as the type of business, nature of work, and customs of the particular industry.  The difference between an exempt and non-exempt employee can be very difficult to determine, so unless you are 100% sure the employee is exempt, assume the opposite.

Therefore, the following guidelines (unless otherwise noted) will deal with non-exempt employee situations.

Minimum Wage Laws: The federal government and most states have minimum hourly wage amounts you must pay. The federal minimum wage provisions are contained in the Fair Labor Standards Act (FLSA). The federal minimum wage is $7.25 per hour effective July 24, 2009. Many states also have minimum wage laws. Some state laws provide greater employee protections; employers must comply with both.

Overtime Pay:  All non-exempt employees must be paid one and one-half times the regular hourly rate for any hours worked in excess of 40 in a week.  The employer cannot average the weeks, so even if the employee worked only 20 hours the week before, overtime must be paid if the work hours exceed 40 the next week.  Also, the hours are calculated based on the full week, not per day.  Thus, in this case the hours are averaged for the week.  If an employee works 10 hours one day it doesn't mean overtime is required so long as the total hours for the week do not exceed 40.

Vacation Pay, Other Fringes:  Normally there are no set requirements forcing you to pay for items such as vacation time, sick pay, premium pay, meal money, or other fringe benefits such as medical insurance, life insurance, etc.  You may elect to do so as part of the employer package, but it isn't covered under Federal laws.  However, if you are providing any of these to any employees, there may be various "nondiscriminatory" testing rules to meet if you aren't covering ALL of your employees.  This is a very complicated part of the compensation regulations.

Travel Pay:  Unless it is part of an employee's job to travel between required job sites or meetings, you normally do not have to pay for travel time.

Workers' Rights Notices:  The employer is required to post various notices listing workers' rights and grievance procedures.  The particular notices to be posted vary with the type of employment and employees.  If your employee files for unemployment benefits, the State will notify you and request information regarding the nature of the separation from employment.  These notices should not be ignored if you are challenging the unemployment claim.  Incidentally, your state unemployment rate you can rise with incidents of employee unemployment claims, so don't ignore any situation you feel is unwarranted.

Worker's Compensation Requirements:  With very few exceptions, an employer should obtain Worker's Compensation coverage for all required employees.  The rate that will be charged for the coverage varies with the type of work involved, and employees covered. Without this coverage, however, the employer is extremely vulnerable for damages should an employee receive job-related injuries.  This coverage is obtained on the State/local level rather than the Federal level.

Employee Tax Registration Forms Needed
Employees must record certain information for income and payroll tax validation purposes.  These forms are:  W-4 Form, I-9 Form, and related State Withholding Allowance Certificates.

W-4 Form:  This form records the employee's name, address, social security number, and number of "withholding allowances" to be claimed.  These allowances help to determine how much income tax should be withhheld from one's pay.  The employee signs this form. The employer keeps this W-4 on file.

State Withholding Allowance Certificate:  Similar to the W-4 Form, this helps to determine how much State income tax should be withheld from an employee's pay(in States where an income tax  exists).

I-9 Form:  This is now a required form for nearly every employee. There are few exceptions, and since the potential penalty for failing to have one of these on file can be upwards of $20,000 per violation, you should make this mandatory for all employees.  The purpose of this form is to verify an employee's eligibility for employment according to Immigration laws.

The "citizen vs alien" status is recorded, and a section containing identity and employment eligibility verification is checked off. Both employer and employee sign this I-9 Form, and it is kept on file with the W-4.  In effect, the purpose of this form is to ascertain that the person is not an "illegal alien" for job purposes.

Types Of Payroll Taxes That Must Be Paid
As an employer, you must take on the task of being a type of collecting agent for the government.  You are required to properly withhold and/or pay various Federal and State payroll taxes.  Failure on your part to properly do this can result in heavy penalties.

Some of these taxes are paid by the employee, and therefore withhheld from pay. Others are paid by you, the employer. The main taxes paid by the employee are Federal Income Tax, Federal Social Security Tax, Federal Medicare Tax, and State Income Tax. The main taxes paid by are the the employer's share of Federal Social Security Tax, Federal Medicare Tax, Federal Unemployment Tax, State Unemployment Tax, and State Worker's Compensation.

These employer/employee taxes are collected by you, the employer, and sent to the government or a designated agent on a periodic, timely basis.  Failure on the employer's part to do this can result in very heavy penalties and interest.  For the Federal government, the normal procedure is to make these deposits using a set of pre-printed Tax Deposit Coupons(Form 8109) which are obtained by applying on Form SS-4.

On a timely basis you fill out one of these coupons designating the type and amount of the tax payment; usually it is brought to an authorized depository bank(most commercial banks are authorized). States have similar types of coupons to use for State withholding purposes; however most businesses are allowed to send these coupons directly to the State instead of going through the bank.

Payroll Deposit Rules:  The size of the calculated payroll tax liability usually determines the frequency with which you must make these deposits.  It can get quite complicated as the payroll liability grows.  The government offices want the money as soon as possible!  On the State level the payment usually is based on a monthly or quarterly schedule except for very large businesses. However, the Federal requirements are either monthly or semi-weekly deposits for the average business.

The two main exceptions to this are:  If the total of payroll tax liability (FUTA excluded) for a 3 month period is less than $1,000. then this amount can be paid when the quarterly payroll tax return is filed.  If the tax liability reaches $100,000. the deposit generally must be made the next banking day after this threshold is reached. FUTA tax must be deposited once the liability reaches $100.

State Unemployment Tax:  This is generally calculated on a quarterly basis and paid subsequently.  Since this is a State employer-paid tax it doesn't come under the previously-mentioned deposit due dates.

Special Note On Payroll Tax Liability:  The government views the employer as a collecting agent with fiduciary responsibilities to forward these payroll taxes.  It is important to keep current with them since you can be held personally liable for any deficiencies. If your company becomes unable to pay these taxes, the IRS can impose this obligation on any responsible party.  Also, bankruptcy does not absolve you of these particular tax obligations.

Tax Returns That Must Be Filed
Above and beyond collecting the required payroll taxes, an employer is required to file periodic Federal and State payroll tax returns. These are filed on a quarterly basis.  The returns are actually due by the end of the following month of the quarter in question.  In addition, yearly W-2 Forms must be filed to summarize the payroll numbers.  A brief description of the tax returns and forms is as follows:

Federal Form 941:  A quarterly tax return which summarizes the Federal income tax withholding, Social Security tax, Medicare tax, and tax deposits made.

Federal Form 940:  A yearly tax return which summarizes the Federal Unemployment Tax owed and paid on behalf of all appropriate employees.

Federal and State W-2 Forms:  Yearly forms to be given to employees and copies to be sent to the governments detailing the wages and taxes per employee.

Federal and state W-3 Transmittal Form:  A yearly form which summarizes the totals of the individual W-2 Forms for federal and state income tax, and Social Security Administration purposes.

State Unemployment and/or withholding Tax Return: Usually a quarterly tax return which calculates the unemployment tax and/or withholding tax the employer must pay on behalf of each qualifying employee.

Worker's Compensation Reporting:  This employer-paid expense is not truly a payroll "tax" but it is a direct result of having employees, so it is listed here.  This is payable on the State level, usually to an authorized State agency/ carrier.  The report is usually in the form of a yearly review by the appointed agent.  Since Worker's Compensation rates are based on the type of employee and nature of the work, this report categorizes the payroll and size to determine if any additional liability is due.

Required Recordkeeping
Having employees means keeping good records for a number of reasons. First, it's the law. Second, in the event an employee challenges you regarding pay or overtime or worker's compensation issues, the burden is oftentimes on you to prove your case instead of the employee's claims.

With the exception of the previously mentioned Federal and State Withholding Allowance forms, records may be kept in many ways. 

However, the minimum requirements are:

Personal information:	name, address, birth date, social security number.
Workweek information:	hour and day week begins, hours required to be worked for the week.
Pay Calculations:	hours worked per day and week, hourly pay rate, straight-time and overtime rate calculations, deductions from wages, pay period date, and payment date.

Most employers do this with a form of a payroll register.  While time cards are not legally required, most employers also have employees fill out some type of record of hours worked.

Payments to the employee should detail how the gross and net pay has been calculated, and a form of a "pay stub" should be given for each pay period.  Obviously employees should be paid by check whenever possible.  In situations where this is not possible, a signed receipt from the employee should be obtained.

Payroll records should be kept for a minimum of three years beyond the year of occurrence. However, due to possible State or Social Security Administration inquiries, a more widely used time frame is 7 years.

Put Your Payroll Policies In Writing
Even if you may have no legal requirement to have written personnel policies, it is a good idea to at least have pay policies in writing.  It can avoid serious misunderstandings with employees, and it can bolster your case against any challenges by authorities.

If you are going to offer any extra benefits like vacation pay, sick pay, holiday pay, insurance, retirement funding, etc., you should put your policy in writing--especially if these benefits will not be available to all employees.  Disclosing in advance how you will handle severance pay can save you from a disgruntled employee's challenge down the road.  Legally clarifying Exempt vs Non-exempt employees is practically mandatory.

Here are some tips on a written pay policy:

• Be as specific as you can be for each issue.  If you are paying for 
holidays, which holidays?  How many vacation days?  What type of 
insurance coverage?

• Get a receipt from the employee acknowledging a copy of the pay policy was received.

• If certain employee categories are excluded from certain benefits detail these variances clearly.

• Have a qualified legal advisor go over it before you give it to anybody.

Conclusion
Payroll issues for a business can get complicated--and expensive. You take on fiduciary responsibilities,and legal responsibilities. The forms, reports, and returns that must be timely and properly filed can be quite a challenge.  There is added expense above and beyond the actual cost of paying the employee wages.  First, there is the extra cost of the employer's share of various payroll-related taxes.  Then there is the cost of filing the required Federal and State tax returns, W-2's, and so forth.

Unfortunately, this complexity is a "necessary evil" if you want the business to operate on a legitimate level.  The positive aspects are that you can deduct the qualified business expenses associated with payroll, so you are sharing some of the expense with the government. In addition, if you do this properly instead of cutting corners you can have peace of mind and protection for yourself, your business, and your employees.

Reference:  Practice Enhancers, Able & Co.