Who is this guy named FICA?

Who is this guy named FICA?
FICA is the acronym for Federal Insurance Contributions Act. The acronym is often used in the US when referring to the combination of the Social Security tax and the Medicare tax.

Generally, all of an employee's earnings which are less than $117,000 in the calendar year 2014 are subject to payroll withholdings of 6.2% for the Social Security tax plus 1.45% for the Medicare tax. In addition, the employer is required to pay a similar amount. The result is that the employer must remit 15.3% (6.2% + 6.2% + 1.45% + 1.45%) of each employee's wages or salaries that are less than $117,000 in a year.  

A self-employed person must pay both the employee portion and the employer portion of the FICA tax.

There are specific rates that apply to an employee's annual earnings in excess of the FICA wage limit ($117,000 in 2014).

Additional Medicare Tax

Effective in 2013, the Additional Medicare Tax of 0.9% applies to earned income of more than $200,000 ($250,000 for married couples filing jointly). Employers withhold this tax on wages in excess of $200,000 regardless of an employee’s filing status.

The Additional Medicare Tax raised an individual wage earner’s portion on compensation above the threshold amounts to 2.35 percent from 1.45 percent; the employer-paid portion of the Medicare tax on these amounts remained at 1.45 percent. 

Net Investment Income Tax

Net Investment Income Tax is separate from the new Additional Medicare Tax, which also went into effect on January 1, 2013. You may be subject to both taxes, but not on the same type of income. The 0.9% Additional Medicare Tax applies to individuals’ wages, compensation, and self-employment income over certain thresholds, but it does not apply to income items included in Net Investment Income.

In general, net investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, and non-qualified annuities.

Net investment income generally does not include wages, unemployment compensation, Social Security Benefits, alimony, and most self-employment income.

Additionally, net investment income does not include any gain on the sale of a personal residence that is excluded from gross income for regular income tax purposes. To the extent the gain is excluded from gross income for regular income tax purposes, it is not subject to the Net Investment Income Tax.

If an individual has too little withholding or fails to pay enough quarterly estimated taxes to also cover the Net Investment Income Tax, the individual may be subject to an estimated tax penalty.

Social Security Cost-of-Living-Adjustment
Publication 15 (2014), (Circular E), Employer's Tax Guide

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.

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.

Subcontractor vs. Employee

Subcontractor vs. Employee
Employee Status vs, Independent Contractor
For the current year, one of the hottest issues in the eyes of the IRS revolves around determining a true independent contractor from a "disguised employee."

Why is this such a tricky subject, and why do so many businesses try to use independent contractors instead of employees?  One main reason is the tax and money savings differences.

A business that uses an independent contractor instead of an employee saves on payroll taxes.  There is no required FICA tax, FUTA (federal unemployment), or State Unemployment Tax.  Since these taxes can amount to upwards of 15% combined for the business, one can see a decided advantage shaping up.

In addition, no worker's compensation coverage is generally required. For certain occupations (especially construction, tree work, or other more "dangerous" work) the cost of worker's compensation can exceed 33% of overall payroll!

An independent contractor does not have to be covered under any retirement or fringe benefit plans (such as medical, or insurance) either.  The savings here can be equally substantial.

Finally, from an administrative and tax form reporting basis, independent contractors are far easier for businesses to deal with than employees.  No quarterly payroll tax returns, no worker's compensation audits, and no yearly W-2 forms are required to be filed- -to name a few.

So one can see where the inducement lies in using independent contractors instead of employees.  There's nothing wrong with properly using an independent contractor--that's good business practice.  However, the temptation--and danger--exists if a business owner tries to claim independent contractor status for a worker when that worker is really a true employee.  This is because if the relationship is challenged down the road, and it turns out the business owner cannot properly prove true independent contractor status existed, the penalties can be enormous in a number of ways.

If the business loses on the challenge, all back payroll taxes must be paid as if the worker were an employee.  Additionally, a portion of taxes that should have been withheld for income and FICA from the employee's portion must now be paid by the business employer instead.   Then various penalties are added in, and they can amount to over 150% of the recalculated taxes!  Finally, interest is charged on the total amount due, dating back to the original liability date, not when it was challenged. Also, workers' compensation insurance can then be back-billed to the original date of hire.

Taking it a step further, if the person being used as an independent contractor were to get hurt on the job, and the business owner were to be challenged as to independent contractor status(perhaps even by the worker who was hurt) the risk of being responsible for all medical expenses, workers compensation payments, and legal damages becomes a frightening reality.

From a retirement plan standpoint, if the business were to lose an independent contractor status challenge, the existing retirement plan for all employees could face disqualification for tax purposes on the basis of failure to cover all required employees.  This could be a financial and administrative nightmare.

So, how does a business protect itself from losing these challenges? The answer lies in being able to meet the various legal "tests" the government and insurance companies use to compare an employee with an independent contractor.  Note that just because the business owner and the worker both voluntarily agree it will be an independent contractor situation  does not make it so.

What makes it so?  Unfortunately, there are a number of these so- called tests that are used by the authorities to make a determination so it is not always such a "cut and dry" matter. Overall, the factors used center around the issues of Control, Integration, and a Continuing Relationship.

Control and Continuing Relationship
The more control the business has over the worker in the day to day activities, and the longer the continuing relationship between the business and the worker (especially if it is an exclusive one), the more the stage is set for it being considered an employee relationship.

Integration
This refers to how important the services being rendered are towards the overall day to day survival of the business in question.  The more important this service, the more it slants towards an employee relationship.

Listed on the next page are the majority of the issues used in deciding these three main factors to determine if the person is an independent contractor instead of an employee of your business.

♦ Their services are available to the general public, not just your organization.  
They work for other businesses, too.

♦ All required licenses and registrations for the services being performed
should be in the name  of the independent contractor, not your business.

♦ Hours for the job are primarily set by the contractor, not by you.

♦ Tools, vehicles and equipment are provided by the contractor, not you.  
All repairs on such are borne by contractor.

♦ Contractor provides for his/her own work facilities outside of your    workplace.

♦ Business expenses--especially travel--are paid by contractor.

♦ Contractor has no significant involvement in company fringe benefit 
programs such as insurances, and retirement plans.

♦ Separate liability insurance is maintained.

♦ Payments should be based on a job basis, not an hourly, weekly, or 
monthly basis.

♦ The work shouldn't require extra specialized training the contractor 
must receive by the business owner.

♦ The contractor should not wear any business uniform or company 
insignia from your business.

♦ Any assistants or workers helping contractor should be under 
contractor's employ, training,  and direction.

♦ There should be no regular, mandatory meetings between contractor 
and business owner similar to ones regular employees attend.

♦ Assignments should be in the form of a written contract with a formal 
method of termination. Contractor should also have other assignments 
from other businesses along the way.

♦ Record keeping, advertising, and other normal business activities for 
the contractor should be handled by the contractor, not by the 
business using the services.

♦ The more the work is done solely on business premises, the less 
likely it is an independent contractor status.

♦ Work patterns and work schedules should be set primarily by 
contractor, not business owner. Too many detailed, written instructions 
by the business can jeopardize independent contractor status.

♦ It should be a profit/loss arrangement, meaning the contractor could 
conceivably lose on the deal just like any other business--unlike an 
employee.

♦ The allowable customary method within the field in question carries 
some weight as well.  As an example, in the real estate field, agents 
are treated as independent contractors, not employees.

As you can see, the list for interpretation purposes is lengthy and quite subjective.  The more a business can prove that it did not have control, integration, and continuing, exclusive relationships with the worker, the better the case for independent contractor status.

Special note
If a business uses an independent contractor, it is imperative that proper reporting of these payments be made to the government.  If the payments to this individual exceed $600. for the calendar year, a form 1099 (usually 1099-Misc) should be filed with the IRS.

This form lists the name, address, and tax identification number of the individual, and how much was paid for the year.  Failure to file this can result in penalties, and a possible weakening of the case for independent contractor status.  So businesses should always get the pertinent tax information from any independent contractors before paying them.

Independent Contractor Agreement

This agreement is made between the client and the independent contractor according to the terms and conditions set forth:

Independent Contractor:
Name: ______________________________________                            
Address: ____________________________________
City, State,Zip: _______________________________ 
    Social Security Number (Tax ID #): _______________

Client:  
    Name: ______________________________________
Address: ____________________________________
City, State Zip: _______________________________

Payment Terms:	Client will pay according to the following terms:  _______________________________ _______________________________
Work Description:	The independent contractor will perform the following work: _______________________________ _______________________________
Term of agreement:	This agreement will terminate on:  _______________________________
Termination without cause:	Either party may terminate this agreement after a period of 30 days from which written notice has been issued.  No cause is required.
Termination with cause:	Either party may terminate this agreement immediately if reasonable cause occurs, and said cause is identified in writing.
Notices:	All notices relating to this agreement must be given in writing.  They may be hand delivered or sent to the party at the party's stated address.
No Representation:	Neither party is authorized to enter into any agreements or contracts with others on behalf of the other party.
Expense Reimbursements:	Unless otherwise agreed to in writing, client is not liable for any expenses incurred by the independent contractor
Tools, equipment, transportation:	Independent contractor will supply his/her own tools, equipment, transportation for the stated work purpose.
Taxes:	No form of any taxes will be paid by client on behalf of independent contractor.  It is agreed that this is not an employer/employee status.  Independent contractor acknowledges that all required tax payments, and tax filings are solely the responsibility of the independent contractor, including any possible social security taxes.
Fringe benefits:	Independent contractor will not be eligible for any type of fringe benefit plan the client may have available to the client's employees.
Worker's Compensation:	Client is not responsible for providing any form of worker's compensation to independent contractor, or employees of said independent contractor.   Further, independent contractor states that all required worker's compensation insurance that must be carried for this assignment is current at this time.
Licenses, permits:	Independent contractor states that all required licenses and permits needed to carry out stated assignment have been obtained.
Assignability:	Independent contractor may assign this agreement provided written notice is given, and client agrees.
Severability:	If a portion of this agreement is held to be unenforceable, the rest of the agreement will still remain in force.
Amendments:	Amendments, and revisions may be made to this agreement only if in writing, and only by joint consent of both parties.

Client Name: _________________________________________ 
Signature of Client: ____________________________________
Date: _______________________________________________

Independent Contractor Name: _____________________________
Signature of Independent Contractor: ________________________
Date: __________________________________________________

Reference:  Practice Enhancers, Able & Co.