Individuals whose businesses are incorporated typically do not have to worry about self-employment tax if they are paying themselves a reasonable salary. Any salary taken by owner-employees is subject to FICA taxes (Social Security and Medicare). FICA taxes are deducted from the shareholder’s paycheck and are remitted regularly through payroll tax payments to the IRS. Owners of sole proprietorships, partnerships, and limited liability companies (LLCs)—are not considered “employees” but “self-employed individuals”. Instead of paying FICA tax through wages, self-employed people pay self-employment tax. Partners, sole proprietors and LLC members do not take a regular salary through payroll, so there is no tax withheld from the payments they take which are called “draws”.
Self-employed individuals pay self-employment tax equal to the employer and employee share of FICA tax. In other words, they pay 15.3% (comprised of 12.5% for Social Security tax and 2.9% for Medicare tax) on the net earnings of their business. In basic terms, net earnings from self-employment is calculated by subtracting total expenses from total income. Oftentimes, self-employed clients get confused because they think they only pay tax on the draws they pay themselves from the business. This is not the case, however, because if the business is profitable and no draws are taken, the owner will still pay 15.3% self-employment tax on those profits. The draws that the owner takes do not decrease the net profits of the business and generally have no effect on self-employment tax. There are some “draws” called ‘guaranteed payments” taken by some partners in a partnership that do decrease the profits of the other partners, but those guaranteed payments are still subject to the 15.3% self-employment tax for the partner who has received such payments. An LLC can elect to be taxed as a corporation thereby allowing the owners to take a regular salary and have some control over the self-employment tax that they pay. This is a good option for LLCs that are profitable.
Need Help Navigating the Complexities of Staffing Across State Lines?
Businesses of all sizes that operate interstate are subject to a significant regulatory burden with regard to compliance with non-resident state income tax withholding laws, which can take operating resources away from these businesses. Forty-one states impose a personal income tax on wages and partnership income, and there are many differing tax requirements regarding withholding income tax of nonresidents among those 41 states. The amount of research that goes into determining what each state law requires is expensive and time-consuming. The recordkeeping can be burdensome, particularly since a state’s withholding threshold can be as low as one day’s work in another state. Is your business operating between states or planning to in the future? Todd & Co. CPA Group, Ltd. is a member of the American Institute of CPAs, the professional organization supporting CPAs, which advocates on behalf of CPAs and their small business clients. Our membership helps us keep our clients current on new developments, so we can help you navigate through state laws and determine withholding requirements for mobile staff. Contact us today (757) 926-4109 if you need help determining payroll and income tax withholding rules for your out-of-state operations.
Out of State Operations Require Special Reporting
Do You Owe Nanny Tax?
A good domestic worker can help take care of your children, assist an elderly parent, or keep your household running smoothly. Unfortunately, domestic workers can also make your tax situation more complicated.
Domestic workers of all types generally fall under the “nanny tax” rules:
- First, you must determine whether your household helper is an “employee” or an “independent contractor.”
- If you provide the place and tools for work and you also control how the work is done, your helper is probably an employee.
- For example, at one end of the spectrum, a live-in housekeeper is probably an employee.
- At the other end of the spectrum, a once-a-month gardening service may qualify as an independent contractor.
- If your household worker is an employee, then you, as the employer, may be required to comply with various payroll tax requirements.
- For the years 2014 and 2015, the important threshold amount is $1,900. If you pay your employee $1,900 or more during either year, you are generally responsible for paying social security and Medicare taxes on your worker’s wages.
- In addition to social security taxes, you may be required to pay federal and state unemployment taxes as well as other state taxes.
- With these taxes go various deposit and filing requirements, including the requirement that you provide your employee with an annual W-2 form that shows total wages and withholding.
- February 2, 2015, is the deadline for providing W-2 forms to workers to whom the nanny tax applies for 2014.
As you might expect, most people need assistance complying with the nanny tax rules. If you need details about the rules or help in dealing with them, contact our office.
Six myths that lead to worker misclassification.
Follow the link above to read a piece that supports the blog I did last year about common mistakes made by entrepreneurs. Email me at masteringbusiness<at> gmail<dot>com if you’d like an electronic brochure detailing the tests to determine worker classification.
More often than not I come across both new and seasoned business owners who think that they have a choice in whether they will treat a worker as a subcontractor or as an employee. By treating a worker as an independent contractor, the business does not have to withhold and remit payroll taxes on the amounts paid to the worker. The business also avoids paying the FICA tax match (currently 7.65%), federal unemployment tax, as well as any state and local employer taxes on the worker’s pay. The business also may be able to avoid having to include the workers in their worker’s compensation and health and welfare insurance coverage if they are not considered employees. Companies also skirt overtime and employer wage rules by classifying workers as independent contractors. Therefore, it is quite tempting for business owners to want to treat workers as independent contractors instead of as employees since it is certainly cheaper in the short run.
At the federal level, the IRS and the Department of Labor are interested in enforcing laws designed to protect workers and the government’s interest (i.e. taxes due to them) and the authorities, not the business owner, have the ultimate say in how workers should be classified. The IRS has dedicated a whole area of their website to the topic – you can view it by clicking the link at the bottom of this page. The site even has nice audio lessons and the training materials that IRS agents use to determine whether a worker is in fact an employee or independent contractor. The DOL also has a nice section about the topic on their site too (link below).
The following conditions are common in an employee/employer relationship:
- Payer retains significant control over the result of the work to be performed.
- Payer retains significant control over when and how the work will be done.
- Payer reimburses worker’s expenses.
- Payer provides most tools, equipment and supplies to carry out the work.
- Payer provides benefits such as insurance, paid time off or retirement pay.
The following conditions, while not all inclusive, are common in an independent contractor/contractor relationship:
- Worker has made a significant financial investment in the equipment used to carry out the work.
- Payer does not reimburse expenses of the worker.
- The worker provides services to more than one payer, or is actively looking for more business by way of advertising etc.
- Worker is paid a flat fee for the work performed (i.e. paid by the job).
- Worker has his own trade name, business license and professional, liability and worker’s compensation insurances.
While none of the conditions above guarantee the classification of a worker as one type or the other – it is more likely that those having more of the characteristics of an employee will be treated as such by any taxing or regulatory authority if it is ever challenged.
As a business advisor, I almost always recommend my clients to err on the side of caution when classifying workers to avoid problems down the road. In cases where there is a dispute, or a worker is hurt on the job, or fired, unemployment and other insurance claims made by misclassified workers can cause problems with state and federal agencies. The IRS can examine company records at any time to determine worker status and can then charge the company with back payroll taxes plus penalties and interest if any workers are reclassified as employees. Even if there is a written contract between the worker and the company stating that the worker is an independent contractor, the IRS can reclassify the worker if they deem there is evidence present for them to justify it. While all situations are different and there truly is no one-size-fits-all yardstick by which to gauge every worker relationship, using common sense while planning for the long-term is the best way to avoid trouble later on. Don’t risk problems down the road just to “save” a few bucks today, it’s just not the smart way to run a business.
Click here for IRS guidance on classifying workers:
Click here for DOL coverage on the crackdown regarding misclassified workers:
Image courtesy of Flickr http://www.flickr.com/photos/chrisglass/347972900/sizes/q/in/photostream/