Employment Taxes: What You Need to Know

Employers cannot evade responsibility for deducting employment taxes from wages by simply declaring workers as contract labor. Only independent contractors qualify for exemption from tax withholding by employers.
The federal tax code defines the necessary conditions for independent contractor status. States also provide guidance on defining an independent contractor arrangement. Independent contractors basically present themselves as available for services to a variety of businesses at any time. They are assigned specific tasks to accomplish and work without direct supervision.
A business may produce an annual Form 1099, indicating the amount paid for contract labor. The form is sent to an independent contractor and the federal government. An employee receives Form W-2 annually, indicating gross compensation and taxes withheld.
Federal law requires employers to deduct certain taxes from employee compensation. These deductions include the employee’s federal income tax liability, determined from Internal Revenue Service (IRS) tables on the wages paid. The other deducted federal payroll taxes are the employee portions of Social Security and Medicare contributions under the Federal Insurance Contributions Act (FICA). No withholding of taxes is required from amounts paid to independent contractors. Instead, the independent contractors are entirely responsible for remitting taxes associated with their income.
Employers face penalties for failing to remit all withheld taxes, along with a matching amount of the FICA taxes, when they are due. Most important is the fact that payment of employment taxes to the U.S. Treasury is the responsibility of an employer. Therefore, liability for payment of taxes always rests with employers – even when taxes are not withheld. An employer who incorrectly classifies an employee as contract labor is responsible for payroll taxes. The IRS will assess back taxes on payments that are deemed disguised wages.
The IRS is permitted to collect unpaid payroll tax liabilities of corporations from individuals responsible for collecting and remitting the taxes. The customary protection of individuals from personal responsibility to pay corporate obligations does not apply to payroll taxes.
The IRS may seek to collect payroll tax deficiencies from several individuals for the same tax assessment. However, the IRS cannot collect more taxes than are owed by a business. In this policy of joint and several liability, the IRS conducts a tax assertion on multiple parties. If overpayment results, the last person to pay the taxes owed that caused the overpayment is entitled to a refund.
The IRS may assess a penalty for recovery of unpaid payroll taxes on any person who has status, duty and authority over financial decisions of the business and who willfully failed to collect, truthfully account for and pay payroll taxes.
Essentially, the control person of a business is not permitted to knowingly pay other creditors with payroll tax money payable to the IRS. A responsible person has been defined by court cases and administrative rulings as someone who possesses authority to decide which creditors to pay and when to pay them. Consequently, the test for personal liability is an assessment of who controls payment decisions, regardless of the person’s business title.

Employers cannot evade responsibility for deducting employment taxes from wages by simply declaring workers as contract labor. Only independent contractors qualify for exemption from tax withholding by employers.
The federal tax code defines the necessary conditions for independent contractor status. States also provide guidance on defining an independent contractor arrangement. Independent contractors basically present themselves as available for services to a variety of businesses at any time. They are assigned specific tasks to accomplish and work without direct supervision.
A business may produce an annual Form 1099, indicating the amount paid for contract labor. The form is sent to an independent contractor and the federal government. An employee receives Form W-2 annually, indicating gross compensation and taxes withheld.
Federal law requires employers to deduct certain taxes from employee compensation. These deductions include the employee’s federal income tax liability, determined from Internal Revenue Service (IRS) tables on the wages paid. The other deducted federal payroll taxes are the employee portions of Social Security and Medicare contributions under the Federal Insurance Contributions Act (FICA). No withholding of taxes is required from amounts paid to independent contractors. Instead, the independent contractors are entirely responsible for remitting taxes associated with their income.
Employers face penalties for failing to remit all withheld taxes, along with a matching amount of the FICA taxes, when they are due. Most important is the fact that payment of employment taxes to the U.S. Treasury is the responsibility of an employer. Therefore, liability for payment of taxes always rests with employers – even when taxes are not withheld. An employer who incorrectly classifies an employee as contract labor is responsible for payroll taxes. The IRS will assess back taxes on payments that are deemed disguised wages.
The IRS is permitted to collect unpaid payroll tax liabilities of corporations from individuals responsible for collecting and remitting the taxes. The customary protection of individuals from personal responsibility to pay corporate obligations does not apply to payroll taxes.
The IRS may seek to collect payroll tax deficiencies from several individuals for the same tax assessment. However, the IRS cannot collect more taxes than are owed by a business. In this policy of joint and several liability, the IRS conducts a tax assertion on multiple parties. If overpayment results, the last person to pay the taxes owed that caused the overpayment is entitled to a refund.
The IRS may assess a penalty for recovery of unpaid payroll taxes on any person who has status, duty and authority over financial decisions of the business and who willfully failed to collect, truthfully account for and pay payroll taxes.
Essentially, the control person of a business is not permitted to knowingly pay other creditors with payroll tax money payable to the IRS. A responsible person has been defined by court cases and administrative rulings as someone who possesses authority to decide which creditors to pay and when to pay them. Consequently, the test for personal liability is an assessment of who controls payment decisions, regardless of the person’s business title.

Petty Cash 101: How to Avoid Accounting Errors

Many companies hold petty cash as a convenient means for making small purchases. The money is also used to reimburse employees for office items they buy. Unfortunately, petty cash is prone to accounting errors.
One of the problems is failure to accurately record expenses paid with petty cash. The money is an asset just like a bank account. Businesses should therefore subject petty cash to the same controls as funds in a bank. A policy is needed that establishes who approves petty cash disbursements as well as who reconciles the cash drawer.
Money removed from petty cash is replaced with receipts for a business expense attached to a supervisory approval for the purchase. The custodian of petty cash periodically totals the receipts and determines the amount of petty cash spent for each business expense category. The sum of the receipts and the remaining cash always equals the same original petty cash amount. After the petty cash fund is nearly depleted, the custodian turns in the receipts and obtains replacement cash. This returns the petty cash amount to its original balance.
Businesses must conduct reimbursements to employees under the rules of an accountable plan. Doing so means that reimbursements are not considered income for employees and are therefore exempt from payroll taxes. Businesses with accountable plans treat reimbursements as if they had paid the expenses directly. Accountable plans require reasonable accounting of expenses with a business purpose. Disbursements in advance require the employee to return with a receipt for the business purchase and the change.

Many companies hold petty cash as a convenient means for making small purchases. The money is also used to reimburse employees for office items they buy. Unfortunately, petty cash is prone to accounting errors.
One of the problems is failure to accurately record expenses paid with petty cash. The money is an asset just like a bank account. Businesses should therefore subject petty cash to the same controls as funds in a bank. A policy is needed that establishes who approves petty cash disbursements as well as who reconciles the cash drawer.
Money removed from petty cash is replaced with receipts for a business expense attached to a supervisory approval for the purchase. The custodian of petty cash periodically totals the receipts and determines the amount of petty cash spent for each business expense category. The sum of the receipts and the remaining cash always equals the same original petty cash amount. After the petty cash fund is nearly depleted, the custodian turns in the receipts and obtains replacement cash. This returns the petty cash amount to its original balance.
Businesses must conduct reimbursements to employees under the rules of an accountable plan. Doing so means that reimbursements are not considered income for employees and are therefore exempt from payroll taxes. Businesses with accountable plans treat reimbursements as if they had paid the expenses directly. Accountable plans require reasonable accounting of expenses with a business purpose. Disbursements in advance require the employee to return with a receipt for the business purchase and the change.

Why It Pays to Read Your Balance Sheet

There’s more to the financial operations of a business than tracking revenue and expenses. The balance sheet shows what happened to the profit or loss and reveals the overall condition of a business.

By examining the balance sheet you see the assets acquired with your profits as well as debt you incurred to buy those assets or to cover an operating loss. You already know to monitor your available cash. The balance sheet permits you to also supervise the levels of what’s owed to you and how much you owe.

The most useful function of the balance sheet is that it permits you to locate any accounting mistakes. As the name implies, this financial report must balance, so any incorrectly reported expenses or unreported revenue must create an equally erroneous amount in an offsetting account on the balance sheet.

Some incorrect amounts are obviously too large or too small in relation to known facts. For example, you generally know about how much you paid for your inventory on hand. So a glance at the amount indicated for inventory on the balance sheet confirms some general accuracy.

In addition, the balance sheet provides an opportunity for specific accuracy of your accounting. That is, most of the figures on the balance sheet are verifiable against independent sources.

For example, cash asset balances should reconcile to bank statements, the inventory asset balance should reconcile to a physical inventory count, loan balances should reconcile to reporting by lenders and credit card balances should reconcile to monthly statements.

The Tax Ins and Outs of S Corporations

An S corporation is taxed differently than an unincorporated proprietorship because the S corporation doesn’t incur self-employment tax. This is the tax on a proprietor’s profit that substitutes for payroll taxes covering Social Security and Medicare.

Shareholders of an S corporation pay only regular income tax on their respective shares of business profit – regardless of whether the corporation distributes any profit. This regular income tax assessment is identical to a proprietorship. However, there are no payroll taxes on S corporation profits. S corporation employees – including shareholders who operate the business – incur payroll taxes on their wage compensation.

Wage Requirements

These circumstances result in an incentive for S corporation shareholders to minimize their own wages. This increases the corporate profit that’s not subject to payroll taxes. The Internal Revenue Service (IRS) is increasingly interested in these situations. After all, someone must operate the corporation. This person is therefore an employee who should receive wages. The IRS expects payroll taxes on some amount of wages for the operating shareholder.

The general IRS rule is that an operating shareholder of a profitable S corporation must receive “reasonable” wages for services. S corporations that pay less than “reasonable” wages to shareholders have drawn IRS attention.

Determining What’s Reasonable

The IRS has authority to adjust S corporation tax reporting to reflect reasonable wages. Doing so causes an assessment of back payroll taxes – along with penalties and interest – on shareholder wages disguised as non-payroll distributions.

This doesn’t mean that S corporations are not a viable opportunity to reduce taxes on a business. However, it does indicate that those forming S corporations should obtain competent advice about compensation to operating shareholders. Distributions of profit to shareholders should not substitute for reasonable wages.

The tax code doesn’t contain a definition of “reasonable” wages, but the IRS suggests it is determined by such things as hours worked, duties performed, and the complexity and size of the business.

S corporations making distributions to shareholders that exceed their wages commonly draw IRS scrutiny.
In addition, wages to operating shareholders that are far below the market wage garner attention.

The trade-off for escaping self-employment tax on S corporation profit is incurring payroll taxes on wages that are fairly related to the value of services rendered.

In some circumstances, lower-than-market wages are justifiable. For example, a high level of debt service might impact wages. When debt includes loans from shareholders, it must involve documentation and include interest.

Another factor related to operating shareholder wages is the effect on retirement plans.

Because the profit of S corporations is not self-employment income, the IRS has ruled that such profit is not considered for determining contributions to qualified retirement plans.

The only basis for retirement plan funding is wage compensation.