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Filing Options For Married Taxpayers

So it’s the start of the next year and here you are gathering your papers together to file your taxes.  Inevitably, sometime during the process you will encounter the question “what was your filing status?”

While this seems like a straightforward inquiry, it often poses a challenge for those who recently married, divorced or separated.  Can I file as single if I didn’t change my name with the Social Security Administration (SSA)?  Am I considered married if I’m separated but not divorced?  What do I choose if my spouse passed away last year?

As with anything involving taxes, the answer often changes depending on the circumstances.  In general, if you are married before December 31st of a given year, your two options are to go married filing joint (MFJ) and married filing separate (MFS).  But we’re pretty sure you might have the following questions:

Wait, I can’t file as single?  Nope, not under ANY circumstances.  You are now married and have to file as such.

But what if I didn’t change my name with the SSA?  Doesn’t matter.  You will show your maiden name on your return, but your filing status will NOT be single.

Okay, so what if I married someone from another country and we haven’t been married in the US yet?  This opens up another can of worms that we’ll write about in another post.  But the short answer is the same as point number one, you have to file MFJ or MFS.

What happens if my spouse leaves me?  This one can get tricky.

  • Typically you would file MFJ
  • If you and your spouse aren’t on speaking terms (or you don’t know where they are) you would file MFS unless…
  • You have a child AND your spouse didn’t live with you for the last 6 months of the year – you may qualify to file Head of Household (HOH)

Okay, what if we got married and divorced in the same year?  If on December 31st you were legally divorced OR legally separated, according to state law, under a decree of divorce or separate maintenance then you can file as single.

What happens if I was married, but my spouse passed away?  If you spouse died during the tax year you are filing (e.g. 2012 in 2013) you can file MFJ for that year.  For 2013 and 2014 you may be able to file Qualifying Widow(er) if certain conditions are met.

As you can see, picking the right status can be a challenge.  If you need further help, check out IRS Publication 17 or their tool What Is My Filing Status?  If you want to know if it’s better to file MFJ or MFS, check out this post we did last year.

By |2020-09-18T11:37:15-06:00February 7, 2013|Categories: Tax Talk|Tags: , , , , , |Comments Off on Filing Options For Married Taxpayers
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Who do I issue a 1099-Misc to?

****UPDATE as of 01/01/21****

The information below was originally written when money paid to independent contractors was reported on Form 1099-MISC.  As a result of the The Protecting Americans from Tax Hikes Act of 2015 (the PATH Act), independent contractor payments are now reported via Form 1099-NEC effective tax year 2020 (being filed in 2021). The deadline for filing remains January 31st.

While most of the information below for Form 1099-MISC applies to Form 1099-NEC and generally is still relevant, please refer to the YouTube video below for instructions on how to complete Form 1099-NEC.

******** Original Post Begins Below **********

If you employ an independent contractor in your trade or business, you are obligated to report their earnings to them and the IRS.  This is typically done via the IRS form 1099-MISC.  But just who is supposed to receive this form, when is it due and what are the penalties if it’s not filed on time?

Who Receives Form 1099-MISC

Form 1099 goes out to independent contractors if you pay them $600 or more to do work for your company during the tax year.  Additionally, those whom you pay at least $10 in royalties or broker payments in lieu of dividends or tax-exempt interest should also receive a 1099.

Taxpayers should note that if you earned less than $600 and you don’t get a 1099, this doesn’t mean you don’t have to report the income.  All income (it doesn’t matter if it’s $1) is taxable and should/must be reported.

In addition to individuals, you must also send a 1099 to the following if you paid them for doing work:

  • Businesses that file on form 1040 Schedule C (i.e. sole proprietors/self employed)
  • Single member LLCs, as they are considered disregarded entities (DREs) and also file on Sch C
  • Partnerships or Multimember LLCs as they essentially file the same return as a partnership

However, there are some instances in which you don’t need to issue a 1099-MISC.  These exceptions include:

  • Suppliers of merchandise, telegrams, telephone, freight, storage, and similar items, with the exception of those who deal in fish or other aquatic life
  • Corporations (e.g. those who’s names contain Corporation, Company, Incorporated, Limited, Corp., Co., Inc. or Ltd.) are also exempt from 1099 requirements, with the exception of those you pay for medical or health care, or law firms that you’ve hired for legal services
  • Those corporations that have filed a S-Corp election with the IRS
  • Tax-exempt organizations or to American or foreign governments

Need the specifics on who is exempt and who isn’t and don’t mind reading the Internal Revenue Code?  Check out section Treasury Regulations, Subchapter A, Sec. 1.6049-4(c)(1)(ii) where it talks about a corporation, as defined in section 7701(a)(3).

When Is Form 1099 Due?

Generally you must furnish a copy of form 1099-MISC to the recipient by January 31st of the year following when the payments were made.   If you are reporting payments in boxes 8 or 14, then you have until February 15th of the year following when the payments were made.

In addition to the recipient, you must also send a copy to the IRS (along with Form 1096) by January 31st IF you are reporting amounts in Box 7 for Nonemployee Compensation.  If you are reporting amounts in any other box:

  • You must submit it by February 28th of the year following when the payments were made if you are sending it via paper
  • If you are submitting everything electronically, then you have until March 31st of the year following payment.

What are the penalties for filing late?

If you fail to file a correct information return by the due date and you cannot show reasonable cause, you may be subject to a penalty. The amount of the penalty is based on when you file the correct information return. Currently, the penalty is:

  • $50 per information return if you correctly file within 30 days; maximum penalty $532,000 per year ($186,000 for small businesses)
  • $100 per information return if you correctly file more than 30 days after the due date but by August 1; maximum penalty $1,596,500 per year ($532,000 for small businesses)
  • $260 per information return if you file after August 1 or you do not file required information returns; maximum penalty $3,193,000 per year ($1,064,000 for small businesses)

Obtaining the information needed to file Form 1099

To ensure that you issue a correct 1099 to the recipient, complete Form W-9, Request for Taxpayer Identification and Certification.  The W-9 includes the individual or businesses legal name, tax ID number, address and their signature attesting to the correctness of the content. You will then use this information to create the 1099 and send it to the IRS.

Do you have 1099s that you need to file?  Shoot us an email at the address below or give us a call at 773-239-8850.  Our filing services are extremely affordable (as low as $10/form) and not only will your documents be filed with the IRS, SSA and state, they can also be mailed to the recipient!

By |2021-02-08T15:16:52-06:00January 30, 2013|Categories: Tax Talk|Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , |Comments Off on Who do I issue a 1099-Misc to?
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Chicago’s Protection Against Unfair Tax Preparers

In February 2012, there was a group of taxpayers in Chicago (and other states) that were pretty irate with one tax preparation company.  Essentially, consumers were complaining of being told that the preparation of their tax return would cost $ and were told they had to pay $$$ when they went to get their return.  There were a host of other charges made regarding this firm (e.g. inability to cash refund checks, checks for lesser amounts, etc) which ultimately led to the company being barred by the Illinois Attorney General from conducting business in Illinois.

Taxpayers in urban areas are sometimes targeted by unscrupulous tax preparation companies.  These companies often use deceptive advertising practices, fail to fully disclose the cost of their services and often prey on the ignorance of those taxpayers who are less knowledgeable of their options.  Well, the IRS and other governmental agencies got tired of getting complaints from Senators and Congress on behalf  dissatisfied taxpayers.  The result?  The elimination of certain “predatory” products (e.g. Refund Anticipation Loans) as well as greater regulation/enforcement of preparers.

In an effort to protect Chicagoans, the Chicago City Council passed an ordinance in 2012 to help educate and protect them against unfair tax preparers.  If you are a taxpayer using a paid preparer in 2013, know that most* tax preparers must do the the following:

  • Offer a detailed explanation of their available services.
  • Prior to rendering any service must provide the price of each offered service, any and all fees, and an estimate of the total charge based upon the services chosen for purchase.
  • Inform customers of the reasonable period of time they can expect to wait for a refund.
  • Tell customers they have the right NOT to utilize an alternative settlement product.
  • Certify that they provided a clear explanation and the required disclosures.
  • Inform customers of their right to file a complaint.

We recommend that you visit the City’s website and print the appropriate copy (English or Spanish) applicable to you.  That way you can discuss it with your preparer if they give you any indications that they may not be on the “level” so to speak.  Personally, we’d look for another preparer if one gives you any reason to believe that they may be unscrupulous.  Matter of fact, we know just who to recommend!

Until next time.

* This ordinance applies to preparers physically located in the City of Chicago, with the exception of CPAs and Attorneys.

By |2020-09-21T12:32:19-06:00January 14, 2013|Categories: Tax Talk|Tags: , , , , , |Comments Off on Chicago’s Protection Against Unfair Tax Preparers
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2013 Tax Changes – The Fiscal Cliff Fallout

On January 1st, 2013, HR 8, the American Taxpayer Relief Act of 2012, passed the Senate and the House of Representatives.  Below is a summary of the tax impact from what was changed and maintained by the bill.

TAX RATES

Income tax rates made permanent. For 2013 and beyond, the top individual income tax bracket will increase from 35% to 39.6% for taxpayers with taxable income of $400,000 or more ($450,000 or more Married Filing Jointly). Taxpayers with income below the thresholds will not see an increase in tax rates.

Capital gain rates. Beginning in 2013, the maximum capital gains tax will increase from 15% to 20% for taxpayers with taxable income of $400,000 or more ($450,000 or more Married Filing Jointly).

Payroll tax holiday. The 2% reduction in Social Security tax for employees and self-employed individuals expired at the end of 2012 and will not be extended for 2013. An employee’s Social Security portion of FICA will increase from 4.2% to 6.2%, with a corresponding increase in self-employment tax.  Result?  A little less take home pay each pay check.

Employer withholding. On December 31, 2012, the IRS issued guidance on withholding, assuming expiration of the 2001 and 2003 tax rates and subsequent tax rate increases at all income levels. The IRS instructed employers to begin using the new withholding rates as soon as possible, but no later than February 15, 2013.  As this guidance was issued before the new law, the IRS is expected to release new withholding tables to reflect the changes in tax rates shortly.

Alternative Minimum Tax (AMT).  The AMT “patch” is applied retroactively to January 1, 2012, and made permanent. For 2012, the AMT exemption amounts will be $50,600 for individuals and $78,750 for married couples.

Estate Tax.  Beginning in 2013, the estate tax rate will increase from 35% to 40% for estates that exceed $5 million in value.

EXTENDERS

Earned Income Credit. The enhanced Earned Income Credit amounts have been extended for five years.

Child Tax Credit. The $1,000 amount for each child for the Child Tax Credit has been extended Permanently.

American Opportunity Credit. The partially-refundable American Opportunity Credit has been extended for five years.

Tuition and fees. The adjustment to income for tuition and fees has been extended through 2013.

Educator expenses. The adjustment to income for educator expenses for primary and secondary teachers has been extended through 2013.

State and local general sales taxes. The deduction on Schedule A, Form 1040, for state and local general sales taxes has been extended through 2013.

Qualified principal residence indebtedness. The exclusion from income for qualified principal residence indebtedness has been extended through 2013.  This is good news for those who were in the process of foreclosure proceedings at the end of 2012 that had not yet been finalized.

Mortgage insurance premiums. The deduction for mortgage insurance premiums as mortgage interest on Schedule A, Form 1040, has been extended through 2013.

Charitable distribution of IRAs. The provision allowing tax-free distributions from IRAs for charitable purposes has been extended through 2013.

Energy Tax Extenders  A variety of energy tax credits have been extended for energy-efficient homes, alternative fuel vehicle refueling property, and energy-efficient appliances.

AGI PHASEOUTS

Phaseout on itemized deductions. Beginning in 2013, itemized deductions will begin to phase out for taxpayers with AGI of $250,000 or more Single, $275,000 or more Head of Household, or $300,000 or more Married Filing Jointly.

Phaseout of personal exemptions. Beginning in 2013, personal exemptions will begin to phase out for taxpayers with AGI of $250,000 or more Single, $275,000 or more Head of Household, or $300,000 or more Married Filing Jointly.

OTHER ITEMS

Unemployment Compensation.  The temporary extension for unemployment benefits has been extended for one year.

Sequestration.  The mandated sequestration spending cuts that were scheduled to take effect at the end of 2012 were delayed for two months by the new legislation.

Marriage Penalty.  In 2001, legislation enacted marriage penalty relief to avoid a higher tax bill for a married couple as compared to two single individuals. As evidenced by the $400,000/$450,000 income thresholds for increased tax rates and standard deduction, the provisions for marriage penalty relief expired beginning in 2013.

By |2013-01-07T14:17:36-06:00January 7, 2013|Categories: Tax Talk|Tags: , , , , |Comments Off on 2013 Tax Changes – The Fiscal Cliff Fallout
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Tax Impact of being 1099 vs. a W2 Employee

So back in this post we reviewed how an employer goes about classifying a worker as either an employee or an independent contractor.  However, what if you are on the receiving end of that classification?  What is the financial and tax impact of receiving your pay either via W2 or 1099?  In this post will follow the exploits of two workers, Suzy Salary and Contractor Chuck.  To keep this example simple and straightforward, we’ll assume the following about both Suzy and Chuck:

  • Work similar jobs (with different companies)
  • Don’t have any pretax contributions coming out of their checks
  • Each  make $100,000 per year
  • Are both single without any dependents and take the standard deduction
  • Didn’t have any Federal income taxes withheld from their checks (i.e. Suzy didn’t have these deducted from her check, but we’ll assume Social Security and Medicare were withheld)
  • IRS penalties don’t apply
  • We’ll ignore the whole 2% payroll holiday that has been in effect the past few years

Amount Earned The easiest difference to spot will be in the amount of their checks.  Suzy will take home about $93,800 (due to combined 7.65% withholding of Social Security and Medicare) while Chuck will take home the full $100,000.  However, it gets interesting when the two actually go to file their tax returns.

Self Employment Taxes The basic concept to remember with this is that when you work for someone, you and they split the Social Security and Medicare taxes equally (i.e. 7.65% for each of you).  However, when you are self employed, you have to foot the whole bill or 13.3% up to income of $106,800.  True you will see an adjustment on the 1st page of your tax return (it’s labeled “Deductible part of self-employment tax”), however due to the nature of the calculations, it doesn’t yield you a true 50% benefit.

Bottom Line Tax Impact  At the end of it all, Suzy will wind up paying about $18,957 in income taxes and $6,200 in Social Security and Medicare for a total of $25,157.  Chuck on the other hand will pay $16,979 in income taxes and $12,283 in self employment for a total of $29,262.  Total tax bill difference winds up costing about $4,105.

Why Bother Being 1099?  If your employer gives you the option between the two, the W2 option will more than likely put you at ease.  You won’t have to worry about setting cash aside for your taxes bills as your boss will simply withhold them.  However, the truth of the matter is that most individuals who are “truly” considered contractors actually may pay a lower tax bill due to having expenses associated with earning their income.  For example, a cable installer will typically have the cost of keeping up their vehicle, supplies necessary to perform the work as well possible office related expenses.  In the end, they can deduct these allowable expenses on their return whereas an employee cannot.

So if faced with a choice of which type of way you would like to be paid, take the time to consult with your tax practitioner as they can advise you on the possible ramifications of your particular situation.

By |2012-12-24T13:15:58-06:00December 24, 2012|Categories: Tax Talk|Tags: , , , , |Comments Off on Tax Impact of being 1099 vs. a W2 Employee
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The Unavoidable 2013 Tax Season Delay

Back in 2010, the IRS was forced to delay when it began processing tax returns due to late passing legislation made by Congress.  In a recent letter from Acting Commissioner Steven Miller, who wrote to Representative Sander Levin, who sits on the House Ways and Means Committee, the IRS warned that this could be the case in early 2013.  Why?  Well, as Congress works on the Fiscal Cliff, there are two other pieces of legislation that must also be voted upon.  As noted in Commissioner Miller’s letter, these are:

  1. Whether the parameters of the alternative minimum tax are revised (referred to as “the AMT patch”)
  2. Whether any already expired tax deductions are revived and made effective for 2012 (the “tax extenders”).

AMT Patch Of the two items, this one poses the more significant challenge for the IRS.  AMT applies to individual taxpayers with incomes above specific thresholds set by law.  For many years, Congress has been “indexing” these amounts for inflation to prevent taxpayers from being subject to AMT.  If this is not done, or Congress delays doing it, under current law the thresholds revert to much lower levels for 2012 – $33,750 for individuals and $45,000 for married taxpayers filing jointly. At these levels, approximately 33 million taxpayers would pay AMT for tax year 2012 (with returns filed in the spring of 2013). This is about 28 million more taxpayers who would pay the AMT than if the exemption amounts were increased as in the past.

Tax Extenders At the end of 2011, a number of other tax provisions affecting individuals expired.  These include tax deductions for educators’ out-of-pocket classroom expenses, tuition and related fees for higher education, and state and local sales taxes.  The challenge for the IRS on these items is whether or not legislation will be passed to extend these provisions again.

So just how delayed could the filing season be?  According to Commissioner Miller if the AMT patch is enacted before the end of 2012, there would be minimal delays to opening the 2013 tax filing season for most taxpayers.  This is because the IRS has already programmed it’s systems as if the patch will be enacted.  However, if the AMT patch is allowed to expire, the magnitude and complexity of the changes necessary to get the system ready could delay the filing season for impacted taxpayers until late March 2013, if not even later.  Conversely, processing would only be delayed by about four weeks if Congress decides to revive and extend already expired tax provisions.

What This Means For You

  • Tell people to spread the word.  For some taxpayers, the timing of when they file and receive their refunds is critical to their financial situations.  Being informed that there could be delays regarding the above could impact items such as how Christmas spending is arranged for.
  • Be prepared for the possibility that tax return processing and the issuance of refunds may be delayed this upcoming 2013.  While you may be able to file starting in January, the IRS may hold these returns in a queue, which could create a processing backlog.  Depending on the size of this queue, returns that are filed in January may not be processed until a few weeks later, if not several.
  • Start to get your documents ready and file as soon as you have your information.  Firstly, you want to get your information in early so that if a queue does manifest, you are on the top of it and not the bottom.  Secondly, make your tax preparers life a little easier.  While the start of the filing season may move, the April 15th deadline will be the same as it is enacted by law.  With that being said, it will be a stressful time for most preparers and many will be thankful if you “help them help you” so to speak.

Be patient throughout the process.  A lot of what may happen is largely out of the control of your preparer, the tax software companies and even the IRS.  So while it may be a little frustrating, realize that we will all get through it if we just take the advice of our friends Telepopmusik and just breathe.

01/03/13 Update:  So on January 1st 2013 HR 8, the American Taxpayer Relief Act of 2012, was passed by the Senate and the House of Representatives.  This bill makes the AMT issue noted above mute as they have permanently patched AMT so it doesn’t have to be done every year.  They also passed some of the extenders as well.

Everyone is still awaiting definitive guidance from the IRS, but at this point in looks like filing may open late January or early February.

01/08/13 Update:  So the IRS has issued IR-2013-2 and announced today it plans to open the 2013 filing season and begin processing individual income tax returns on Jan. 30.

The IRS will begin accepting tax returns on that date after updating forms and completing programming and testing of its processing systems. This will reflect the bulk of the late tax law changes enacted Jan. 2. The announcement means that the vast majority of tax filers — more than 120 million households — should be able to start filing tax returns starting Jan 30.

The IRS estimates that remaining households will be able to start filing in late February or into March because of the need for more extensive form and processing systems changes.

By |2020-09-16T12:00:51-06:00December 16, 2012|Categories: Tax Talk|Tags: , , , , , , , |Comments Off on The Unavoidable 2013 Tax Season Delay
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2% Shareholders, S Corporations and Fringe Benefits

The IRS code section related to fringe benefits allows employers (in most cases) to deduct the cost of fringe benefits, while employees may exclude those amounts from their gross income.  Employer paid health insurance costs are an example of such costs.  However, while it seems like deducting health insurance premiums for a shareholder/employee of an S corporation should be a simple matter, only the tax law can make something that should be simple, complicated.

The problem goes back many years and arose soon after S corporations became part of tax law. Initially, S-corporations were viewed as similar to partnerships, and there was a prohibition on deducting certain fringe benefits of partners.  Thus, a deduction was denied to S corporations for certain fringe benefits, most importantly health insurance, paid on behalf of S corporation shareholders.  Well, not all shareholders, only those owning more than a 2% interest.

Approach.  Health insurance of a 2% shareholder isn’t deductible by the corporation unless it’s included in the shareholder-employee’s income.  Thus, the approach to make it a deductible expense by the corporation is to include the income on the shareholder’s W-2.  At this point it’s a wash – the corporation gets a deduction and the shareholder has income (of course, the deduction is “passed through” to the shareholder).  In the final step the shareholder deducts the premiums on his Form 1040, making the insurance premiums deductible.

Corporation or shareholder’s plan? What if the plan isn’t exactly 100% paid for by the corporation?  The plan providing for coverage is established by the S corporation if:

  1. The S corporation makes the premium payments for the health insurance policy covering the 2% shareholder-employee (and his or her spouse or dependents, if applicable) in the current taxable year, or
  2. The 2% shareholder makes the premium payments and furnishes proof of the payment to the S corporation and the S corporation reimburses the shareholder-employee for the premium payments in the current tax year.

If the accident and health insurance premiums are not paid or reimbursed by the S corporation and included in the 2% shareholder-employee’s gross income, a plan providing medical care coverage for the shareholder is not established by the S corporation and the shareholder is not allowed the deduction.

In order for the shareholder to deduct the amount of the premiums, the S corporation must report the premiums paid or reimbursed as wages on the shareholder-employee’s Form W-2 in that same year. In addition, the shareholder must report the premium payments or reimbursements from the S corporation as gross income on his or her Form 1040.

Examples. It always helps when one has an example to clarify the various scenarios that may be encountered.  In the examples below, Goofball Inc. is an S corporation and Jeb and Bobbi Joe are 2% shareholder-employees.

  1. In 2012 Jeb, a shareholder in Goofball Inc., obtains an accident and health insurance policy in his name and makes the premium payments on the policy.  Goofball makes no payments or reimbursements with respect to the premiums. In this case a plan providing medical care for Jeb has not been established by the S corporation and Jeb is not entitled to the deduction under Sec. 162(l).
  2. In 2012 Goofball obtains a health insurance plan in the name of Goofball. The plan provides coverage for Jeb, his spouse, and dependents.  Goofball makes all the premium payments to the insurance company. Goofball reports the amount of the premiums as wages on Jeb’s Form W-2 for 2012 and Jeb reports that amount as gross income on Form 1040 for 2012. In this case a plan for providing medical care for Jeb has been established by Goofball and Jeb is allowed the deduction under Sec. 162(l).
  3. For 2012, Bobbi Joe obtains a health insurance policy in her name. Goofball makes all the premium payments to the insurance company. Goofball reports the amount of the premiums as wages on Bobbi Joe’s Form W-2 and Bobbi Joe reports that amount as gross income on Form 1040. In this case a plan providing medical care for Bobbi Joe has been established by Goofball and Bobbi Joe is allowed the deduction under Sec. 162(l).
  4. For 2012, Bobbi Joe obtains a health insurance policy in her name. She makes the premium payments to the insurance company and furnishes proof of premium payment to Goofball. Goofball then reimburses Bobbi Joe for the premium payments. Goofball reports the amount of the premiums as wages on Bobbi Joe’s Form W-2 and Bobbi Joe reports that amount as gross income on Form 1040. In this case a plan providing medical care for Bobbi Joe has been established by Goofball and Bobbi Joe is allowed the deduction under Sec. 162(l).
By |2012-11-25T17:45:12-06:00November 25, 2012|Categories: Tax Talk|Tags: , , , , |Comments Off on 2% Shareholders, S Corporations and Fringe Benefits
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Hiring Your First Employee & Payroll Taxes

So, in this post we discussed the trials and tribulations of finding the perfect employee for your company.  Now we’ll take a look at the tax implications so you keep yourself out of hot water with the regulators, or said another way, what ever employer should know BEFORE they hire their first employee.

Eligibility to Work in the United States.  Every employer must verify that each new employee is legally eligible to work in the United States. You don’t want to run into problems later so have the employees you hire fill out Form I-9, Employment Eligibility Verification.  You can also get their SSN at this stage.

Employee vs. Independent contractor.  While you may want to classify a person as independent contractor to avoid the hassle of dealing with payroll taxes, make sure the classification is proper.   Generally speaking, an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.  Not sure what your new hire will be?  Check out this site for a little assistance.

Independent Contractors Agreement.  If you do determine that the person who’ll work for you does qualify to be classified as an independent contractor, it’s a good idea to draft an agreement.  This document should outline the duties they will/won’t perform, how they are compensated and the responsibilities with reporting their earnings to the IRS.  This way you are protected in case the employee disagrees that they were an independent contractor or worse files a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

Fill out Form W4.  To know how much income tax to withhold from an employees’ wages, you should have them complete Form W-4, Employee’s Withholding Allowance Certificate.  Ask all new employees to give you a signed Form W-4 when they start work. Make the form effective with the first wage payment.  If the employee claims exemption from income tax withholding, they must indicate this on their W-4. The amount of income tax withholding must be based on filing status and withholding allowances as indicated on the form. If a new employee does not give you a completed Form W-4, the IRS recommends that you withhold tax as if he or she is single, with no withholding allowances.

Withholding & Matching Taxes.  So as an employer you will act as a collector and depositor of taxes.  You should withhold the proper amount of federal income tax based on the employees Form W4.  Additionally, you are required to withhold social security and Medicare taxes from your employees’ wages and pay the employer’s share of these taxes.  Generally speaking the employee AND employer tax rate for social security is 6.2% on wages while the tax rate for Medicare is 1.45% each for the employee and employer (2.9% total).  All of the above is deposited via a system called EFTPS by the employer.

Reporting.  In addition to withholding and depositing payroll taxes, employers must periodically report these amounts to the government.  These are done via Form 940, 941 or 944.  You may be asking yourself “What is the difference between Federal 940, 941 and 944 taxes?”  941 tax filings are submitted each quarter. 944 tax is the same as the 941, but is filed and paid on an annual basis.  The IRS makes the determination on which tax form you will file and how often you need to deposit your tax withholdings depending on the size of your payroll.  940 tax is Federal Unemployment. Unless you are exempt, you are required to report/pay this tax on an annual basis in addition to your 941 or 944 taxes.

By |2020-09-16T11:19:36-06:00October 29, 2012|Categories: Tax Talk|Tags: , , , , , |Comments Off on Hiring Your First Employee & Payroll Taxes
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IRS Notices & How To Handle Them

So, you go to the mailbox and one of the letters has a return address that sends chills down your spine: IRS.  While your first instinct is to drop the letter on the ground and hightail it back into the house and hide under the bed, that’s probably not the best choice.  While most people don’t like being contacted by the IRS, many of their letters are no cause for panic because they are not audit related.  This post will help you determine what type of notice you received and the steps you should  take to begin clearing matters up.

The first step in the process is to determine what type of notice you have received.  This IRS has over 76 different form letters that you can receive for various reasons.  Listed below are the four main categories that they fall into.

Automated Adjustment Notice.  These notices tend to start with a CP### and tend to contain the language “Summary of Proposed Changes.”  The good news is that this is a computer generated notice and its far more straightforward and easier to deal with than an audit.  About 3% of tax returns filed will produce an automated adjustment notice.  The notice you receive will be due to one of the following four reasons:

  • Error correction – the IRS believes it has found a math error or similar problem in the return
  • Penalty assessment – the IRS believes you did not meet a filing or tax payment deadline
  • Interest assessment – the IRS believes you did not pay a tax bill on time
  • Under reporting – your tax return doesn’t list all the income others have reported to the IRS via 1099 or W-2 forms.

Next Steps

  • Read the notice and determine what the IRS is asking you about
  • Call the IRS (800-829-1040 if the numbers isn’t on the notice) and ask the representative for an explanation of the automated adjustment
  • If you are prepared, state why you believe the notice is wrong or correct
  • If you don’t clear up the matter on the phone, ask the person to note on its record that you disagree with the notice (take down the date and time you called)
  • Draft and send in your response.  If you agree with the IRS/amount then sign the form and return it to the IRS along with payment.  If you disagree, draft a brief letter stating why and send it (along with a copy of the notice) back to the IRS

Correspondence Audit.  These notices tend to contain a check list of items, some of which may or may not be checked.  While the bad news is that this is in fact an audit, the good news is that of the three audit types, this one is typically the easiest to deal with.  Correspondence audits make up 75% of all IRS audits and do not require you to meet face-to-face with an IRS auditor.

Correspondence audits are used to verify straightforward matters.  For example, the IRS may request that you send in purchase and sale documentation to verify gains or losses on stock sales, or closing statements for real estate sales.  Typically resolution can be had by simply sending in the requested documents, but sometimes the IRS is proposing changes that you may disagree with.

Next Steps

  • Read the notice and determine what the IRS is asking you to do/provide
  • Make photocopies of the documents you gather and neatly organize them so they can easily be examined by the IRS (don’t send your originals)
  • Write a clear and concise cover letter to send with your items (send it to the IRS agent that send you the letter) that list all the documents you are providing
  • Send your items certified mail, return receipt requested, so you have a record of actually responding

Office Audit.  This letter will typically have the numbers 2202 located on it somewhere and may reference an appointment date/time.  Just as it sounds, an Office Audit takes place at an IRS office where you will meet face to face with an auditor.  According to IRS statistics, the average additional tax and penalties owed resulting from an office audit is about $6,000.  The notice you receive should list the specific issues on your tax return that the IRS wants to examine.

Next Steps

  • Call the IRS to schedule the audit or confirm the day and time that the IRS has proposed
  • Highlight or circle all the listed issues on the notice as you find them so you can ensure you gather all of the needed information
  • Review your records and find the documentation needed to justify each issue
  • Organize all relevant documentation into neat categories based on the items in question (only include documentation directly related to the item in question)
  • Make necessary copies to provide to the auditor during your meeting
  • Remain credible during your meeting.  If you lie to the auditor once, they may not believe anything else that you say
  • If further documentation is needed to prove your case and you have it, schedule a date/time to send it to the auditor

Field Audit.   This letter will typically have the numbers 3253 located on it somewhere and may reference an appointment date/time.  Field audits are the most serious of the three and the amount owed often runs into several thousands of dollars.  The subjects of these audits tend to be small business owners, self-employed taxpayers, owners of multiple rental real estate properties, earners of more than $100,000 and individuals with complex tax returns.

The steps to resolve a field audit are essentially the same as an Office Audit.  However, due to their nature and the rigor involved, it’s probably advisable that you secure someone to represent you.  This can be an Enrolled Agent (EA), Attorney or Certified Public Accountant (CPA).  Your agent will then help you gather the necessary information and can even speak to the IRS on your behalf if you prefer not to.  However, the real benefit of representation is that the person can address complex tax matters that you may not know the specifics of (especially if someone else prepared your return).

By |2012-10-10T12:59:26-06:00October 10, 2012|Categories: Tax Talk|Tags: , , |Comments Off on IRS Notices & How To Handle Them
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S-Corps and Taxation Considerations

An S corporation (sometimes referred to as an S Corp) is a special type of corporation created through an IRS tax election (you must first incorporate the business and then make the IRS election via Form 2553).  Many new business owners often contact us asking if this is a good form to conduct business under.  While there are advantages to operating as an S Corp, there are some things that one should consider prior to making the election.  Depending on your goals, one may find that it’s better to operate under another organizational structure.

Ownership Restrictions

Per IRS guidelines, S Corp owners (shareholders) must first meet the following criteria:

  • Limited to 100 or fewer persons/entities
  • Must be US citizens/residents (cannot be non-resident aliens)
  • Cannot be C Corporations (C Corp), other S Corps, limited liability companies (LLCs), partnerships or certain trusts
  • Any shareholder who works for the company must pay him or herself “reasonable compensation.” Basically, the shareholder must be paid fair market value, or the IRS might reclassify any additional corporate earnings as “wages”

Benefits

Many small business owners elect S Corp status for two main reasons:

  • Avoid double taxation on distributions
  • Allow corporate losses to flow through to its owners (however there are 3 loss limitations discussed later)

Other typical advantages include:

  • Limited liability protection. Owners are not typically responsible for business debts and liabilities.
  • Easy transfer of ownership. Ownership is easily transferable through the sale of stock.
  • Unlimited life. When a corporation’s owner incurs a disabling illness or dies, the corporation does not cease to exist.
  • Potential use of personal assets for business use.  Check out this post about S-Corp vehicle usage and this one for S-Corp home office usage.

Pass Through Taxation

What makes the S Corp different from C Corp is that profits and losses pass through to your personal tax return. Consequently, the business is not taxed itself, only the shareholders are taxed.  The amount which is taxed is determined by the shareholders basis (i.e. their interest in the business).  What is unique about S Corp basis is that it fluctuates depending on several things including the company’s operational performance.

Additionally, since the tax liability lies with the shareholder and not the corporation, individuals have to make sure that they receive enough money from the corporation in the form of distributions in order to satisfy their tax obligation.  Non dividend distributions aren’t taxable to the extent the shareholder has adequate basis.

Importance of Basis

It is important that a shareholder know their stock AND debt basis at all times. As such, it is imperative that it be calculated every year.  If the corporation allocates a loss or deduction to the shareholder, in order to claim it the shareholder needs to demonstrate that they have enough stock or debt basis.  For example, if a person invests $10,000 in a company (i.e. stock basis) and the company then passes through a $18,000 loss to them in a single year, only $10,000 will be deductible in that year.  The remaining $8,000 becomes “suspended” until the shareholder has adequate basis in the future.

Loss Limitations

As mentioned above, losses are limited to the extent that an owner has basis.  However, there are in fact three limitations which could cause a loss to be nondeductible at any given time.  Each limitation must be met in the following order before a shareholder is allowed to claim a flow through loss:

  • Stock and Debt Basis Limitations
  • At Risk Limitations
  • Passive Activity Limitations

Calculating Stock Basis

A good way to think of stock basis is in terms of a checking account.  Basis essentially equals deposits and earnings less any withdrawals made.  Furthermore, similar to a bank account (with no overdraft protection) basis cannot go negative – that is more cannot come out than goes in.

  • Initial basis typically starts with the money a shareholder paid for the S Corp shares, property contributed to the corporation, carryover basis if gifted stock, stepped-up basis if inherited stock or basis of C Corp stock at the time the C Corp converts to an S Corp.
  • Subsequent basis is made via adjustments which are typically recorded at the end of the corporations tax year.  First they are increased by income items, then decreased by distributions and lastly decreased by deduction and loss items.  The order is important because if basis is positive before distributions but would be negative if all deduction items were subtracted (however, again, basis cannot be negative) then the excess loss would be suspended rather than the excess distribution being taxable.

Other Important Considerations

  • S Corps must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee.
  • The instructions to the Form 1120S, U.S. Income Tax Return for an S Corporation, state “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.”
  • Under section 7436 of the Internal Revenue Code, the IRS has the authority to reclassify payments made to shareholders from non-wage distributions to wages (which are subject to employment taxes).
  • Suspended losses and deductions due to basis limitations retain their character in subsequent years. Any suspended loss or deduction items in excess of stock and/or debt basis are carried forward indefinitely until basis is increased in subsequent years or the shareholder disposes of their stock.
  • In determining current year allowable losses, current year loss and deduction items are combined with the suspended loss and deduction items carried over from the prior year, though the current year and suspended items should be separately stated on the Form 1040 Schedule E or other appropriate schedule on the return.
  • If the current year has different types of loss and deduction items, which exceed stock and/or debt basis, the allowable loss and deduction items must be allocated pro rata based on the size of the particular loss and deduction items.
  • If a shareholder sells their stock, suspended losses due to basis limitations are lost. Any gain on the sale of the stock does not increase the shareholder’s stock basis. A stock basis computation should be reviewed in the year stock is sold or disposed of.
  • A non-dividend distribution in excess of stock basis is taxed as a capital gain on the shareholder’s personal return. Stock held for longer than one year is a long-term capital gain (LTCG).
By |2019-08-28T07:38:59-06:00September 30, 2012|Categories: Tax Talk|Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , |Comments Off on S-Corps and Taxation Considerations
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