Payroll is like a giant octopus wrapping its long tentacles around your business and personal life. Those income, social security, and unemployment taxes are being used to churn the economy. The need for the government to collect supersedes any political jargon you hear about them “helping” small businesses. The truth is that one of the biggest obstacles any small business faces is dealing with payroll and payroll compliance issues.
I can do a whole course just on this chapter alone, but because of the scope of this course, I’m going to leave a lot of the details to a more advanced course and stick to the documentation and bookkeeping aspects of payroll.
Here are the main issues when it comes to payroll and your business:
- Payroll registration
- Employee/Employer documentation
- Payroll compliance
- Independent contractors
Under the heading of payroll, due to compliance issues is the topic of independent contractors. This has been the business owners solution to circumventing payroll taxes.
Let’s explore the independent-contractor. Always a bone of contention with IRS, but they lacked human resources and political clout to enforce the rules. It’s not like that anymore. Today the IRS and states department of labor and insurance companies are attacking this on many fronts.
- 1099 filing requirements – IRS now has a box on all tax returns asking if the business was required to and in fact, they did file all 1099s
- Companies are required to send 1099s to unincorporated entities receiving over $600 per year.
- Technology – a dominant driving force in all of today’s compliance is the fact that the governments have learned how to leverage technology. Sharing of information between government agencies and third party vendors has made isolationist and “underground” businesses come out into the light and start paying taxes.
Why is this an issue? Social Security. It’s that simple. Individuals classifying themselves as independent-contractors are notorious for not filing returns. By forcing businesses to submit form 1099 for independent contractors, the IRS can quickly identify those “businesses” that have not filed.
|TRUE STORY: I recently prepared a return for a new client, a sole proprietor that worked as a subcontractor. He “forgot” to file his 2013 tax return and report the income. A business he had worked as a subcontractor for filed 1099s with the IRS and 18 months later he received a bill from the IRS.
The IRS is slowly but methodically using the laws already on the books to conjure up the underground economy. An economy where taxpayers like my new client “forget” to file their tax returns. You don’t need a 1099 to prepare your tax return. In fact, you don’t even attach a 1099 to your tax return unless there were taxes withheld. If you have a business, you’re supposed to report your income. That’s the law, and up until now the IRS had limited methods and resources to identify these forgetful people.
Employee Vs. Independent Contractor
Identifying individuals and businesses that should be reporting income but “forget” is a huge deal. The approach the government has taken over the past few years has been very effective. For anyone that still wants to play the roulette game and not report their income, I can tell you they will be getting even better. That’s just a part of the story. The other issue that has always been of paramount importance is the employee Vs. independent contractor. This has been an issue since I’ve been in accounting (probably even longer than that) but there were limited ways it could be addressed (policed).
It’s not like that anymore because of “the government needs money” issue and technology. Today, government agencies are sharing data that they couldn’t afford to share before. It may be that the banks and insurance companies are part of the red flag brigade. If you remember the federal government bailing out insurance giant AIG, you can probably start connecting the dots. Bank and insurance companies have a significant stake in the compliance game so be careful about how you keep your books.
Remember that part of my promise to you was to show you how to “audit proof” your books and records. These issues may play an even more significant role than having some expense deductions disallowed. Time will tell but if the trends that began in 2010 continue, we will be looking at some severe changes in the way businesses view their books and records.
Now getting back to the issue of independent contractor vs. employee, the IRS has a few rules to follow. Here is a snippet from the IRS.gov website:
It is critical that business owners correctly determine whether the individuals providing services are employees or independent contractors.
Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.
Select the Scenario that Applies to You:
- I am an independent contractor or in business for myself
- If you are a business owner or contractor who provides services to other businesses, then you are generally considered self-employed. For more information on your tax obligations if you are self-employed (an independent contractor), see our Self-Employed Tax Center.
- I hire or contract with individuals to provide services to my business
- If you are a business owner hiring or contracting with other individuals to provide services, you must determine whether the individuals providing services are employees or independent contractors. Follow the rest of this page to find out more about this topic and what your responsibilities are.
Determining Whether the Individuals Providing Services are Employees or Independent Contractors
Before you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services maybe –
- An independent contractor
- An employee (common-law employee)
- A statutory employee
- A statutory nonemployee
In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered.
Common Law Rules
Facts that provide evidence of the degree of control and independence fall into three categories:
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
- Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.
The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.
This is the end of the IRS site info
Form SS-8 Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding is used to gather facts about the issue. Although the instructions state that a business can file it to get a determination as to the worker’s status, I would tread lightly. Forms like these are used by larger companies to obtain direct, documented approval from IRS. Those businesses have legal and accounting departments and operate on a different plane than small businesses.
|WARNING WARNING WARNING: The IRS issues a number for individuals that do not qualify for a social security card called an I-Tin. They start with the #9 and they can not be used to work here either as an employee or as an independent contractor. They can be used to open a bank account and some individuals are still getting away with using them to work. They are specifically NOT allowed to work and the businesses that hire them could be subject to fines, penalties and yes, audit.|
Other forms and compliance issues:
Form W-9: Request for Taxpayer Identification Number and Certification: Used when hiring an independent contractor.
Form 1099: Used to report payments made to the independent contractor.
|NOTE: 1099’s only have to be issued if the business pays the independent contractor over $600 during the calendar year. Sometimes it’s difficult to predict if that’s going to happen if you’re paying small amounts throughout the year. My recommendation is that as soon as you start paying anyone as an independent include form W 9 with a letter requesting they submit it before their next payment is made.
Accountants and business owners spend way too much time during February and March trying to track down individuals that are supposed to be issued 1099’s. If you don’t get them to fill it out at least you have documentation that you tried. Believe it or not making an honest effort goes a long way.
Form I9 -Employment Eligibility Verification – you won’t find this form on the IRS.Gov website. It’s from The Department of Homeland Security. Do you think it may be an important form?
|True Story: One of my clients was paid an unannounced visit from Homeland Security. All they wanted to see was the I9 forms. Luckily the client followed instructions and had employment folders for every employee along with the specific documents called for in the I9 instructions. What do you think would have happened if they did not? Let’s put it this way- it wouldn’t have been very pleasant for anyone except their attorneys trying to keep them in business.|
Form I9 has specific instructions about what documents are acceptable. I encourage you to become familiar with it if you are hiring either an employee or an independent contractor. You see, the government is adamant about the people working here being legal. Times have changed, drastically.
Form W4: Everyone’s favorite form. It used to be semi optional but not anymore. IRS is scrutinizing how many dependents individuals claim and matching it to tax return filings. Individuals that habitually owe money at the end of the year are having their withholdings involuntarily increased, substantially. What happens is the employer is notified that the withholding amount has to be increased, otherwise they will be penalized. Are you beginning to see a trend here?
Payroll tax registration forms:
When you start a business you need to open a business bank account. The only way to do that is to first apply for a Federal Tax ID #. That’s form SS-4. Filing online at www.irs.gov gets you instant gratification by magically generating your own, unique tax identification #.
A few of the questions pertain to your future plans to hire employees. The questions seem innocent enough but what you are doing is starting the clock. You will begin receiving a lot of what seems like junk mail. A lot of it is useless information but some of it is actually important. For instance, form 941.
Form 941- is used to report your quarterly payroll wages, tax withholdings and social security taxes. If you ignore it, even if you do not have any payroll, you will eventually start getting notices for unfiled payroll tax returns. This is why you need a good accountant. When you get to the point of having employees there is little chance that you will keep up with the avalanche of forms and information.
Form 940- annual report of Federal Unemployment insurance. Another tax most people don’t pay attention to because it’s filed annually. It’s filed annually but the taxes may have to be paid quarterly if your FUI tax is over $500.
State registration: You must also register with you state income tax bureau and/or department of labor. Each state has its own rules and regulations but the one common factor is that they all want you to pay for the national unemployment problems. Non-compliance could be hazardous to your business’s health.
Insurance: Workers compensation and disability insurance may also be required, depending on your state laws. If required, policies must be in place before you begin paying wages, otherwise you’re sure to be hit with penalties. Check with your state department of labor for your requirements.
|This report is about books and records and becoming audit proof. Being audit proof is no longer confined to income taxes. As you can see by all the forms and rules pertaining to payroll how important it is to have all of the required documents in place. Payroll non-compliance is an area that can cripple a business so proceed with caution.|
|Joe DiChiara CPA offers Small Business Advisory Services to passionate entrepreneurs that want to Start, Build and Manage a small business successfully. He enjoys being an “Out of The Box Thinker” and has helped thousands of small business owners start, build and manage their own business. In 2009 Joe discovered a new approach to business through “The Science of Getting Rich” written by Wallace Wattles and the inspiration behind the movie “The Secret”.
After successfully applying the SOGR principles as well as Napoleon Hill’s “Think And Grow Rich” to his own business, Joe discovered that there is a large market segment that is being overtaxed, unprotected and unfairly targeted by IRS. Every year over 3,000,000 entrepreneurs start businesses unaware of the dangers of operating as a sole proprietor with over 25,000,000 in the process of going bankrupt. This discovery inspired Joe to develop programs, tools, and resources to help stem the tide of these avoidable small business failures.
Currently, Joe is building an online school for small business owners www.bedrockbusinessbuildersuniversity.com and www.taxauditsmackdown.com which will help entrepreneurs create the books and records needed to survive any tax audit.
Joe is a #1 Amazon Best-Selling Author and you can Check Out Joe’s Books on Amazon by clicking here!