Choosing a SEP or SIMPLE IRA Retirement Plan

Why Establish an Employee Retirement Plan?

Largely because it’s going to provide for security in retirement. People need income after their paychecks stop because I think we all probably realize that Social Security probably isn’t going to be enough so we need to have employer-sponsored retirement plans to fill this gap. Less than half of all Americans with small employers have a retirement plan at work, and about a third of all Americans have less than $1,000.00 in savings, so a retirement plan will be necessary. Also this is a good way to avoid taxes.

 

Best Reasons to use 401k Plan

For example, if you have something like a 401(k) plan, the taxes are going to be deferred until retirement, so you won’t pay taxes on the money you defer in 2015 but maybe in 20 or 30 years when you start taking the money out. That’s when you start paying taxes on it. And also, you have the value of compound earnings. Just small contributions that you make today can lead to significant savings over the years. And also, very importantly, the employees are going to thank you. You will be able to attract and keep the most qualified employees because those employees will think that you’re a real player since you have a retirement plan.

 

Tax Benefits of Retirement Plan for Employees and Employer

Besides having some security when you retire, a retirement plan has some tax benefits for both your business and your employees. For your business, at the most basic level, you can generally deduct the employer contributions you make to the retirement plan. For the employees, we mentioned the tax benefit of deferring income. When employees make salary deferrals and employers make contributions on an employee’s behalf, they aren’t included in employees’ current income so they aren’t taxed until the employee withdraws them later, usually during retirement. We also mentioned contributions in the plan have the benefit of compound earnings, we’re hoping for many years. And the earnings are also tax deferred. Of course, when you have Roth accounts, they’re taxed differently. When you make contributions to Roth accounts, you include them in current income and pay tax on them.

In exchange, when you later withdraw the money, it’s all tax free, even the earnings, if you meet certain requirements. So, considering the tax savings, employees might favor a retirement plan where the company makes contributions for them in the same amount of taxable salary.

 

Retirement Contribution Savings Credit

There are two credits related to retirement plans. The first one is for employees called the Retirement Contribution Savings Credit, or Savers Credit. This one is designed especially for workers in the low and moderate income range. They can get a credit for up to half the contributions they make to an IRA or a retirement plan. And depending on a person’s income and filing status, the employee can receive a credit of up to $2,000.00 in savings for joint filers.

 

Start Up Costs Credit

The next credit is for the business, the Start Up Costs Credit. You can claim a credit on your business tax return. It’s 50% of the cost to set up, administer and educate employees about the plan. There’s a maximum of $500.00 each year for the first three years. Learn more about these credits on at irs.gov/retirement, and you would just search for retirement savings contribution credit or startup cost credit.

 

Choosing a Small Business Retirement Plan

Something you always have to keep in mind that there’s always going to be a tradeoff between the cost of the plan and the flexibility that you’ll have with the plan. For example, any time you’re talking about IRA-based plans, like SIMPLE IRA plans, or SEP IRA plans, there’s always going to be a very low administrative burden, but there’s also going to be very few special features. Like, for example, if you have an IRA-based plan, it’s not going to allow for loans, it’s not going to allow for hardship distributions, it’s going to have inflexible vesting. All employer contributions will have to be 100% vested at all times.

 

Small Business 401k Plan Maintenance

Now on the flip side, if you have a 401(k) plan, it’s going to offer a lot more features, but there’s going to be more maintenance and there’s going to be more cost. You also have to consider does the plan require annual returns, which is going to be a Form 5500 for a pension plan. That’s a return you generally are going to file with the Department of Labor through their EFAST2 system.

You have to consider does the plan require annual testing, like you have discrimination tests, for example, 401(k) plans like the ADP test and the ACP test. There’s also topheavy tests you might have to consider or coverage tests you’ve got to consider, whereas in like IRA-based plans you don’t have to worry about those. But in the 401(k) plan you will.

The ADP and ACP tests, top heavy, all that stuff, is time consuming and it can be costly. Now you also need to consider the features that you want in the plan, you’ve got to consider the costs, and you’ve got to consider the time that you’re willing to put into the plan. That can help you determine the most appropriate type of plan for your employees.

 

Benefits of Using Traditional IRA for Small Business

You don’t formally adopt a retirement plan. And, to get started, notify your employees that you’re offering this option. It’s really up to your employees to decide whether and how much they’d like to contribute to their individual IRAs through payroll deductions. Your role is simply to collect the contributions and then send them to the IRA provider. You don’t have to file Form 5500. If you’d like to learn more about the basics of setting up a payroll deduction IRA, look for Publication Payroll Deduction IRAs, Publication 4587, and that’s on the IRS website irs.gov/retirement. You could find it a couple ways, either under the Types of Plans link or the Forms and Publications link.

The employees’ role in the payroll deduction IRA is fairly easy. They have to set up either a traditional or a Roth IRA. If they choose a traditional, their ability to deduct contribution depends on their filing status and their modified adjusted gross income. The maximum amount the employee can contribute is the same for traditional and Roth IRAs, and that’s $5,500.00 this year plus an additional $1,000.00 for employees age 50 and over.

 

Payroll deduction IRAs

It’s important to know that payroll deduction IRAs are not considered a plan under the law for reporting disclosure and fiduciary responsibilities. This keeps your role simple. They’re a good option if you think you can’t afford to contribute right now toward your employees’ retirement because employer contributions aren’t allowed. It’s strictly the employee deducting from his or her salary. This may also be good for you if you’re not sure about the future of your business because employees’ IRAs are separate assets. They control the investments, and even if your business closes, they could keep saving in their accounts. A downside to this type of arrangement is the most a person can contribute is the IRA limit, which is lower than the limits in retirement plans.

 

SEP Retirement Plans for Small Business

Let’s talk about SEP plans, Simplified Employee Pension plans. These are going to be funded by employer contributions. It works very similarly to a profit-sharing plan. Generally, there are going to be no employee contributions to these types of plans. The employers can decide how much money to put into the plan each year. And this works largely like a profit-sharing plan whereas the contributions can fluctuate from year to year. So like one year the employer can put in zero. It maybe they didn’t have a good year. And the next year they can put in, you know, maybe $20,000.00 or something. But when they do put money in, it has to be the same percentage of pay for everybody. So in other words, the owner just can’t give himself twenty-five percent and then give everybody else five percent. Also, the owner can’t establish a SEP plan only for himself and then not allow his ten employees to be in the plan. Everybody who is eligible to be in the arrangement has to be in the arrangement.

 

SEP IRA Plan

Now who is going to be included in a SEP plan? It’s got to be all employees who meet the following provisions. Basically, you’ve got to be age 21 and you have to have worked for the employer for three out of the last five years with compensation of at least $600.00 during the current year. Now that is the most stringent that an employer can be with those requirements. They can be more liberal. For example, they can say age 18, or they can have no age requirement at all, they can just say everybody is eligible to be in the plan as of their date of hire.

 

Pros and Cons of SEP plans

Well, it’s an IRA-based plan because all the money is going to IRAs, so it’s going to have very low administrative expenses. It’s going to be easy to set up with a Form 5305-SEP or a similar document that’s offered by a bank or financial institution. Basically, that document, you just download from the IRS’s website, and you have it. It virtually takes five or ten minutes to complete it, and once you complete it you have yourself a plan document. It’s very easy. But when you have a SEP, you’ve got to tell all the employees about it, you’ve got to tell all the employees you have a SEP IRA. It has to be established with each eligible employee. Again, you can’t just cover the owner.

 

Using a SEP IRA Plan

The SEP contributions are flexible, like a profit-sharing plan but, generally speaking the same percentage of compensation must go to everyone. There are no employee salary deferral contributions in a SEP. There’s no testing. There’s no coverage tests, there’s no top heavy tests, there’s no discrimination tests, you don’t have to worry about any of that. And there’s also no annual return that has to be filed. You wouldn’t have to file a 5500 with the Department of Labor or a 5500EZ with the IRS. And another really nice feature is that the contributions can be made as late as the due date of the taxable return including extensions. So like, for example, the contribution for 2015 wouldn’t actually have to be made until 2016, by the due date of the tax return.

 

Information about SIMPLE IRA Plans

If you’re willing to contribute to your employees’ accounts, a SIMPLE IRA plan might be right for you. SIMPLE stands for Savings Incentive Match PLan for Employees, and in this type of plan, employees can make salary deferrals through payroll deduction. So they’re contributing to the plan as soon as they are paid. And the annual limit this year is $12,500.00. Employees age 50 and over can contribute an additional $3,000.00. With the SIMPLE IRA plan, every year you have to decide which one of two formulas to use to make contributions. You could either match what the employee contributes dollar for dollar up to three percent of pay, or you can make a fixed contribution of two percent of pay for all eligible employees, even those employees who don’t make salary deferrals.

 

What to include in SEP IRA Plan?

Okay, so who do you have to include in a SIMPLE IRA plan? You must cover all employees who earned at least $5,000.00 in any two prior years and who you expect will earn that much in the current year. The eligibility requirements, as you can see, are very basic.

You cannot set an hours of service or age requirement to participate in a SIMPLE IRA plan. This doesn’t necessarily mean that Ben would have to include every part time worker in his retirement plan. For an example, if Ben hires students during the summer, it’s likely that they would earn less than $5,000.00 in the time they worked as a part time summer employee. And most students wouldn’t work for more than one year. However, if a student did earn more than $5,000.00 working for Ben for a third year, then Ben would have to include that student in the SIMPLE IRA plan. Not every company can adopt a SIMPLE IRA plan. Your business has to have 100 or fewer employees who made at least $5,000.00 in the prior year. And the other rule about SIMPLEs is called the Exclusive Plan Rule. You can’t have any other type of retirement plan such as a 401(k) or a SEP. The SIMPLE IRA plan has to be your only plan.

 

Advantages of using SIMPLE IRS versus SEP Plan

The key advantages of a SIMPLE IRA plan, like the SEP, are that there’s limited administration, you’re free from testing, and you don’t have to file Form 5500. Before you adopt this plan, though, understand that it does have that required employer contribution. So, you must make either a three percent match or a two percent fixed contribution every year regardless of your business profits. If you elect the matching contribution, you can reduce it to as low as one percent, but you could only do this for two out of five years, and you can’t reduce the contribution in the middle of the year. This is a good plan you can consider if you want to give employees the opportunity to make salary deferrals and you’re not going to have the added complexity of a 401(k) plan. A downside to a SIMPLE IRA plan is that the contribution limits are somewhat lower than 401(k)s. Also you can’t make employer contributions other than the required two percent fixed or the three percent matching.

Starting a SIMPLE IRA Plan

If you’d like to start a SIMPLE IRA plan, the IRS offers two model forms to help you. You would use Form 5305-SIMPLE if you want to choose the financial institution to receive the plan contributions. If you want to allow your employees to choose their own financial institution, use Form 5304-SIMPLE. You could also use a plan document approved by the IRS. One of the requirements in a SIMPLE IRA plan is that you have to notify employees before each year that they’re eligible to be in the plan, they can make salary deferrals, and you also have to let them know the contribution formula you will use. So your paperwork will largely be keeping track of who’s eligible, giving them required information, tracking their contributions, giving notices about the plan terms and elections that your employees have. One note here that if you’re using an outside administrator to help you with your plan, make sure that they have accurate compensation amounts for employees and that they’re including all employees in the plan.

 

 

 

 

Tax Tips for Direct Sellers

The IRS has released a fact sheet that provides guidance to direct sellers on reporting income, properly claiming deductions, and inventory recordkeeping. As you probably know, a direct seller’s compensation is related to sales rather than to the number of hours worked. Services are performed under a written contract between the direct seller and the person for whom the direct seller performs the services, and the contract stipulates that the direct seller is not treated as an employee for federal tax purposes.

 

Direct sellers may include persons who:

  • sell consumer products in the home or a place of business other than a permanent retail store; or
  • sell consumer products on a deposit or commission basis, or to other persons who will sell the products in the home or place of business; or
  • deliver and/or distribute newspapers or shopping guides.

 

A direct seller may need to report as income:

  • sales, commissions, or bonuses; or
  • the value of prizes, awards, gifts and products received from the selling business; or
  • a percentage of the sales of others who work for the direct seller.

 

Filing Form 1099-MISC as Direct Seller

Generally, the direct seller will receive a Form 1099-MISC from the payer under any contract. However, if this information return is not provided, the direct seller is still required to report all of the income received on their income tax return. Additionally, if consumer products totaling $5,000 or more are sold to a buyer for resale, the direct seller is required to report the amount of the sale on Form 1099-MISC and check box 9.

Direct Sellers Taking Business Deductions

Direct sellers can generally deduct ordinary and necessary business expenses, but start-up expenses are not deductible unless the direct seller makes an election during the year the business begins. A deduction may be taken for start-up expenses the year the business begins for an amount equal to the lesser of the amount of start-up expenses, or $5,000 reduced by the amount the start-up expenses exceed $50,000. Any remaining expenses may be deducted over the 180-month period beginning with the month the business begins.

 

Start-up expenses may include the following costs:

  • exploring different direct-selling opportunities;
  • training to be a direct seller for a product line;
  • fees paid to the company to become a direct seller; and
  • purchasing a starter kit from the company.

 

Direct Selling Inventory

Direct sellers must take a physical inventory of products on hand at the beginning and end of each taxable year in order to correctly reflect income. Products held in inventory may include:

  • merchandise with title vested in the direct seller;
  • goods under contract for sale but not yet segregated and applied to the contract; and
  • goods out on consignment.

Methods to Calculate Self-Employment Tax

There are several steps that can used to calculate self-employment tax. It is important to calculate self-employment tax correctly because taxpayers must pay self-employment tax, in addition to income tax on their federal returns if certain situations are met.

 

Rules for Calculating Self-Employment Tax

The rules for calculating the amount of self-employment tax due are a bit different than the rules for calculating federal income taxes. it important to realize these differences when completing a self-employment tax return. Tax self-employment is a social security tax and Medicare primarily for people who are self-employed, operate with the intention of making a profit, generating net earnings from self-employment of $ 400 or more.

 

Step 1: Determine Net Income for Self- Employment

To begin the first step is determining net earnings from self-employment, identifying income, expenses, and deductions that can be used in the calculation of tax self-employment. All allowable deductions, including depreciation, should be claimed. Net income from self-employment usually includes all business income and allowable deductions for purposes of the tax in Puerto Rico.

 

Deductions and Exemptions Not Included in Self Employment Tax

Some deductions and exemptions are not included when the self employment tax is calculated on their own. Do not include:

  • The deduction for personal exemption of the taxpayer, spouse, or dependent
  • Deductions for loss of business (Casualty Claims)
  • Deductions out of business (eg, itemized deductions)
  • The net operating losses from previous years
  • The deduction for health insurance taxpayer (but the deduction is allowed for employee health insurance business)
  • The deduction for 50% federal tax on self-employment
  • The deduction for contributions to pension plans or deferred income, other contributions for the benefit of the taxpayer

Taxpayers with multiple trades or businesses combined net income of all these to compute net income of self-employment. A loss reduces one of the business income earned in another.

Notice: Giving false or increase for Social Security benefits can lead to penalties taxpayer testimony. While taxpayers paying too much tax are rarely ticketed. The Social Security Administration may deny benefits if a taxpayer can not prove who is involved in a trade or business.

 

Step 2: Determine the Adjusted Income for Self-Employment

The second step of the regular method to determine the net earnings from self-employment. We use this formula to determine the adjusted profit of a business:

Net gain x .9235 = Profit adjusted

 

Step 3: Determine Self-Employment Tax

The third step is to determine the current tax. Use these formulas to determine the tax self-employment of a taxpayer:

  • Adjusted profit x .124 = Social Security Tax
  • Adjusted profit x .029 = Medicare Tax
  • Social Security tax Medicare + tax = Tax self-employment

 

What IRS Forms for Self-Employment Tax?

Use the following forms to file your self-employment tax return.

  • Form 1040-SS (English) or Form 1040 (Spanish) if they have no taxable income US
  • Form 1040-SS and Form 1040 can also be used to claim the additional child tax credit (as)
  • Form 1040, Schedule C and Schedule SE if they have income subject to US tax
  • Taxpayers who complete Schedule C and Form 1040, only to pay the contribution of written self-employment “tax for self-employment only” to indicate that self-employment is not subject to US income tax .S., after it is exempt under IRC 933. Enter 0 on line 12 of Form 1040.

 

Estimated Tax Forms for Self-Employed

Taxpayers must make estimated tax payments during the year when the annual contribution is $ 1,000 or more.

Usually, taxpayers make four payments of the same amount. If you do not owe taxes the first quarter, or start doing business in the middle of the year, they must make estimated tax payments for the corresponding quarters. Taxpayers who do the required estimated tax payments can be penalized for underpayment of estimated tax. Use Form 2210, underpayment of Estimated Tax by Individuals, Estates, and Trusts (Underpayment of Estimated Tax by Individuals, Secession and Trust), to compute the infringement. The rate is determined each year using the interest rate at certain times of the year.

 

When are estimated quarterly tax payments due?

Estimated payments are made quarterly on:

  • April 15
  • June 15
  • September 15 and
  • January 15 of the following year

Use the worksheet on Form 1040-ES to compute the estimated tax for self-employment. Taxpayers must register their payments as these payments are reported on Form 1040 year-end. The record must include:

  • Date of payment
  • Amount of payment
  • Credits for the carryover from previous years
  • Net payment for the quarter

Form 1040-ES includes a table to record this information.

Paying the IRS Individual Estimated Tax

Some individuals have to pay estimated taxes or face a penalty in the form of interest on the amount underpaid. Self-employed persons, retirees and nonworking individuals most often must pay estimated tax to avoid the penalty. But an employee may need to pay them if the amount of tax withheld from wages is not sufficient to cover the tax on other income. The potential tax owed on investment income also may increase the need for paying estimated tax, even among wage earners.

 

Paying the IRS Individual Estimated Tax

 As a self-employed individual, generally you are required to file an annual Federal tax return and pay estimated tax quarterly. Quarterly estimated tax payments are due on the following dates: April 15th, June 15th, September 15th, and January 15th. Self-employed individuals generally must pay self-employment tax as well as income tax. As I said before, SE tax is Social Security and Medicare tax primarily for individuals who work for themselves, similar to those withheld from the pay of most wage earners. In general, any time the wording “self-employment tax” is used, it only refers to Social Security and Medicare taxes and not any other tax, like income tax. Before you can determine if you are subject to self-employment tax and income tax, you must first figure your net profit or net loss from your business.

How to Estimate IRS Taxes

You do this by subtracting your business expenses from your business income. If your expenses are less than your income, the difference is net profit and becomes part of your income on page 1 of Form 1040. If the expenses are more than your income, the difference is a net loss. You usually can deduct business loss from gross income from other sources such as wages, interest or dividends on page 1 of Form 1040. But in some situations, your loss is limited. See Publication 334, the Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ) for more information.

 

 

Paying Estimated Tax to IRS

The trick with estimated taxes is to pay a sufficient amount of estimated tax to avoid a penalty but not to overpay. That’s because while the IRS will refund the overpayment when you file your return, it won’t pay you interest on it. Individual estimated tax payments are generally made in four installments. For the typical individual who uses a calendar tax year, payments generally are due on April 15, June 15, and September 15 of the tax year, and January 15 of the following year (or the following business day when it falls on a weekend or other holiday).

 

Who must pay estimated taxes?

Generally, you must pay estimated taxes in 2015 if (1) you expect to owe at least $1,000 in tax after subtracting tax withholding (if you have any) and (2) you expect that your withholding and credits to be less than the smaller of 90 percent of your 2015 taxes or 100 percent of the tax on your 2014 return.  There are special rules for higher income individuals.

 

When is there an estimated tax penalty?

Usually, there is no penalty if your estimated tax payments plus other tax payments, such as wage withholding, equal either 100 percent of your prior year’s tax liability or 90 percent of your current year’s tax liability. However, if your adjusted gross income for your prior year exceeded $150,000, you must pay either 110 percent of the prior year tax or 90 percent of the current year tax to avoid the estimated tax penalty. For married filing separately, the higher payments apply at $75,000.

 

Estimated tax is not limited to income tax

Estimated tax is not limited to income tax. In figuring your installments, you must also take into account other taxes such as the alternative minimum tax, penalties for early withdrawals from an IRA or other retirement plan, and self-employment tax, which is the equivalent of social security taxes for the self-employed.

Suppose you owe only a relatively small amount of tax? There is no penalty if the tax underpayment for the year is less than $1,000. However, once an underpayment exceeds $1,000, the penalty applies to the full amount of the underpayment.

 

What if you realize you have miscalculated estimated taxes before the year ends?

What if you realize you have miscalculated before the year ends? An employee may be able to avoid the penalty by getting the employer to increase withholding in an amount needed to cover the shortfall. The IRS will treat the withheld tax as being paid proportionately over the course of the year, even though a greater amount was withheld at year-end. The proportionate treatment could prevent penalties on installments paid earlier in the year.

 

Income Installment Method of Paying Estimated Tax

If you receive income unevenly over the course of the year, you may benefit from using the annualized income installment method of paying estimated tax. Under this method, your adjusted gross income, self-employment income and alternative minimum taxable income at the end of each quarterly tax payment period are projected forward for the entire year. Estimated tax is paid based on these annualized amounts if the payment is lower than the regular estimated payment. Any decrease in the amount of an estimated tax payment caused by using the annualized installment method must be added back to the next regular estimated tax payment.

Defined Benefit Plans and the IRS

A defined benefit plan provides for a fixed, pre-established benefit for employees at retirement. Those plans provide for a very predictable benefit. In a profit-sharing plan, the amount you end up with at retirement is a combination of contributions, earnings and probably a little bit of luck.

Defined Benefit Plans and the IRS

You’re hoping to save and earn enough. In a defined benefit plan, you have a fixed amount at retirement. The amount the employer has to contribute each year depends on the projected benefits and the trust earnings. If the earnings are very good, the contributions will be lower; and poor earnings will mean more contributions.

 

Defined Benefit Plan Retirement Compliance

These plans are much more complex and more costly to establish and maintain than any other type of plan. They also have a required employer contribution each year. Contributions are not discretionary. These plans employ an actuary to determine the benefits being earned and the yearly funding requirement of the plan. Many have an investment team to monitor and select investments.

 

Defined Benefit Plan Benefits

A defined benefit plan can provide substantial benefits and they can accrue within a very short time. You’ll find some of the largest deductions for contributions made to a defined benefit plan. And just like the profit-sharing and 401(k) plans we discussed earlier, the plan must cover all employees age 21 who work at least 1,000 hours of service during the plan year. These plans also have a Form 5500-series filing requirement. There’s also a Schedule B that the actuary is going to have to complete and sign. You’ll find that most defined benefit plans are sponsored by larger companies, government employers, and very small businesses with large cash flows. During my audit days, it was really common to see a defined benefit plan with a doctor in their 50s. They have a short time left until retirement, so they’re able to contribute and deduct very large amounts into those defined benefit plans.

 

Company Sponsoring a Defined Benefit Plan

A business that sponsors a defined benefit plan is also allowed to have another plan. And since a defined benefit plan generally will have a required contribution each year, it is typical to see companies that have very stable incomes and cash flows have those plans. And when you look at the pros and cons of those, the biggest pro is that these plans provide a predictable benefit at retirement. In a plan that has participant accounts, you’re saving money, and whatever it grows to is what you have. In a defined benefit plan, if you decide you want to replace 80 percent of your compensation in retirement, you can set up a defined benefit plan with a formula that provides 80 percent of your compensation. So, you then just make the contributions each year that are required by the actuary. And they’ll grow to accommodate that monthly income.

2015 Payroll Taxes and Being Self-Employed

The differences between being an employee and being an independent contractor, otherwise known as being self-employed. This is a summary of info on irs.gov and should not be taken as personal tax advice. It is important to pay proper taxes when having self-employment income

 

Introduction to 2015 (2016) Payroll Taxes and Self-Employment

All wage earners in the United States are required to pay three types of federal taxes: FICA Social Security, FICA Medicare, and Federal Income Tax. When a wage earner is an employee, these taxes are withheld from paychecks, then sent on to the IRS by the employer in the form of wage withholding. The employer pays half of the FICA taxes, and the other half is withheld from the paychecks of the employee. The employee will then pay all Federal Income Tax on wages from the

2015 Payroll Taxes and Being Self-Employed

When a taxpayer accepts a job with an employer, one of the first matters of business should be determining if the wage earner will be an employee, or a contractor. Employees have their taxes withheld from paychecks, and the employer will pay half of them. On the other hand, a self-employed contractor will be responsible for the entirety of the FICA tax due because there is no employer paying the other half. This is called Self-Employment tax. It’s comprised of FICA-Social Security and FICA-Medicare.

 

What are 2015 FICA taxes?

The current FICA-SS tax rate is 12.4% – 6.2% for the employer, and 6.2% for the employee, or 12.4% for the self-employed WE. The FICA-M is 2.9% total, or 1.45% for the employer and 1.45% for the employee. The FICA-SS tax has a wage ceiling of $113,700 in 2013 and $117,000 in 2014. When your income is over these amounts, your FICA-SS will not increase.

There is no ceiling for FICA-M. All wages earned are subject to this tax. There is a new Medicare tax of 0.9% relating to the Affordable Care Act for some wage earners. The threshold amounts are $250,000 for married taxpayers who file jointly, $125,000 for married taxpayers who file separately and $200,000 for all other taxpayers

Picking Independent Contractor or Employee?

It is essential that a worker is classified correctly as an employee or independent contractor for many different reasons. The IRS uses several factors that will override whatever the employer or the employee think they are. It is very important to have the correct employment status because there are hugely different tax consequences of being classified an independent contractor rather than an employee.

 

The IRS contractor test:

  • Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job? How much can the worker decide what to do?
  • Financial: Are the business aspects of the worker’s job controlled by the payer?
  • Type of Relationship: Are there written contracts or employee type benefits ? Will the relationship continue and is the work performed a key aspect of the business?

In general, if the employer provides the employee with supplies, gives the employee a mandatory schedule, and provides benefits, the worker is an employee. If the worker provides his own supplies, can work at his own pace or turn down projects completely, and is not provided any kind of benefits, he is likely an independent contractor and will taxed as that.

 

Deducting Business Expenses as Independent Contractor:

Both independent contractors and employees are given the opportunity to deduct (or “write-off”) their un-reimbursed business expenses. For the employee, these expenses are deducted as part of their Itemized Deductions. If the worker’s un-reimbursed business expenses – including mileage, supplies, insurance, materials, uniforms, etc – total more than 2% of the Adjusted Gross Income, everything above that 2% will be added to the Itemized Deduction form (Schedule A). If the employee does not itemize, the IRS is assuming that the standard deduction ($6100 in 2013) will cover the cost of said expenses. Thus, the employee will not be able to deduct these expenses individually on their tax return.

For the independent contractor, all legitimate expenses can be deducted from their tax returns if they are related to earning income. Self-employment is reported on form Schedule C. The Schedule C totals all income, all expenses, and calculates Net Profit or Loss. The Schedule C is used for sole proprietors and some LLCs. Corporations and Partnerships are reported on their own tax form to report income and expenses to the IRS. A wage earner could be an independent contractor who works under their own corporation.

Popular Schedule C Deductions for Business Expenses

  • Cost of goods sold,
  • advertising,
  • car and truck, c
  • ommissions and fees,
  • contract labor (paying other independent contractors),
  • depreciation,
  • employee benefit programs,
  • insurance (other than health),
  • interest paid,
  • mortgage,
  • legal and professional services,
  • office expenses,
  • pension or profit sharing,
  • rent or lease,
  • repairs or maintenance,
  • supplies (not included in cost of goods sold),
  • taxes and licenses,
  • travel, meals and entertainment,
  • utilities,
  • wages (paying employees),
  • and other (including telephone).

It is essential to keep an accurate record of these business expenses in order to deduct them.

The order of the Schedule C looks like this: Total Income -minus- Cost of Goods Sold =equals= Gross Income -minus- expenses =equals= Net profit or loss. Net profit or loss is then reported on the first page of your 1040, and this number is used to calculate the self-employment tax (15.3% of net profit).

 

Estimated Tax Payments for Self-Employed

After all other aspects of your tax return are put in, your self-employment tax will be added to your income tax, increasing your total tax due.. If a tax payer is entirely self-employed, he should have made quarterly estimated payments based on the amount of tax that was due the previous year. Not making quarterly payments leaves the wage earner subject to penalties.

 

Self Employed Tax Resources

IRS Form 1099 MISC Reporting Self-Employment Income

If you receive a 1099 MISC for services that you provide to a client as an independent contractor and annual payments that you receive total $ 400 or more, you need to present your taxes in a slightly different way than a taxpayer receiving a regular income as an employee reported in a W2 form.

Reporting Income on 1099-MISC

It is very important to report income on a 1099 MISC to the IRS because the person issuing the 1099 MISC will also be sending that information to the IRS

 

Who pays self-employment tax?

Self employment tax is a replacement to social security tax and Medicare tax. He would have paid that if he was an employee anyway, the reason it sounds like a lot is because the employer pays half, and as such the self employed pay both halves, and he’s paying it all at once rather than out of each check.

 

What to do if you receive a 1099-MISC?

  • not report the income, which is illegal, but it doesn’t sound like there is much chance of being caught. The fine if you are caught is far worse than the tax though, so keep that in mind. No one ever goes to jail for this, but it still isn’t sunshine and roses.
  • report as a self employed sub contractor, take all the deductions you are eligible for (which may be a lot since you’re a company now), and pay the tax. Not the best choice, but depending on the deductions, might not be that bad.
  • report as an employee incorrectly filled as subcontractor, (this is “technically” what sounds like the most correct choice) which would require you to pay your half, no extra deductions for being a business, and the IRS would go after the employer for the other half, and likely scrutinize all his other employees’ statuses as nonemployees, then local authorities might question the pay rate as well.

 

When to File 1099-MISC

File this form for each person to whom you have paid during the year:

  • at least $10 in royalties or broker payments in lieu of dividends or tax-exempt interest;
  • at least $600 in rents, services (including parts and materials), prizes and awards, other income payments, medical and health care payments, crop insurance proceeds, cash payments for fish (or other aquatic life) you purchase from anyone engaged in the trade or business of catching fish, or, generally, the cash paid from a notional principal contract to an individual, partnership, or estate;
  • any fishing boat proceeds,
  • gross proceeds of $600, or more paid to an attorney during the year, or
  • withheld any federal income tax under the backup withholding rules regardless of the amount of the payment.

Direct Sellers and Form 1099-MISC

Also, use this form to report that you made direct sales of at least $5,000 of consumer products to a buyer for resale anywhere other than a permanent retail establishment.

Penalties for not reporting Form 1099-MISC

If you receive a Form 1099-MISC that reports your miscellaneous income and you don’t include the income on your tax return, you may also be subject to a penalty. Failing to report income may cause your return to understate your tax liability. If this occurs, the IRS may impose an accuracy-related penalty that is equal to 20 percent of your underpayment. As an example, if the failure to include your miscellaneous income caused you to understate your tax liability by $500, your penalty would be $100 ($500 x .20 = $100).

 

Self-Employed Paying 0.9% Additional Medicare tax

Beginning in 2013, a 0.9% additional Medicare tax is imposed on higher-income earning individuals. This additional medicare tax also has an effect on people who earn self-employment income. On Nov. 26, 2013, the IRS issued final regulations (TD 9645) implementing the Additional Medicare Tax as added by the Affordable Care Act (ACA). In all future tax years, additional Medicare taxes may be due.

 

When are individuals liable for Additional Medicare Tax?

The 0.9% additional Medicare tax, which is in addition to the 2.9% (regular) Medicare tax that taxpayers currently pay, applies to self-employment income in excess of $250,000 for joint filers, $125,000 for married individuals filing separately, and $200,000 for all others. There is more information on this on the chart below.

 

Self-Employed Paying 0.9% Additional Medicare tax

An individual is liable for Additional Medicare Tax if the individual’s wages, compensation, or self-employment income (together with that of his or her spouse if filing a joint return) exceed the threshold amount for the individual’s filing status:

Filing Status

Threshold Amount

Married filing jointly $250,000
Married filing separate $125,000
Single $200,000
Head of household (with qualifying person) $200,000
Qualifying widow(er) with dependent child $200,000

But these thresholds for application of the tax are reduced by any wage income that either you or your spouse earn. Wages for this purpose are defined the same as for the regular Medicare tax and so may include items such as taxable noncash benefits and tips. When you or your spouse (or both you and your spouse) have both self-employment income and wage income, calculating what portion of your income is subject to the additional Medicare tax can get complicated.

 

Employer Portion of Medicare Tax

Self-employed taxpayers should also note that unlike the “employer” portion (1.45%) of the regular 2.9% Medicare tax paid by self employed individuals, additional Medicare tax is paid only by the “employee” (not the employer) and so a business deduction can’t be taken for additional Medicare tax payments. If you anticipate that you’ll owe the additional Medicare tax, you can account for that liability in determining your estimated income tax payments.

 

Paying Medicare Tax with Estimated Taxes

You’ll need to consider your estimated total tax liability in light of your self-employment income, wages, and other compensation, as well as the threshold for imposition of the additional Medicare tax for your filing status. Also, if you or your spouse also earn wages as an employee, you have the option of filing a new Form W-4 with the employer, and requesting that an additional amount of income tax be withheld from your, or your spouse’s, paycheck. (You can’t request that your employer just withhold more additional Medicare tax.) Any estimated tax payments or additional income tax withholding can then be applied against any and all tax liabilities shown on your individual return, including any additional Medicare tax liability.

There are no special rules for nonresident aliens and U.S. citizens living abroad for purposes of this provision. Wages, other compensation, and self-employment income that are subject to Medicare tax will also be subject to Additional Medicare Tax if in excess of the applicable threshold.

 

How to Report and Pay Medicare tax on Form 8959?

You will report Additional Medicare Tax on Form 8959, Additional Medicare Tax, and attach Form 8959 to your income tax return. If you are liable for Additional Medicare Tax and/or your employer withheld Additional Medicare Tax from your wages or compensation, you must file Form 8959.

 

What is the Nanny Tax on Household Employees?

If you employ someone who’s subject to the “Nanny Tax,” you aren’t required to withhold federal income taxes. You have to withhold only if your nanny asks you to and you agree to withhold. (In that case, have the nanny fill out a Form W-4 and give it to you, so you can withhold the correct amount.) However, you may be required to withhold social  security and Medicare tax (FICA).

 

What is the Nanny Tax on Household Employees?

And you may also be required to pay (but not withhold) federal unemployment (FUTA) tax. FICA: You have to withhold and pay FICA taxes if your nanny earns cash wages of $1,800 (annual threshold) or more (excluding the value of food and lodging) during the calendar years 2012 and 2013. If you reach the threshold, the entire wages (not just the excess) will be subject to FICA.

 

Nanny Tax and FICA (Household Employees)

However, if your nanny is under age 18 and child care isn’t her principal occupation, you don’t have to withhold FICA taxes. Thus, if your nanny is really a student who is a part-time baby-sitter, there’s no FICA tax liability for her services. On the other hand, if your nanny is under age 18 and the nanny job is her principal occupation, you must withhold and pay FICA taxes.

 

How to pay the Nanny tax?

You should withhold from the start if you expect to meet the annual threshold; your nanny won’t appreciate a large, unexpected withholding from her pay later on. If you aren’t sure whether the annual threshold will be met, you can still withhold from the start. If it turns out the annual threshold isn’t reached, just repay the withheld amount. If you make an error by not withholding enough, withhold additional taxes from later payments.

 

Obligation to pay FICA taxes

Both an employer and a nanny have an obligation to pay FICA taxes. As an employer, you are responsible for withholding your nanny’s share of FICA. In addition, you must pay a matching amount for your share of the taxes. The FICA tax is divided between social security and Medicare. For 2012, a two-percentage-point reduction in the employee’s share of social security tax is in effect. Therefore, the social security tax rate is 6.2% for the employer and 4.2% for the nanny, for a total rate of 10.4%. The Medicare tax is 1.45% each for both the employer and the nanny, for a total rate of 2.9%. For 2013, the social security tax rate is 6.2% for the employer and 6.2% for the nanny, for a total rate of 12.4%. The Medicare tax is 1.45% each for both the employer and the nanny, for a total rate of 2.9% on the first $200,000 of income.

 

Making Estimated Tax Payments as an Individual 1040 ES

For some taxpayers, it is necessary for them to make estimated tax payments and the applicable rules for paying the minimum amount of estimated tax without triggering the penalty for underpayment of estimated tax.

 

Making Estimated Tax Payments as an Individual 1040 ES

Paying estimated taxes is a fine line between paying the government too much, and having them hold on to your money, or paying them too little, and be liable for a penalty when you file your annual tax return. This is why it is essential to understand Form 1040-ES and understand how to calculate and pay estimated taxes. The IRS provides Form 1040-ES for you to calculate and pay estimated taxes for the current year.

 

What do Individuals Need to Know About Estimated Tax?

Estimated tax is the method used to pay tax on income that is not subject to withholding (for example, earnings from self-employment, interest, dividends, rents,alimony, etc.). In addition, if you do not elect voluntary withholding, you should make estimated tax payments on other taxable income, such as unemployment compensation and the taxable part of your social security benefits.

 

Who Needs to Make Estimated Tax Payments on Form 1040-ES?

Individuals must pay 25% of a “required annual payment” to the IRS by Apr. 15, June 15, Sept. 15, and Jan. 15, to avoid an underpayment penalty. (When that date falls on a weekend or holiday, the payment is due on the next business day.) This is what most people are referring to when talking about estimated tax payments. The required annual payment for most individuals is the lower of 90% of the tax shown on the current year’s return or 100% of the tax shown on the return for the previous year. Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits.

 

High Income Individuals Making Estimated Payments

Certain high-income individuals must meet a more rigorous requirement when filing their estimated tax returns. This is to ensure that taxes are paid when income is earned to the IRS in certain employment of investment situations. If the adjusted gross income on your previous year’s return is over $150,000 (over $75,000 if you are married filing separately), you must pay the lower of 90% of the tax shown on the current year’s return or 110% of the tax shown on the return for the previous year. Most people who receive the bulk of their income in the form of wages satisfy these payment requirements through the tax withheld by their employer from their paycheck. Estimated tax payments generally start affecting people when they are not paid a monthly salary or have income from other sources.

 

What is the Estimated Tax Underpayment Penalty?

If you fail to make the required payments, you may be subject to an underpayment penalty. The underpayment penalty equals the product of the interest rate charged by IRS on deficiencies, times the amount of the underpayment for the period of the underpayment. The penalty is avoided if you meet certain specified exceptions or waivers. Most individuals make estimated tax payments in four installments. For calendar year taxpayers (which is most individuals), the due dates are April 15, June 15, September 15 of the current year and January 15 of the following year.

You may be able to make smaller payments under the annualized income method. This method is useful to people whose income flow is not uniform over the year, perhaps because of a seasonal business. For example, if your income comes exclusively from a business that you operate in a resort area during June, July, and Aug., no estimated payment is required before Sept. 15. You may also want to use the annualized income method if a significant portion of your income comes from capital gains on the sale of securities which you sell at various times during the year.

 

When the Underpayment Penalty Does Not Apply?

The underpayment penalty doesn’t apply to you:

  • if the total tax shown on your return is less than $1,000 after subtracting withholding tax paid;
  • if you were a U.S. citizen or resident for the entire preceding year, that year was 12 months, and you had no tax liability for that year;
  • if you are a farmer or fisherman and pay your entire estimated tax by Jan. 15 of the following year, or pay your entire estimated tax by Mar. 1 of the following year and also file your tax return by that date; or
  • for the fourth (Jan. 15) installment, if you aren’t a farmer or fisherman, file your return by Jan. 31 of the following year, and pay your tax in full.

 

Other Circumstances with no estimated tax penalties

In addition, IRS may waive the penalty if the failure was due to casualty, disaster, or other unusual circumstances and it would be inequitable or against good conscience to impose the penalty. The penalty can also be waived for reasonable cause during the first two years after you retire (after reaching age 62) or become disabled.

You should also use Form 2210 (PDF) to request a waiver of the penalty for the reasons shown above.

If you had no tax liability for the prior year, you were a U.S. citizen or resident for the whole year and your prior tax year covered a 12-month period, then you do not have to file Form 1040-ES.