Payroll Taxes and Federal Income Tax Withholding

Employers withhold payroll taxes and income tax from employees’ pay. Employers send the amounts withheld to the federal government. Employees complete Form W-4. Employers use Form W-4 to determine how much income tax to withhold from employee pay. The Social Security tax is also called the FICA (Federal Insurance Contributions Act) tax.

 

Social Security tax provides the following benefits for employees and their dependents:

  • Retirement benefits
  • Benefits for the dependents of retired workers
  • Benefits for the disabled and their dependents
  • The Medicare tax is used to provide medical benefits for certain individuals when they reach age 65. Workers, retired workers, and the spouses of both are eligible to receive Medicare benefits upon reaching age 65.

 

Federal income taxes finance:

  • National defense, veterans, and foreign affairs
  • Social programs
  • Physical, human, and community development
  • Law enforcement
  • Interest on the national debt

Employers withhold taxes from employees’ pay.

  • Gross pay is the amount the employee earns.
  • Net pay, or take-home pay, is the amount the employee receives after deductions.

 

The difference between gross pay and net pay is:

  • Social Security taxes
  • Medicare taxes
  • income tax withheld
  • other amounts withheld

Employers send the withheld taxes to the federal government.

What are Payroll Taxes?

Payroll Tax Rates
Social Security tax rate 6.20%
Medicare tax rate 1.45%
Total payroll taxes 7.65%

 

If an employee earns $1,000, the payroll taxes are:

Social Security tax $62.00
Medicare tax $14.50
Total payroll taxes $76.50

The employer deducts $76.50 from employee’s pay and it will be sent to the federal government. There is a maximum annual amount of Social Security tax withheld per employee. Social Security taxes are not withheld on amounts over the earnings limit. For 2014, the earnings limit was $117,000, and the maximum Social Security tax was $7,254 ($117,000 x 6.2%). There is no limit on the amount of wages subject to Medicare tax.

Employees complete Form W-4, Employee’s Withholding Allowance Certificate to determine how much federal income tax to withhold.

 

The amount of federal income tax withholding depends on

  • the employee’s marital status,
  • the number of withholding allowances claimed by the employee,
  • any additional amount the employee wants to withhold, and
  • any exemptions from withholding that the employee claims.

 

Reviewing Form W-4

Review Form W-4 for Alicia Myers. Notice that Alicia is single and claims one withholding allowance.

An employee earns $2,000 a month as a physical therapist’s assistant. In addition to payroll taxes and income tax withholding, her employer withholds $50 for her retirement account. Angela’s net pay is calculated as follows:

Gross pay $2,000.00
Social Security tax (6.2 percent of gross pay) -$124.00
Medicare tax (1.45 percent of gross pay) -$29.00
Income tax (per Form W-4) -$237.00
Retirement -$50.00
Net pay $1,560.00

Angela earns $2,000 gross pay and receives a net paycheck for $1,560.

Her employer sends $390 ($124 + $29 + $237) to the federal government and $50 to the retirement fund.

 

 

IRS Worker classification and Employment Taxes

Worker classification does seem to be a recurring employment tax issue. We’ll provide an overview of the issue. Workers may be classified as either independent contractors or employees. An independent contractor is different from an employee, both in definition and tax responsibility. If a worker is an employee, the business will have to meet all of the withholding requirements, file the proper employment tax returns, and furnish a W-2 wage and earnings statement to the employee. Generally, if the worker is an independent contractor and the business pays $600 or more to the worker during a calendar year, the business must issue a Form 1099-Miscellaneous to the worker.

 

Backup Withholding Responsibilities

The business should also be aware that they may have backup withholding responsibilities if they fail to secure a valid taxpayer identification number, or TIN, from the worker. On the next two slides are copies of Forms W-2 issued to employees and 1099-Miscellaneous issued to independent contractors. Form W-2, which is used to report wages to employees, Form 1099- Miscellaneous is used to report income to independent contractors.

 

How to make a determination as to who is an employee and who is an independent contractor?

Contractors and subcontractors, for example, who follow an independent trade, business, or profession in which they offer their services to the public are generally not employees. However, whether such people are employees or independent contractors depends on the facts and circumstances of each case. The right to direct and control the workers really is key in determining the proper worker classification, and evidence falls into three categories: Behavioral control: does the company control or have the right to control what the worker does and how the worker does his or her job? Financial control: are the business aspects of the worker’s job controlled by the payer? This would include criteria like how the worker is paid, whether the expenses are reimbursed, and who provides tools and supplies. Relationship of the parties: are there written contracts or employee benefits, including for example fringe benefits, insurance, or vacation pay? Will the relationship continue, and is the work performed a key aspect of the business?

 

Factors to Determine Employee of Independent Contractor

There is quite a lot we can say about behavioral control. The key issues for behavioral control are instructions and training. Types of instructions includes things like how, when, where to do the work, what tools or equipment to use, what workers to hire or to assist with the work, where to purchase supplies and services, what work must be performed by a specified individual, what order or sequence to follow when performing the work. Degree of instruction means that the more detailed the instruction, the more control the business exercises over the worker. More detailed instructions indicate that the worker is an employee. Less detailed instructions reflect less control, indicating that the worker is more likely an independent contractor.

 

What are some of the other factors in determining whether the worker is an employee versus independent contractor?

The next factor is training. Training means explaining detailed methods and procedures to be used in performing a task. If the business provides the worker with training on how to do the job, this indicates that the business wants the job done in a particular way. This is solid evidence that the worker is an employee. Periodic or ongoing training about procedures and methods is even stronger evidence of an employee/employee relationship. However, if a former employee who had terminated employment is rehired by the company to perform substantially similar duties, training would not typically be required. Therefore, training or the lack of training in this circumstance is not indicative of the worker being an independent contractor.

 

Controlling Independent Contractors

When looking at behavioral control, the key fact to consider is whether the business retains the right to control the worker and the details of how the services are performed, regardless of whether the business actually exercises that right. Here’s an example. An electrician agrees to install wiring in a new warehouse under construction. Upon arriving at the warehouse, the electrician is given the building plans showing where the wiring is to be installed and advised that the wiring must be completed within five days. In this example, the directives concern what is to be done rather than how it is to be done, and is consistent with independent contractor status. Here’s another example, which points more to the worker being an employee. An electrician works for a general contractor. The warehouse owner hires the general contractor and the general contractor tells the electrician what wiring has to be done, gives specific instructions on installation regarding the wiring, provides the tools to use, and dictates the order in which the wiring is to be installed. In this example, these are specific instructions on how the work is to be performed. This is consistent with employee status.

Financial Control of Employees

The second category is financial control. Financial control refers to whether the business has the right to control the financial aspects of the worker’s job. Let’s talk about several different ways a business exercises financial control. First, there’s investment. An independent contractor often has a significant investment in the equipment he or she uses in working for someone else. However, in many occupational industries, such as construction, workers spend hundreds of dollars on the tools and equipment they use and are still considered to be employees. There are no precise dollar limits that must be met in order to have a significant investment. Furthermore, a significant investment is not necessary for independent contractor status, as some types of work simply do not require large expenditures. Next are expenses. Employers are more likely to reimburse employees for their job expenses, while businesses usually do not reimburse independent contractors for expenses. However, employees may also incur expenses that are not reimbursed.

A school teacher is an employee. She buys erasers, posters, and other minor supplies throughout the year, and she is not reimbursed for these expenses. Minor expenses incurred by an employee are not indicative of an independent contractor relationship. The opportunity to make a profit or loss is another important factor. If a worker has a significant investment in the tools and equipment used, and if the worker has unreimbursed expenses, the worker has a greater opportunity to lose money; that is to say, their expenses will exceed their income from the work. For example, the electrician we mentioned a moment ago, might agree to wire a warehouse for a set price. That electrician stands to make a profit or bear a loss depending on the electrician’s skill in bidding the job. Having the possibility of incurring a loss or turning a profit indicates that the worker is an independent contractor. Another indication of financial control would be who provides the insurance coverage, including workers compensation insurance.

If a worker covers their own insurance, the relationship is probably that of an independent contractor. If the business provides the insurance coverage, the relationship would more likely be an employee relationship. A final point here concerning profit and loss is that you should consider who is responsible for correcting a mistake on the job. If the business is responsible for correcting and paying for the mistake, the relationship is probably an employee relationship. If the worker is responsible for correcting and paying for the costs to rectify an error or mistake, the worker is more likely to be an independent contractor. While we’re talking about the category of financial control, we also want to consider the availability of the services. Are the workers’ services available to the general public?

Who is an Independent Contractor?

Independent contractors often advertise, maintain a visible business location or presence, and are available to the relevant market. Also, an independent contractor is generally free to seek out other business opportunities. Finally, the method of payment must be considered. What method of payment does the worker receive? Are they paid by the job or by the hour? Hourly, weekly, or similar basis for payment in return for services or labor generally is evidence of an employer/employee relationship. A flat fee is generally evidence of an independent contractor, especially if the worker incurs the expenses of performing the services. Again, just as with behavior control factors, in the financial control category, there is no one factor that takes precedence over the others. It is a matter of looking at the whole relationship and seeing where the preponderance of evidence lies.

Let’s start by taking a look at some of the elements which may be present in the relationship between the two parties. Is there a written contract? Although a contract may state that the worker is an employee or an independent contractor, this is not sufficient to determine a worker’s status. The IRS is not required to follow contracts stating that the worker is an independent contractor responsible for paying his or her own self-employment tax. How the parties work together determines whether the worker is an employee or an independent contractor.

 

Businesses should consider whether there are employee-type benefits provided

Businesses should consider whether there are employee-type benefits provided. Employee benefits could include things like insurance, pension plans, paid vacations, and sick days and disability insurance. Businesses generally do not grant these fringe benefits to independent contractors. However, the lack of these type of benefits does not necessarily mean the worker is an independent contractor. Other questions are how permanent is the relationship? If you hire a worker with the expectation that the relationship will continue indefinitely rather than for a specific project or period, this is generally considered evidence that the intent was to create an employer/employee relationship.

Are the services provided a crucial activity of the business? If a worker provides services that are a key aspect of your regular business activity, it is more likely that you will have the right to direct and control his or her activities. For example, if a law firm hires an attorney it is likely that it will present the attorney’s work as their own and would have the right to control or direct that work. This would indicate an employer/employee relationship.

 

How to treat seasonal or part-time workers?

We often get questions from business owners about how to treat seasonal or part-time workers. For each worker you will need to look at all of the factors we have just discussed and see whether they indicate an employee or an independent contractor status. The length of time the worker performs services for you is not a standalone factor in determining his or her status. A worker can be an employee even if he or she only performs a few hours of services. It is important to remember that businesses must weigh the factors under all three categories of evidence when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee while other factors may indicate that the worker is an independent contractor. There is no set number of criteria that makes the worker an employee or an independent contractor. No one factor stands alone in making this determination. Also, factors which are relevant in one situation, may not be relevant in another. The key is to review the entire relationship, consider the degree or extent of all the factors in the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

 

IRS Publication 1779, Independent Contractor or Employee

There is a host of useful information about worker classification available. There is the IRS Publication 1779, Independent Contractor or Employee; Publication 15A, Employer’s Supplemental Tax Guide; and IRS podcast and training materials available on the IRS website, www.irs.gov. As we end the worker classification part of the presentation we would like to pose our first question for the audience. Which of these are important factors in determining proper worker status?

When making a worker classification determination, the business should consider all aspects of the work relationship and make the decision based on all the factors. The business should not simply rely on one or two factors that may indicate the worker is an employee or an independent contractor. And finally, answer D is incorrect. It does not matter whether a worker is permanent or seasonal. The right to direct and control the worker is a key factor while considering the overall relationship.

 

Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax

A worker or firm may file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax. The Form SS-8 is filed to request a determination of the status of a worker under the common law rules for purposes of federal employment taxes and income tax withholding. Additionally, the IRS developed Form 8919, Uncollected Social Security and Medicare Tax on Wages, to simplify the process for employees to report their share of uncollected social security and Medicare taxes due on their compensation when their employers have misclassified them as independent contractors. Additional information can be found in the instructions for Form 8919.

IRS Raises Tangible Property Expensing Threshold to $2,500; Simplifies Filing and Recordkeeping

The Internal Revenue Service today simplified the paperwork and recordkeeping requirements for small businesses by raising from $500 to $2,500
the safe harbor threshold for deducting certain capital items.

The change affects businesses that do not maintain an applicable financial statement (audited financial statement). It applies to amounts spent to
acquire, produce or improve tangible property that would normally qualify as a capital item.

 

Expensing Threshold to $2,500; Simplifies Filing and Recordkeeping

The new $2,500 threshold applies to any such item substantiated by an invoice. As a result, small businesses will be able to immediately deduct many
expenditures that would otherwise need to be spread over a period of years through annual depreciation deductions.

“We received many thoughtful comments from taxpayers, their representatives and the professional tax community, said IRS Commissioner John Koskinen. “This
important step simplifies taxes for small businesses, easing the recordkeeping and paperwork burden on small business owners and their tax preparers.“

Responding to a February comment request, the IRS received more than 150 letters from businesses and their representatives suggesting an increase in the
threshold. Commenters noted that the existing $500 threshold was too low to effectively reduce administrative burden on small business. Moreover, the cost
of many commonly expensed items such as tablet-style personal computers, smart phones, and machinery and equipment parts typically surpass the $500
threshold.

As before, businesses can still claim otherwise deductible repair and maintenance costs, even if they exceed the $2,500 threshold.

The new $2,500 threshold takes effect starting with tax year 2016. In addition, the IRS will provide audit protection to eligible businesses by not
challenging use of the new $2,500 threshold in tax years prior to 2016.

For taxpayers with an applicable financial statement, the de minimis or small-dollar threshold remains $5,000.

Further details on this change can be found in Notice 2015-82, posted today on IRS.gov

If you hire a security guard for an event, is he considered an employee or a contractor?

If you hire a security guard for an event, is he considered an employee or a contractor?

 

That’s a difficult question to answer without some very specific facts. The determination as to whether a worker is an independent contractor or an employee is whether the business has the right to direct and control a worker. And there are many factors that go into it; but we basically break the factors down into three categories of evidence, which are behavioral control, financial control, and relationship with the parties.

Factors the Affect Independent Contractor Status

There are many questions that go into that, such as for behavioral control, whether the business directs the worker as to what time they need to show up; whether they need to wear a uniform; and whether they are required to submit reports; and basically how the worker performs his services. For financial control, that will depend upon the method of payment and whether the worker has the ability to show a profit or loss from performing those services. And when we look at the last part, the relationship of the parties, we look at things like what was the intent of the parties? Did they both have the same understanding as to whether the worker was an independent contractor or employee, whether the business is providing benefits, if there was a contract between them? So there is no simple answer to that. The only way to make that determination is to go through the various factors. And when you look at the various factors, some factors will point toward independent contractor status; and some factors will probably point toward employee status. But you have to look at the overall result of looking at that to determine whether the business has the right to direct and control. And one of the significant factors that you look at when making a determination as to whether a business has the right to direct and control is whether that worker is an integral part of the payer’s business. Because obviously, the more important that worker is to that business, the more likely it is that that business will direct and control that worker as to what services they perform.

Is a Security Guard an Employee or Contractor?

But if a business isn’t sure whether a worker is an independent contractor or employee, we do have a form. Businesses can write to the IRS; it’s Form SS-8. It basically walks through a series of questions which are directed toward the right to direct and control. And the business can complete that and receive what’s called a Determination Letter from the IRS, in which we will then tell you whether we believe that the worker is an employee or independent contractor.

 

Filing Form SS-8

If the owner of the business is confused and they go and they look through the criteria and they still cannot decide if this person is an employee or a contractor, then the SS-8 can be completed, sent into the IRS; and we’ll give them a response to help them out in that situation about the determination.

 

Determining Worker Status with Form SS-8

It’s really a good service to have. And businesses can use it. And in addition, individuals can use it also. So individuals who are treated either as – in most cases what we see is individuals who are treated as independent contractors who believe they may be employees can write in for the same determination and get a Determination Letter from the IRS as to whether they really, truly are an independent contractor or whether the business should be treating them as an employee.

 

 

CP2100 or CP2100A, Backup Withholding Notice

When the IRS receives Forms 1099, the IRS matches the name and TIN for verification purposes. The IRS may send you a CP2100 or CP2100A, Backup Withholding Notice if the payee’s TIN is missing or obviously incorrect or the payee’s TIN doesn’t match the payee’s name. The CP2100 will include a list of payees with missing TINs and payees whose TIN and name do not match.

 

What do you do if you receive a CP2100 or CP2100A Notice?

What do you do if you receive a CP2100 or CP2100A Notice? The first step is to compare the listing with your records. The error could be an oversight or an error in your own records. If this is what happened, the only thing you should do is correct your records and update them. For missing or obviously incorrect TINs, determine if you are already backup withholding on payments made to that payee. If you are not, begin backup withholding immediately.

 

Incorrect TINs

You must also make up to three solicitations for the TIN — initial, first annual, second annual – to avoid a penalty for failing to include a TIN on the information return. For incorrect TINs, compare the accounts on the listing with your business records. If they agree, send the appropriate “B” Notice to the payee. A “B” Notice is a letter to the payee asking the payee to verify his or her TIN. The specific documentation the payee must provide, will depend on whether this is the first time the payee appeared on a CP2100 list. Specific instructions are included on the CP2100 Notice. Generally, you should begin backup withholding if a payee fails to respond to a “B” Notice within 30 days. It’s important to backup withhold when required and follow the instructions on the CP2100 Notice. If you don’t, you, the payer, may be held liable for any backup withholding that was required. In addition to backup withholding, a payer may also be subject to penalties for failure to file a correct information return if information is missing or incorrect or a payer fails to issue a required Form 1099.

 

 

Penalty for failure to file a correct Form 1099

The penalty for failure to file a correct Form 1099 is $100 per Form 1099. There is also a $100 penalty for failure to furnish Form 1099 to the payee. This concludes the video portion of our webinar, and we thank you for watching. If you would like to submit a question, select the Ask a Question link under the PowerPoint window and then click Submit.

 

Payments Subject to Backup Withholding

Rents, non-employee compensation for services, royalties, reportable gross proceeds paid to attorneys, and other fixed or determinable gains, profits, or income payments that are reportable on Form 1099-MISC, Miscellaneous Income.

Backup withholding does not apply to wages or pension payments.

 

“B” Notice

If the IRS sends you a CP2100 or CP2100A Notice indicating an incorrect payee TIN, you are required to send the “B” Notice within 15 days from the date you received it, or the date of the CP2100/2100A, whichever is later. See Publication 1281 for details. Begin backup withholding no later than 30 business days after the date of the CP2100 notice or the date you received it, whichever is later. Stop backup withholding no later than 30 days after the payee furnishes a TIN and certifies that it is correct.

What is an IRS B Notice?

A “B” Notice is when a business has mismatches on the 1099 between the name and the TIN or they have missing TINs. The business will receive a CP2100 Notice. And it will have procedures that they need to follow. And one of those procedures is for them to send a “B” Notice to the payees. The “B” Notice, it’s identified in the letter; and the “B” Notice basically is going to ask for the information from the payee, telling them that they need to provide their correct TIN to the payer. And it’s basically a form letter. And that can be found in Publication 1281.

 

Payments to Independent Contractors Form 1099

This article will give you the basic information needed to properly report payments to independent contractors to the IRS, Form 1099 miscellaneous filing requirements, backup withholding and how to avoid being liable for it, and CP2100 backup withholding notices for payee name, in tax for identification number, or mismatches.

 

What is an Independent Contractor?

It is critical that you 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 taxes on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to 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 may be an independent contractor. The general rule is that 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. The person performing services may be an employee. Under common law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. What matters is that you have the right to control the details of how the services are performed. To determine whether the person providing the service is an employee or independent contractor, all information that provides evidence of the degree of control in independence must be considered.

 

Common Law Independent Contractor Test

The common law rules that provide evidence of the degree of control and independence are divided into three categories. One is behavioral. Does the company control, or have the right to control, what the worker does and how the worker does his or her job? Two is financial. Are the business aspects of the worker’s job controlled by the payer? These include things like: how is the worker paid, whether expenses are reimbursed, or who provides tools and supplies, et cetera. Finally, three, the type of relationship: are there certain contracts or employee-type benefits, such as a pension plan, insurance, vacation pay, et cetera? 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. The keys are to look at the entire relationship, consider the degree or the extent of the right to direct and control. And finally, document each of these factors used in coming up with a determination.

If after reviewing the categories of evidence, it is still unclear to you whether a worker is an employee or independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, can be filed with the IRS. Either the business or the worker may file Form SS-8. If the worker files the form, the IRS will follow-up with the firm to get the firm’s views as well. IRS will review the facts and circumstances and officially determine the worker’s status

 

Reporting requirements for payments to independent contractors- Forms 1099

There are many kinds of Form 1099. But for this presentation, I will be exclusively talking about Form 1099-MISC. Form 1099-MISC is most commonly used by payers to report the payments made in the course of a trade or business to others for services. If you paid someone who is not your employee, such as a subcontractor, an attorney, or an accountant, $600 or more for services provided during the year, the payment might need to be reported on a Form 1099. You must provide Form 1099 to the independent contractor by January 31st of the year following the payment.

You must also send a copy of this form to the IRS by February 28th, although the form does not have to be filed with the IRS until March 31st if your business files their 1099s electronically. You may have to file Form 1099 to report payments for services performed for your trade or business if the following four conditions are met. One, you made the payment to someone who is not your employee. Two, you made the payment for services in the course of your trade or business, including government agencies and non-profit organizations. Three, you made the payment to an individual, a partnership, a state, or in some cases a corporation. And four, you made payments to the payee of at least $600 during the year.

 

How are Payments to Independent Contractors Report to IRS?

Generally, you report a payment as a Non-Employee Compensation. Payments for services to corporations generally are not required to be reported on Form 1099 unless those payments were for legal or medical services. However, payments for services to partnerships are required to be reported on Form 1099. A common mistake is failing to issue Form 1099 to a limited liability company or LLC. An LLC is a business structure allowed by state statute. Depending upon elections made by the LLC and the number of members, the IRS will treat an LLC as either a corporation, a partnership, or as part of the LLCs owner’s tax return. Payments for services to LLCs must be reported on Forms 1099 unless the payee has elected to be treated as a corporation for federal tax purposes. It’s important to properly complete Form 1099 in order to avoid backup withholding and penalties, which will be discussed later. Be sure to complete the payer’s – that’s your name and address; the payer’s Federal identification number; the recipient’s identification number; the recipient’s name and address; and, in Box 7, the amount paid to the independent contractor. Your business is only required to secure the payee’s TIN when the payment becomes a reportable payment; that is, generally when the total payments in a calendar year exceeds $600.

 

Form W-9, TINs, and other Identifying Information for Taxes

Form W-9, Request for Taxpayer Identification Number and Certification, can be used to request the correct name and TIN of the payee; but it’s not required at this point. A TIN may be either a Social Security number, or an SSN, or an Employer Identification Number or EIN. You can secure the payee’s TIN in any manner, written or orally. If you do secure the payee’s TIN using Form W-9, keep the Form W-9 in your files for four years for future reference and in case of any questions from the payee or from the IRS. What should you do if a payee doesn’t provide or refuses to provide you their TIN? You, as the payer, should initiate backup withholding.

What is backup withholding?

“What is backup withholding?,” you might ask. Under the provisions of Internal Revenue Code, Section 3406(b), persons making certain payments to payees must withhold and pay to the IRS a specified percentage of those payments under certain conditions, including payments to independent contractors. Publication 15 includes a listing of other types of payments that may be subject to backup withholding. Backup withholding is also applicable if a payee provides you with an obviously incorrect TIN. An obviously incorrect TIN is one that contains more or less than 9 digits or contains alpha characters, say, letters. If a payee does not provide you with his or her TIN, you as the payer are required to withhold 28% from the payment as backup withholding. If the IRS discovers that you, the payer, did not withhold the required backup withholding, you can be held liable. You report backup withholding on Form 945, Annual Return of Withheld Federal Income Tax. For more information, including the deposit requirements for Form 945, see the instructions for Form 945 or Publication 15.

 

What if a company pays cash to an independent contractor; does that need to be reported?

Yes, the method of payment is not dependent upon whether a taxpayer business is required to file a Form 1099. Whether a business pays in cash or by check or by credit card, if they make a payment to an independent contractor that exceeds $600, they are required to file a 1099. So again, the method of payment is not the criteria. It is the amount of the payment that is the criteria.

What if someone is paid $500 for one job, and later this company pays the same person $500 for another job? Those are both under $600. So does a Form 1099 have to be issued or does it not?

That’s a good follow-up question because it’s important to understand that it’s not just the payment for each specific job. If you have an independent contractor that is performing separate jobs throughout the year, a business determines whether a 1099 is required to be filed depending upon the total payment that’s made during the year. So in that case, since the total payment would be $1,000 — $500 for the first job and $500 for the second job – the business would be required to file a 1099. But it’s important to note that if the first $500 payment, that payment would not, in and of itself, be a reportable payment. So the business would not be required to have secured the payee’s TIN at that point. But when they made the second $500 payment, that put them over the $600 threshold. So if the business did not have the payee’s TIN at the time they made the second payment of $500, they would be required to backup withhold on that second $500 payment.

 

If a contractor does work at someone’s house, do they have to issue a 1099-MISC?

That’s a good question because we’ve been basically talking about Forms 1099 in regard to businesses. And the answer to that is it’s only businesses only if the payment that’s made to the independent contractors is made in the course of a trade or business. So individuals who hire workers to perform work around their house as homeowners, whether someone’s putting a roof on their house or you hire a landscaper, those are independent contractors. But a homeowner, an individual, is not required to file a 1099, only if those payments are made in the course of a trade or business. The difference would be if your house was your business property maybe and you were running your business out of the house and you were hiring them to maybe install a business sign or something out in the front of your yard or something, then you would be required to issue a 1099.

 

If a person owns rental property and they receive payments for rental, does that need to be reported on a 1099-MISC?

Yes, rental payments, again, there are specific requirements regarding rental payments. But businesses that make rental payments are required to issue 1099s. There are some types of exclusions as to when they don’t have to issue them, and that information can be found in the publications on the 1099 reporting requirements.

 

Self Employed Form 1040 and Schedule C or Schedule C-EZ

Overview of Small Business Tax Issues for Self- Employed

If you are in business for yourself or you carry on a trade or business as a sole proprietor or you’re an independent contractor, you generally would consider yourself self-employed; and you would file Schedule C or C-EZ with your Form 1040.Here are a few things the IRS wants you to know about self-employment.Self-employment can include work in addition to your regular full-time business activities, such as part-time work you do at home or in addition to your regular job.

What is Self-Employment Tax?

If you are self-employed, you generally have to pay self-employment tax. Self-employment tax is Social Security and Medicare.It’s similar to the Social Security and Medicare taxes withheld from the pay of most wage earners. You figure self-employment tax yourself, using a Form 1040 Schedule SE. Also, you can deduct half of your self-employment tax in figuring your adjusted gross income. And if you’re self-employed, you generally have to make estimated tax payments. This applies even if you also have a full-time or part-time job and your employer withholds taxes from your wages.

What are Estimated Taxes?

Estimated tax is the method used to pay tax on income that is not subject to withholding. If you don’t make quarterly tax payments, you may be penalized for underpayment at the end of the tax year. You can deduct the costs of operating your business.

What Business Expenses?

These costs are known as business expenses. Assets you will use in your business for more than one year, such as buildings or furniture, are things you’ll have to depreciate. Assets with a life of a year or less, such as office supplies, are not depreciated but are deductible in the year you purchase them. To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your field of business. A necessary expense is one that is helpful and appropriate for your business. In addition, you must be able to substantiate your expenses. Therefore, it’s important to keep good records. And finally, for information, see the Small Business and Self-Employed Tax Center on www.irs.gov. Generally, you are self-employed if any one of the following apply to you.

 

Schedule C or Schedule C-EZ

To file your annual Federal tax return Form 1040, you will need to use Schedule C or Schedule C-EZ to report your income or loss from a business you operated or profession you practiced as a sole proprietor. Also, be sure to include any income reported to you as a self-employed person on Form 1099-MISC. Small businesses and statutory employees with expenses of $5,000 or less may be able to file Schedule C-EZ instead of Schedule C. To report your Social Security and Medicare taxes, file Schedule SE (Form 1040), Self-Employment Tax.

Calculate Social Security and Medicare taxes Due

Use the net income or loss from Schedule C or the net income from Schedule C-EZ to calculate the amount of Social Security and Medicare taxes due for the year. The instructions for the Schedule SE will be helpful in filling out the form.

Schedule C-EZ instead of Schedule C

You may use Schedule C-EZ instead of Schedule C only if you had business expenses of $5,000 or less; used a cash method of accounting; did not have an inventory at any time during the year; did not have a net loss from your business; had only one business as either a sole proprietor, qualified joint venture, or statutory employee; and you had no employees, no depreciation or amortization of business expenses, you do not deduct expenses for business use of a home, and no prior-year un-allowed passive activity losses. Over time, a sole proprietorship may have to switch from Schedule C-EZ to the Schedule C. This is usually an indication that the business has grown and now has more expenses, inventory, employees, et cetera.Use Form 1040 (Schedule C) to report income or loss from a business you operated or a profession you practiced as a sole proprietor.

What does the IRS Consider a Business?

An activity qualifies as a business if your primary purpose for engaging in the activity is for income or profit, and you are involved in the activity with continuity or regularity. Also use Schedule C to report gross receipts and expenses of your sole proprietorship, as well as certain miscellaneous income shown on Form 1099-MISC. Since most businesses start off as sole proprietor, we’re using Form 1040 (Schedule C) in our examples.Calculating a profit or loss from business is divided into five parts. Parts 1, 2, and 3 use terms such as gross receipts, net profit or loss, net sales, cost of goods sold, and gross profit. Parts 4 and 5 ask for information about your vehicle and other expenses. In the next few slides, I’ll explain these terms. Let’s begin with net profit or loss. To figure estimated taxes and to report income earned from your business, you must figure your net profit or loss.

What is Self-Employment Net Profit?

Net profit is the amount on which you pay tax. If you operated at a loss, enter the amount in parentheses. The basic way to determine profit or loss is the same for each type of business organization. You’ll use this formula: Gross income less expenses equals net profit or loss. Net profit is the amount by which the gross profit is more than the business expenses for the same period. A net loss is where the cost of goods sold and business expenses are more than the gross receipts. If your Schedule C shows a profit, enter the amount on both Form 1040 and Schedule SE.

Net Loss on Form 1040 Schedule SE

If you have a net loss and all of your investment is at risk, enter the loss on both Form 1040 and Schedule SE.If you have a loss and some of your investment is not at risk, in most cases you must complete Form 6198, At-Risk Limitations, to figure your allowable loss. The At-Risk Rules may limit the amount of loss you can claim.

What are Considered Gross Receipts?

Next we’ll discuss gross receipts, returns, and allowances and net sales. Gross receipts or sales are the income that a business receives from the sale of its products or services. Take a look at this basic formula: Gross receipts less returns and allowances equal net sales. Individuals that don’t make or buy products for resale as part of their business don’t have returns or allowances to deduct on gross sales.

What is Cost of Goods Sold?

Now for the next term, cost of goods sold. Cost of goods sold is the cost to a business to buy or make the products being sold. It’s easy to figure the cost of goods sold if you sell all your merchandise during the year; however, some of your sales will probably be from inventory that you carried over from earlier years, and you will probably have an inventory left unsold at the end of the year. Note, some companies that provide services, such as lawn care, web design, et cetera, do not have inventories and don’t need to compute the cost of goods sold amount. Here’s another formula for you.

Calculating Cost of Goods Sold

To figure the cost of goods sold, start with the cost of the inventory on hand at the beginning of the year. Add the cost of additional goods purchased or manufactured during the year. Be sure to subtract the cost of any merchandise withdrawn for personal use, such as food a grocer may take home or gasoline a garage owner may give to relatives. The result is the cost of items available for sale during the year. Then subtract the value of your inventory at the end of the year. Your cost of goods sold is the remainder. Some businesses may choose to keep a continuous or automated inventory system. But no matter how you choose to track it, you need to keep good beginning and year-end inventory records. Now I’m going to figure gross profit. Here comes the final formula we’re discussing today. Beginning with gross receipts, subtract your sales, returns, and allowances and the cost of goods sold to determine gross profit.

What expenses can Service Companies Deduct?

Again,we note that sole proprietorships that are service companies don’t need to deduct the cost of goods sold to complete their gross profit.Let’s go into more detail about common business expense deductions. We’ll start with travel, transportation, and entertainment.These deductions are common to all types of businesses. We’ll take a look at each type. Travel expenses are the ordinary and necessary expenses for traveling overnight away from home in the course of your trade or business. These expenses include the cost of public transportation, operating and maintaining your car, meals, lodging, and other related expenses.

Deducting Transportation Costs

You can deduct the actual cost of meals or use a standard per-diem rate. See Publication 463 for the latest per-diem rates and detailed information about your travel expenses. Transportation expenses are the ordinary and necessary expenses of getting from one workplace to another in the course of your business or profession while you are not away from home. Commuting expenses are not deductible.Exactly what are commuting expenses? You cannot deduct the cost of taking a bus, trolley, subway, or taxi, or of driving a car between your home and your main or regular place of work. These costs are personal commuting expenses. You cannot deduct commuting expenses no matter how far your home is away from your regular place of work. You cannot deduct commuting expenses even if you work during the commuting trip.For example, you sometimes use your cell phone to make business calls while commuting to and from work. Sometimes business associates ride with you to and from work, and you have a business discussion in the car.These activities do not change the trip from personal to business.

You cannot deduct your commuting expenses.

You cannot deduct your commuting expenses. If you use a car for business only, you may base your deduction on the full cost of operating it. If you use the car for both personal and business purposes, you must divide your expenses between those uses on the basis of mileage to compute a business percentage. Do not include commuting to and from work as business mileage. You may take a deduction for your actual business expenses for the car or use a standard mileage rate. Standard mileage means multiplying your business mileage by a standard rate. For this year’s rate, check the IRS website.

Using Standard Mileage Deduction

However, to use the standard mileage rate on a vehicle after the first year of business use, you must have used the standard mileage rate for the first year. In later years, you can alternate between standard mileage and actual expenses. This alternating option is not available to you if you claimed actual expenses in the first year of business use. Actual business expenses include gas, oil, repairs, insurance, depreciation, tires, and license plates. Under either method, parking fees and tolls are deductible. See Publication 463, Travel, Entertainment, Gift and Car Expenses, for more information on using standard mileage rates and the use of a car in your business.Business entertainment expenses are deductible only if they are ordinaryand necessary expenses of carrying on your trade or business. To deduct these expenses, you must maintain receipts and records. This includes taking clients to lunch. Publication 463 explains the 50% limit on business meal expenses.

 

When Must Self-Employed File Taxes and Get EIN

When does a self-employed individual files taxes?

You have to file an income tax return if your net earnings from self-employment were $400 or more. If your net earnings from self-employment were less than $400, you still have to file an income tax return if you meet any other filing requirements listed in the Form 1040 instructions. So what if you work for somebody else and you’re also self-employed. If, in addition to your self-employment income you receive wages, then subtract those wages from your total income to figure out how much self-employment income is subject to the taxes.

What is Schedule SE?

If you have income subject to self-employment tax, figure the tax on Schedule SE. If you have more than one business, use one Schedule SE and combine the profits and losses from all of your businesses.

What is a Federal employer identification number or EIN?

As a business owner, you may be required to get a Federal employer identification number, commonly referred to as the EIN. The EIN identifies tax returns filed with the IRS. If you don’t have an EIN, you need to get one if you pay wages to employees, have a self-employed retirement plan, operate your business as a corporation or partnership, or are required to file any of these tax returns: employment, excise, judiciary, or alcohol, tobacco and firearms. The fastest and easiest way to get an EIN is online at www.irs.gov. Type EIN in the Search box.

Applying for an EIN Number on IRS Wesbite

The EIN is issued immediately once the application information is validated. EIN can also be obtained by mailing or faxing Form SS-4, the Application for Employer Identification Number. See the form instructions for details.

When you don’t need an EIN?

If you don’t need an EIN, generally you use your Social Security number as your taxpayer identification number. You must put this number on each of your individual tax forms, such as Form 1040 and its Schedules. If you must have an EIN, include it along with your Social Security number on your Schedule C or C-EZ.

 

Choosing a Small Business Structure Sole Propreitorship

When starting a business, you must determine your business structure. In this webinar, we’re focusing on sole proprietorship.If you are a one-person business, you are automatically classified as a sole proprietor for Federal tax purposes unless you file Form 8832, Entity Classification Election, to request a different classification.

 

What is considered a business by the IRS?

You carry on a trade or business as a sole proprietor or an independent contractor, and you are otherwise in business for yourself including a part-time business. A sole proprietor is someone who owns an unincorporated business by him or herself. People such as doctors, daycare providers, mechanics, and contractors who are in an independent trade, business, or profession in which they offer their services to the general public are generally considered independent contractors.However, whether these people are independent contractor or employees depends on the facts in each case.

 

Who is an independent contractor?

The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the results of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to self-employment tax.A trade or business in which you participate on a regular, continuous basis with the intent of making a profit is generally an activity. The facts and circumstances of each case determine whether or not an activity is a trade or a business. Regular activities and transactions that produce income are important elements. You do not need to actually make a profit to be in a trade or business, as long as you have a profit motive. You do need, however, to make ongoing efforts to be profitable. You do not have to carry on regular, full-time business activities to be self-employed.Having a part-time business in addition to your regular job may be considered self-employment.

 

Example of Independent Contractor

For example, you are employed full-time as an engineer at the local plant; and you fix televisions and radios during the weekend. You have your own shop, equipment, and tools. You get your customers from advertising and word of mouth. You are considered to be self-employed as the owner of a part-time repair shop.

 

What is a sole proprietorship for IRS Tax Purposes?

A sole proprietorship is an unincorporated business owned by one person. It is the simplest type of business organization. The business does not exist apart from the owner. As the business owner, you assume risk of the business to extend to all of your assets, even if you don’t use your personal assets in the business. Usually the ability to finance the business, known as capital, is limited to the amount the owner can come up with. This may limit the expansion of the business when new capital is required. Common cause of failure of sole proprietors is the lack of capital. The exception to a sole proprietorship being a one-person business is a qualified joint venture; that’s next.

 

What is an IRS qualified joint venture?

What is a qualified joint venture? It’s when both spouses have an equal say in the affairs of the business, provide substantially equal services to the business, and contribute capital to the business. This used to be called a partnership.Now spouses can elect to be treated as a qualified joint venture. A qualified joint venture is a joint venture involving the conduct of a trade or business if the only members of the joint venture are husband and wife,and both spouses materially participate in the trade or business and both spouses elect to have the provision apply.

 

What is material participation in the qualified joint venture?

Materially, participation means working on a regular, continuous, and substantial basis in the business. In a qualified joint venture, all items of income, gains, loss, deduction, and credit are divided between the spouses in accordance with their respective interests in the venture. Each spouse takes into account his or her respective share of these items as the sole proprietor. For the purposes of determining net earnings from self-employment, each spouse’s share of income or loss from a joint venture is taken into account, just as it is for Federal income tax purposes. This generally does not increase the total tax on a return, but it does give each spouse credit for Social Security earnings on which retirement benefits are based.

 

Spouses on Form 1040 with business

Spouses make the election on a jointly filed Form 1040 by dividing all items of income, gain, loss, deduction, and credit between them in accordance with each spouse’s respective interest in the joint venture.Each spouse files a separate Schedule C and Schedule SE with the Form 1040. A business owned and operated by the spouses through a limited liability company does not qualify for the election. Only businesses that are owned and operated by spouses as co-owners qualify for the election. If all this sounds too complicated for you, consider finding a tax preparer to assist you in fling your Federal tax return. However, you are legally responsible for what’s on your own tax returns even if they’re prepared by someone else.

Record keeping and Receipts Needed for Self-Employed for IRS

What Record keeping and Receipts must self-employed individuals keeps for the IRS?

The next topic we need to discuss is recordkeeping. You must keep receipts, sales slips, invoices, bank deposit slips, canceled checks and other documents.These documents, either electronic or paper files, can substantiate items of income, deductions, and credits. Keeping these records will help you pay only the tax you owe. Unless you have records showing the sources of your receipts, you may not be able to prove that some are non-business or non-taxable.

 

Keeping Records and Receipts for IRS – Record Retention

You need good records to monitor the progress of your business. Good records can show whether your business is improving, which items are selling, or what changes you need to make.Good records can increase the likelihood of business success. You may forget expenses when you prepare your tax returns unless you record them when you pay them. You need good records to prepare accurate financial statements, such as profit and loss statements and balance sheets. These statements can help you in dealing with your bank and creditors to establish your earnings from self-employment. Your records should show the amount of earnings reportable for self-employment tax purposes. If the IRS audits your income tax return, you may be asked to support the entries on your return with sales slips, invoices, receipts, bank deposit slips, canceled checks, and other documents.

 

What support is needed to deduct expenses for IRS?

These items of support are necessary for you to have adequate and complete records. Visit the IRS Video Portal at www.irsvideo.gov and check out the series, Your Guide to an IRS Audit. This series of videos takes you through the steps of an audit from notification to closing. Also be sure to safeguard your records to prevent theft or loss due to natural disaster. In case of a disaster, planning is an important part of safeguarding your records. Being able to access your records will help you resume business operations more quickly. Take advantage of paperless recordkeeping, including filing your returns and paying your taxes electronically.

 

Downloading Bank Statements to IRS

Many people retrieve bank statements and other documents online, an excellent way to secure financial records. However, we encourage you to download your bank statements on a regular basis. Be sure to back up your electronic files and store them in a safe and secure location.

Bank Statements and the IRS

You can periodically copy them onto a CD, flash drive, or other electronic storage device and send it to a trusted person in another location for safekeeping in case your normal computer backup systems aredestroyed. Also, many retail stores sell computer software packages that you can use for recordkeeping. You should also document valuables and business equipment. One option is to photograph or video the contents of your home and business, especially items of great value.

 

IRS Disaster Loss Workbooks for individuals, Publication 584

You should store this documentation with someone outside your geographic area to reduce risk. The IRS has Disaster Loss Workbooks for individuals, Publication 584 and Business Publication 584-B, that can help you compile a room-by-room list of your belongings and business equipment.This will help you recall and improve the market value for items in insurance and casualty loss claims if needed. How quickly you get back to business after a disaster often depends on emergency planning today.Start planning now to improve the likelihood that your business will survive and recover.