Depreciation rules for automobiles

Depreciating business property must be done carefully. One of the harder types of business property to depreciate is cars. Special limitations apply which may result in it taking longer for you to depreciate a car than it would other business property.

Depreciation rules for automobiles

First of all, note that a separate depreciation allowance for a car only comes into play if you choose to determine the cost of its business use by the “actual expense” method. If, instead, you use the standard mileage rate (for 2013, 56.5¢ per business mile driven; for 2014, 56¢ per business mile driven), a depreciation allowance is built in as part of the rate.

 

Actual expense method in calculating the depreciation allowance

If you are using the actual expense method in calculating the depreciation allowance, an automobile is treated as an asset with a 5-year recovery period. Under the regular depreciation tables, the cost of an automobile is actually depreciated over a 6-year span according to the following percentages: Year 1, 20%; Year 2, 32%, Year 3, 19.2%, Years 4 and 5, 11.52%, and Year 6, 5.76%. Six years are involved because depreciation is deemed to start in the middle of Year 1 and end in the middle of Year 6. (These percentages are not available for cars used 50% or less for business purposes. For these, straight-line depreciation is required.)

 

IRS specified depreciation ceilings

However, under additional limitations applicable to cars, you are limited to specified depreciation ceilings, under “luxury automobile” rules. These ceilings, which are indexed for inflation, operate to extend depreciation beyond the sixth year for cars costing more than what the total depreciation allowance would be over the six years. For most cars first put in service in 2013, the ceiling is $11,160 for that year ($3,160 for cars for which additional first-year depreciation does not apply, including a car purchased used or not used more than 50% for business). The annual ceiling amounts for later years are $5,100 for the second year, $3,050 for the third year, and $1,875 for all later years. Slightly higher ceiling amounts apply for certain light trucks and vans (passenger autos built on a truck chassis, including minivans and light SUVs) first placed in service in 2013.

 

Section 179 Election

You cannot avoid these limitations via an election to “expense” the car (a Section 179 election). With the limitations applying, it may take longer than the regular 6 years to depreciate the entire cost of the car, if it is not disposed of sooner. If the car is used partly for business purposes and partly for personal purposes, the limits are reduced to the business percentage. For example, the maximum depreciation deduction for a qualified automobile first placed in service in 2013 and used 75% for business is $8,370 (75% of $11,160) for the first year. The “personal” 25% portion ($2,790) is disallowed. What is the impact of these limitations from the standpoint of the business decisions you must make?

What is the Section 179 Election?

They raise the “after-tax” cost of automobiles used in your business. That is, the true cost of regular equipment used in the business will be its actual cost reduced by the tax benefits enjoyed via depreciation deductions. To the extent these deductions are reduced (deferred to future years, actually), the tax benefits are less and the true cost is higher. It may be advisable to consider this factor in deciding how much to spend on automobiles used in your business.

 

Deciding to Take Section 179 Election

Please note that these limitations cannot be avoided by leasing a “luxury” car instead of buying it. Although the mechanics of the tax rules are different with leases, essentially your taxable income is increased to mirror the tax savings you would have lost had you bought the car. (These rules do not apply to car rentals for less than 30 days.)

Setting up a 401k Retirement Plan as a Small Business

What is a 401k Plan?

All right, let’s talk about 401(k) plans. I believe that everybody has probably heard of a 401(k) plan. Basically, the way that it works is everybody has a deferral option. And that option is you can keep your cash now as you earn it, or you can defer it into the plan. So, basically, you pay taxes on the money now by keeping it, or you defer taxation to when you actually withdraw monies from the trust. For example, you could put $5,000.00 into the plan in 2015, don’t pay any taxes on it, and you don’t pay until you withdraw the money in 20 or 30 years. Now the employer can also contribute to a 401(k) plan.

 

How much can you contribute to 401k Plan?

You can put in a match. You can put in a fixed contribution. He can put in a discretionary contribution, like something like a profit- sharing plan that would be determined on a year-by-year basis. 401(k) plans are flexible, and you can change the features in the plan to suit your needs. For example, 401(k) plans can provide for loans, they can provide for hardship distributions, and you can have best used vesting schedules. For example, on the profit-sharing contribution, you could have a six-year graded vesting schedule on it.

 

Eligibility for 401k Plans

As for eligibility to be in a 401(k) plan, the most stringent you can be is age 21 or you worked 1,000 hours of service in any prior year. Now, of course, you can have the eligibility requirements be, you know, you’re eligible to be in the plan as of your date of hire if you would like. And the plan document, though, is going to dictate who is eligible to be in the plan. So, whatever the plan document says, that is what you have to go by. And any size of employer can offer a 401(k) plan. We see them going all the way down from one person all the way up to millions of people.

 

Three Different Types of 401k Plan

You have the traditional type of 401(k), which has the most responsibility, and there’s lots of testing involved in it. Something we’ve been seeing a lot now in the last ten years and really picking up is safe harbor 401(k) plans. These are nice because they help you to avoid testing. As long as the employer provides a minimum contribution to the rank and file employees, highly compensated employees can defer large amounts. And there’s also something else that we’ve been seeing more and more of lately. It’s called automatic enrollment, and we’ll explain what this is. And this can help the employer to pass or avoid testing altogether. Now when it comes to 401(k) plans, there is no IRS model form, like you just can’t go to the website and download a 401(k) plan. But, there are a lot of retirement plan providers out there that offer plan documents, and these plan documents are approved by the IRS.

 

Traditional 401k Plans

Okay, so let’s talk a little bit about traditional 401(k) plans. This is going to be one of your most flexible types of plans, and it can allow for very high levels of contributions. For example, in 2015, an employee could defer a salary up to $18,000.00 into a 401(k) plan. If the employee was age 50, he or she could defer an additional $6,000.00 into it, so that’s a lot of money. Now the employer contributions into a 401(k) plan: they can be fixed or they can be discretionary every year. Okay, traditionally the employer is going to offer some kind of a match to go with the plan, and the match, for example, might be like 25 cents on the dollar, up to four percent of pay. But, like whatever kind of a match the employer would offer, that match would have to be stated in the plan and the employer does have to follow the terms of the plan. Employer contributions are not necessarily mandatory in a 401(k) plan. Like if the employer wants to write up the plan documents so that they don’t have to provide a match, then they could do that if they wanted to.

 

Employer Contributions to 401k Plan

Now the total employee and employer contributions are going to be limited to the lesser of 100% of compensation or $53,000.00. And that $53,000.00 would be between deferrals, matching contributions, and any profit- sharing contributions as well. The employer contributions can be deducted up to 25% of the combined compensation for all the plan participants.

 

Annual Testing of 401k Plans – ADP and ACP Test

Okay, now there is annual testing for 401(k) plans that we talked about before. You have nondiscrimination tests. They are the ADP test and the ACP test. The ADP stands for Actual Deferral Percentage, and basically all that that is is you’re taking the amount that the individual is deferring each year and you’re dividing it by their compensation. Okay, and you do it for groups. You do it for the entire group of the rank and file employees, and you do it for the entire group of the highly-compensated employees. And the rank and file and the highly-compensated employees are computed separately, and if the highly compensated defer too much, they actually have to return some deferrals at the end of the year.

 

Highly-compensated employees and 401k Plans

And the ability of the highly-compensated employees to defer is going to be closely tied to how much the rank and file employees defer. And then you have the Actual Contribution Percentage test, ACP, which works the same way as the ADP test. You take the matching contribution provided, divide it by the compensation, it gives you a percentage. It works the same way as the ADP. And it’s like I said before. These tests can limit the amount the highly-compensated employees can defer, and often very significantly. Like you might see a situation where somebody initially deferred like $18,000.00 and come the end of the year they might have to return $15,000.00 of it. And the Form 5500 is going to be required for most 401(k) plans

 

Safe Harbor 401k Plans

Another type of 401(k) plan is the Safe Harbor 401(k). These plans are a good choice if you’re looking for the benefits of a 401(k), but you don’t want the burden of annual nondiscrimination testing. This plan is like a traditional 401(k), but it does require you to contribute. You can choose either a matching contribution or a fixed percentage of pay. The minimum matching contribution is a full match of the employee’s first three percent of salary deferrals and then 50 cents on the dollar for the next two percent of deferrals for a total match of four percent of pay. The fixed contribution is three percent of compensation for each employee even if they choose not to make any salary deferrals. So, these are the minimum contributions required for a safe harbor. The plan can always be more generous than this. Safe harbor contributions and all employee contributions are immediately 100% owned or vested by the employee. So with these types of plans, you can’t use a gradual vesting schedule like you can in other plans, like a traditional 401(k). Also, before each year, you must provide employees a notice, and you have to explain the essential plan features and how to enroll.

 

What is a 401k Safe Harbor?

Safe harbor 401(k)s, again, don’t require nondiscrimination testing. And this is significant for a couple of reasons. First, when you have the nondiscrimination testing, it does require time. Sometimes you pay a third party to perform the testing. So with a safe harbor, you would keep your administrative costs lower than a traditional 401(k). Secondly, higher paid employees, including the owner, can defer the maximum salary deferrals allowed under the law without being tied to the lower-paid employee deferral rate. And, like most 401(k)s, safe harbors must file an annual Form 5500.

 

Automatic enrollment 401(k) plans

Okay, now let’s talk about automatic enrollment 401(k) plans. Whether you have a safe harbor plan or not, it could be an automatic enrollment plan. These types of plans, even though they’ve been around for a while, they have been gaining in popularity recently. Remember that this is an optional feature in plans, it’s not a required feature. And the way that this works is that it will automatically enroll employees in the plan at a certain deferral percentage rate. Traditionally what has happened with 401(k) plans and the reason why it can be difficult to get people to start deferring to them, is an employer will hire an employee, and they’ll sit down with them, and they’ll give them a deferral election form. And they’ll say, we have a 401(k) plan, and what we’d like for you to do is complete this deferral election form and tell us how much you would like to defer into the plan every payroll. And what happens is the employee, for whatever reason, maybe they’re just apathetic, they just never return the form, okay, and so they end up not being in the plan. And then the years go on, and sometimes even entire careers go on, and the employee just never returns the form because they, largely, they’re just apathetic about it, and they largely just really don’t think they have the money. And so, you have situations where people are not saving for their retirement.

 

Automatic enrollment 401(k) plan

So the way you got an automatic enrollment 401(k) plan works, though, is that same employee would come to the employer, and the employer would say, we’d like for you to fill out this deferral election form, but, by the way, we have an automatic enrollment plan, so if you don’t return this deferral election form, we’re automatically going to put you in at three percent, for example. It could be a different amount. And that way, what it does is: if that same employee does not return that deferral election form where they can opt to defer zero, or they can opt to defer ten percent, but if they don’t return it at all, then they will start at a certain percentage of pay, and generally that’s going to be three percent. And, some plans will actually increase this percentage every year, so the next year it’s four percent, the next year it’s five percent. And, something like this can significantly increase plan participation. The theory behind these types of plans is that the employees really don’t notice that their pay is missing, they don’t really miss the money, and then they end up staying in the plan.

This increases participation in these plans. It’s a little bit sneaky, I think, but it’s kind of a good sneaky. And what this does is: it helps the plans to pass nondiscrimination testing and it helps a lot of employees save for their retirement where they otherwise may not have.

 

Automatic enrollment feature to avoid annual nondiscrimination testing

You can use an automatic enrollment feature to avoid annual nondiscrimination testing. To do this, your automatic enrollment feature has to start with a three percent employee deferral and automatically increase it every year so that the employees contribute at least six percent of their compensation by the fifth year. With this type of automatic enrollment, the company is required to contribute to avoid testing. The required contribution, again, is either a match or a fixed percentage of compensation for all participants. And if you choose the match, it must be a full match on the first one percent of deferrals plus a 50% match for the next five percent of deferrals. If you choose the fixed contribution, it will be three percent of compensation for all eligible employees.

 

401k Pros and Cons

Okay, so 401(k) pros and cons. The key advantages of traditional 401(k) plans are that employees can contribute more salary deferrals than in other retirement plans. Remember, in the SIMPLE IRA plan, employees make salary deferrals but they have lower maximum annual limits. Also, the types of employer contributions are flexible. You can contribute any combination of matching, fixed and discretionary contributions. But keep in mind, you have to follow what your plan document says. The 401(k) plan’s enrollment terms are flexible. For example, if you have a work force that’s seasonal, or if your workers are under age 21, the 401(k) may be an attractive option to simplify your plan administration. You’re permitted, under the law, to draft the plan so you don’t need to cover employees under 21 and those working less than 1,000 hours during a plan year.

 

401(k) plans also have flexible plan features

401(k) plans also have flexible plan features, so they can offer loans to participants, hardship distributions, and designated Roth accounts. So if you contrast that to the IRA-based plans like SEPs and SIMPLEs where you aren’t permitted to offer any of those features. The 401(k)s offering optional features is attractive to employees. They might appreciate a loan from the plan, or a hardship distribution, but they do add administrative work for you and your business. And also, for 401(k)s you need a service provider to set up the plan. There’s generally more recordkeeping, we mentioned the testing, and overall maintenance involved than some of the other plan types.

 

How to Start a Small Business Retirement Plan

Starting a retirement plan. If you want to start a retirement plan, there are a lot of different services that you may need. You may need a record-keeper. This is going to be somebody who keeps track of the participant accounts in the plan. They’re going to process and track enrollment contributions and distributions. And this record-keeper could be somebody who’s at the business or possibly you could go out and employ a specialist to do this. It could even be the person who provided the plan to you. You may need a consultant or an adviser. This is going to be somebody who is going to offer advice about choosing and designing your plan investments. You may need an administrator service provider. This is going to be somebody who provides plan documents, required notices and filings. Generally, they will use an IRS-approved plan that they will provide to you. They may also serve as a record-keeper or consultant for the plan.

Other services that you may want to consider. A third party administrator, we call them TPAs. These people specialize in retirement plans. They will take care of the recordkeeping for you, and they may or they may not provide the plan document for you. You’re going to have plan vendors. They may handle every single aspect of the plan for you. And this could be a mutual fund company. It could be a bank, a broker, or a third-party administrator specializing in retirement plans. You also may need the services of accountants or attorneys. So, you need to understand what your service agreement covers and you need to understand how the fees are earned. So, there are some questions that you would need to ask your service provider, and these are very important.

 

401k Plan Language

You would need to ask who is responsible for updating the plan document for any law changes. You know, as a Manager of Revenue agents who go out and audit these plans, this is quite easily the largest failure problem that we see. In fact, these plans are not being timely updated for all the law changes. So you definitely want to know who’s responsibility is this. You also want to know who will provide recordkeeping services for the plan, who will give any required plan notices to the participants, that’s important as well. Who is going to be required to file the annual report, the annual return, the Form 5500 with the Department of Labor? Or is it filed with the IRS, if it’s a Form 5500EZ. You want to determine whether any nondiscrimination testing will be required and who is going to conduct the testing. Like, for example, in a 401(k) plan, you might have to do the ADP and the ACP test.

You need this accurate information to track who’s eligible to be in the plan, and their compensation amounts. You need accurate amounts for limits testing and to calculate contributions. You’ll also need to track deferral amounts for testing. Make sure you’re withholding and depositing salary deferrals. Another ongoing job is completing the Form 5500 if it’s required. And then, we mentioned that you have to make sure that your plan document is current for retirement laws, so even after you set up your retirement plan, you may need to amend it for changes in the law. If you have a service provider and they mail you amendments to sign by a due date, make sure you read them, and sign them. Plan amendments are an important legal document.

 

Common Small Business Retirement Plan Problems

When your plan isn’t well run, some of the most common mistakes are: not including all employees who are eligible for the plan, not using the correct definition of compensation for calculating contributions, and not signing required plan amendments on time. So recognizing that mistakes happen, IRS has a program to get your plan back on track.

And the program is called the Employee Plans Compliance Resolution System, and it’s made up of these three parts. The first two programs, the Self Correction and Voluntary Correction programs, encourage you to find and fix your plan mistakes. The third program, Audit Closing Agreement Program, is when we find a mistake when we audit your plan. You can correct it and pay a negotiated percentage of the tax that would be due if the plan were disqualified. As part of that, you have to fully correct the plan mistake and pay a sanction. So, once you realize you have a mistake in your plan, which program is right for you? Well, self-correction is great because it allows you to correct an error without contacting the IRS and paying a fee. And, if your mistake is insignificant, you can use self-correction at any time. Some problems, though, like late amendments, don’t qualify for self-correction. But, you could still correct this using the voluntary correction program. And this is where you submit an application to the IRS, describe your proposed correction, how you’ll correct it, and you pay a fee. When the IRS approves, they’ll give you a compliance statement. And if the IRS later audits your plan, the auditor will treat the errors you corrected as if they didn’t occur

 

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.

 

 

 

 

Information about Schedule C and Taxes

What is a Schedule C and who needs to file it?

Schedule C is the federal tax form filed by most sole proprietors; one owner businesses. As you can tell from its title, Profit or Loss from Business, it’s used to report both income and losses. Many times, Schedule C filers are self-employed taxpayers who are just getting their business started. In addition to those who do well at the start, this group can also include new business owners who make very little or no profits, or even lose money. There is also a shorter form, Schedule C-EZ, Net Profit for Business. This is for self-employed individuals with less complex situations including business expenses of less than $5,000, no net losses and no employees.

 

What is the process for filing a Schedule C?

The process actually starts when the business does with good recordkeeping. That will ensure the business owner has everything he or she needs when it comes time to file a tax return. Schedule C is filed annually as an attachment to Form 1040, the individual tax return. The quickest, safest, and most accurate way to file is by using IRS e-file, either online or through a tax professional who is an authorized IRS e-file provider.

 

Filing Schedule C Tips

Start making quarterly, estimated payments to cover your income tax and social security self employment tax. You can make deposits electronically, using the Electronic Federal Tax Payment System, EFTPS. If you have workers, classify them properly as employees or independent contractors. This is determined by law not the choice of the worker or the business owner. Be sure to deposit your federal employment taxes on time. Put a plan in place to protect your financial and tax records and help you recover quickly in the event of a disaster. And steer clear of abusive tax avoidance schemes.

 

Where can a new business owner get more information?

Whether you’ve been in business for a while or are just getting started, our Website has a wealth of information. Go to IRS.gov/smallbiz (with a “z”) for starters. You can browse through the information online, order free tax publications and products, or take a small business tax workshop.

“SIMPLE” retirement plans and simple 401(k) plans

The availability of “SIMPLE” retirement plans: “savings incentive match plan for employees.” This type of plan is targeted at businesses with 100 or fewer employees, and is designed to offer greater income deferral opportunities than individual retirement accounts (IRAs), with fewer  restrictions and administrative requirements than traditional pension or profit-sharing plans. Small business might want to consider offering a SIMPLE retirement plan as a benefit to their workers.

 

What is a SIMPLE retirement plan?

Under a SIMPLE plan, any employee with compensation of at least $5,000 must be permitted to enter a “qualified salary reduction arrangement.” Under this arrangement, an employee can elect to have a percentage of compensation, not in excess of $12,000 (in 2014), set aside in an IRA, instead of receiving it in cash. This maximum is indexed for inflation each year. Amounts taken out of the employee’s salary and contributed to a SIMPLE IRA are not taxed to the employee until withdrawn from the SIMPLE IRA. Early withdrawals may be subject to a 10% penalty (25%, if the withdrawal is made within the first two years).

 

Qualified salary reduction arrangement

Under a qualified salary reduction arrangement, the employer must make “matching” contributions to the SIMPLE IRA. That is, the employer must make contributions to an employee’s SIMPLE IRA in the same amount that the employer contributed under the employee’s salary reduction election, up to 3% of the employee’s compensation. For example, if an employee with compensation of $50,000 elects to have 10% of his pay contributed to the plan ($5,000), the employer must contribute an additional $1,500 (3% of $50,000). For these purposes, an employee’s compensation is the amount reported on his Form W-2, plus the amount of elective deferrals (e.g., the amount of the salary reduction contributed to the SIMPLE IRA). But the matching contribution for the year cannot exceed $12,000 in 2014.

 

How much does qualified salary reduction arrangement increase each year?

This amount is indexed for inflation each year. If an employer wishes to contribute less than 3%, he can give employees proper notice and drop the contribution to as low as 1% of compensation, as long as this isn’t done for more than two years out of the five-year period ending with the year of reduced contributions. Alternatively, instead of making “matching” employee contributions, the employer can simply contribute a flat 2% of “compensation” (limited to $260,000 for 2014, and as adjusted for inflation in following years), for every employee eligible to participate in the plan, whether the employee elects to reduce his salary or not. Special notice must be given to employees if the employer wishes to take this approach.

 

Setting up a SIMPLE 401(k) plan

Instead of adopting a simple retirement plan, an employer can set up a SIMPLE 401(k) plan. By making matching contributions (or 2% nonelective contributions) and satisfying rules similar to those for simple plans, SIMPLE 401(k) plans will be considered to satisfy the otherwise complex nondiscrimination test for 401(k) plans. The contribution rules for SIMPLE plans apply to simple 401(k) plans, except that if an employer adopts the matching contribution approach (instead of the flat 2% option), the maximum contribution percentage cannot be dropped below 3%. Unlike a SIMPLE plan, a SIMPLE 401(k) plan is part of a qualified plan, and is subject to the qualified plan rules. Contributions to SIMPLE 401(k) plans are not subject to the 15 percent limits on contributions to profit-sharing or stock bonus plans. SIMPLE plans have the advantages of simplified reporting requirements and the absence of the qualification rules prohibiting the plan from discriminating against lower-level employees.

 

Matching Contributions to SIMPLE plans

These advantages come with some obligations, such as the matching contribution requirement. Additionally, to be eligible to adopt a SIMPLE plan, an employer must not contribute to, or accrue benefits under, any qualified retirement plan for services provided during the year (or in any year after the qualified salary reduction arrangement takes effect). But employers that maintain a plan for collectively bargained employees can maintain a SIMPLE plan for noncollectively bargained employees. A restriction similar to the “exclusive plan requirement” applies to SIMPLE 401(k) plans, but only for services provided by employees eligible to participate in the SIMPLE 401(k) plan.

What is Section 1244 Stock?

Ordinarily, a loss on a sale or exchange of stock is a capital loss. Capital loss treatment is generally less advantageous than ordinary deduction treatment because of the fact that a capital loss recognized by an individual is applied, first against capital gain (which is usually subject to tax at a maximum marginal rate which is lower than that on ordinary income), and, to the extent it exceeds capital gains recognized during the year, is subject to limitations on deductibility.

 

Section 1244 Loss Deductions

Fortunately, the tax law allows ordinary loss treatment on certain losses with respect to stock of small
corporations. In general, this special treatment is only available if the following conditions are satisfied:
(1) As of the time the stock was issued, the aggregate amount that was received by the issuing
corporation for stock, as contributions to capital and as paid-in surplus, must not have exceeded $1
million.
(2) The stock must have been issued for money or property (other than stock or securities). Thus, the
stock can’t be issued as compensation for services.
(3) For the five years before the year the loss was sustained, the corporation must not have received
50% or more of its receipts from certain passive sources.
(4) The taxpayer claiming the special treatment must be an individual (including, if certain conditions
are satisfied, individuals who claim the loss through holding an interest in a partnership that is selling
the stock). The special treatment isn’t available to corporations, trusts or estates.
(5) The stock must have been issued to the individual claiming the special treatment, or to the
partnership through which the individual is claiming the special treatment, and held continuously by
that individual (or partnership) to the time of sale.
In any year, the total loss treated as ordinary under these rules can’t be more than $50,000 (or $100,000
if you file a joint return).

Misclassification of Worker IRS Penalties

As we have seen, the status of a worker as either an independent contractor or an employee must be determined accurately in order to ensure that workers and businesses can anticipate and meet their tax responsibilities. Businesses decide whether to hire employees or independent contractors depending on individual needs, customer expectations, and worker availability. Either worker classification – independent contractor or employee – can be a valid and appropriate business choice. Whatever the choice, the classification of a worker must be correct and this is something that the IRS takes seriously.

 

Work Classification Challenges by IRS

The majority of classifications of workers are not challenged by the IRS. However, when IRS reclassifications are made, it can result in the assessment of significant employment tax liabilities. Congress recognized this in 1978 and passed Section 530 of the Revenue Act of 1978. Section 530 provides businesses with relief from federal employment tax obligations if certain requirements are met. It terminates the business’s, but not the worker’s, liability for the following employment taxes: federal income tax withholding, Social Security and Medicare taxes (FICA), and Federal Unemployment Tax (FUTA). It also means the business is not required to pay any interest or penalties resulting from the liability for employment taxes.

Information on Section 530 relief can be found in Publication 1976 (PDF), titled Section 530 Relief Requirements. This publication is on the IRS Web site.

 

Section 530 Relief Requirements for Worker Classification

Now let’s take a few minutes to address the application of Section 530 of the Revenue Act of 1978. In certain circumstances, Section 530 can relieve businesses of employment tax liability resulting from worker misclassification, but the business must meet specific requirements under the law.

The business must meet the following three requirements to receive relief under Section 530:

  • Reporting consistency
  • Substantive consistency, and
  • Reasonable basis

The business must meet ALL three tests.  Meeting these three tests means that the business will not owe employment taxes for the workers in question. If these tests are not met by an employer, there could be special taxes owed.

 

IRS consistency tests

The business must demonstrate two types of consistency:

  1. First, the business must treat all workers in similar positions the same. This is called substantive consistency. The business (and any predecessor business) must not have treated the workers, or any similar workers, as employees. If you treated similar workers as employees, this relief provision is not available. In other words, treatment of the workers must be consistent with the position that they were not employees. For example, if the business treated a worker as an independent contractor, it must treat all workers in a similar position as independent contractors. Let’s say a business employed 20 workers performing the same duties under the same direction and control, and treated 15 as employees and 5 as independent contractors. In this scenario, the substantive consistency test would not be met.
  2. Second, the business must file all required federal tax returns on a consistent basis. This is called reporting consistency. This means that if a business believes a particular worker or group of workers are properly classified as independent contractors, then the business must demonstrate to the IRS that they have been filing the required forms – for example, Form 1099-MISC – for those independent contractors.

Relief is not available for any year the business did not file the required Forms 1099-MISC. If they filed the required Forms 1099-MISC for some workers, but not for others, relief is only available for the workers for whom the 1099-MISC was filed.

 

Section 530 – Reasonable Basis

In addition to meeting both consistency tests, the business must also have a reasonable basis for not treating the workers as employees. To establish that you had a reasonable basis for not treating the workers as employees, you can show that:

  • You reasonably relied on a court case about federal taxes or a ruling issued to you by the IRS; or
  • Your employment tax liabilities were audited by the IRS at a time when you treated similar workers as independent contractors and we did not reclassify those workers as employees; or
  • You treated the workers as independent contractors because you knew that was how a significant segment of your industry treated similar workers; or
  • You relied on some other reasonable basis. For example, you relied on the written advice of a business lawyer or accountant who knew the facts about your business.

 

What happens if worker is classified?

It is the position of the IRS that the judicial precedent relied upon must have been in existence at the time you made the decision to treat the workers as independent contractors. Additionally, if you are relying on industry practice, you will need to show that you knew, at the time you began treating your workers as independent contractors, that this was the industry practice – for example, a survey of the industry prior to your treatment.

If you did not have a reasonable basis for treating the workers as independent contractors, you do not meet the relief requirements.

Employee versus Independent Contractor IRS Revenue Ruling 87-41

IRS Revenue Ruling 87-41 contains factors, commonly referred to as the twenty common law factors, that assess whether or not a business has the right to direct and control the actions of the worker.  Although this revenue ruling is still valid today, the IRS has grouped the more relevant ones into three main categories of evidence that show whether a worker is an employee or an independent contractor:

 

Independent Contractor or Employee Test

  • One: behavioral control
  • Two: financial control, and
  • The third is the relationship of the parties.

 

The  businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that make the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors that are relevant in one situation may not be relevant in another.

 

Applying Employee Test

The key is to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

Next we will look at each of these factors in more detail.

First, let’s look at behavioral control. The key issues for behavioral control are instructions and training.

 

Types of instructions include things like:

  • When and 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, and
  • What order or sequence to follow when performing the work

 

Other Factors into Classifying Independent Contractor or Employee

You would also want to consider the degree of instruction. The more detailed the instructions, the more control the business exercises over the worker. More detailed instructions indicate that the worker is an employee. Less detailed instructions reflects less control, indicating that the worker is more likely an independent contractor.

The next factor under behavioral control is the evaluation system. If an evaluation system measures the details of how the work is performed, then these factors could point to an employee. On the other hand, if the evaluation system measures just the end result, then this could point to either an independent contractor or an employee.

And finally, there’s 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 strong evidence that the worker is an employee. Periodic or ongoing training about procedures and methods is even stronger evidence of an employer-employee relationship. All of these will be applied together to determine if someone is an employee of independent contractor.

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.

Changes Health Care Tax Credit for Small Business

Small employers should be aware of changes in the tax credit health care for small businesses, a provision of the Affordable Care Act ACA. This arrangement provides a tax credit to eligible small employers that provide health care to their employees. The intended goal of this legislation is to help more Americans get health insurance through their employers.

 

Changes Health Care Tax Credit for Small Business

Beginning in 2014, there are changes to the tax credit can affect your small business or tax exempt organization:

• The percentage of credit increased from 35 percent to 50 percent of premiums paid by the employer; for tax-exempt employers, the percentage increased from 25 percent to 35 percent.

• Small employers can claim the credit only for two consecutive taxable years beginning with the tax year 2014 and beyond.

• For 2014, the credit is gradually eliminating when the average salary equals $ 25.400 and credit disappears completely when the average wage exceeds $ 50.800. The average income that establishes the gradual elimination of credit is adjusted annually for inflation.

 

Qualified Plan of the Health Program Options for Small Business Market (SHOP QHP)

• Generally, small employers are required to purchase a Qualified Plan of the Health Program Options for Small Business Market (SHOP QHP) to be eligible for the EIC Health. Assisting the transition to this requirement is available for some small employers.

Small employers may still be eligible to claim the credit for years prior to 2014. Employers who were eligible to claim the credit in previous years, but did not, can consider whether they are still eligible to amend tax returns for years Previous to claim the credit.

 

Information about IRS Form 8941

The following information will help you complete Form 8941 , Credit Insurance Premiums for Small Employer.

• Documentation or letter of eligibility SHOP QHP, unless the applicable transitional assistance 
• Number of full-time employees and part-time and number of hours worked 
• Average annual salaries for employees 
• Premiums paid by employer employee if is relevant 
• Schedule K-1 Relevant and other credit information of the individual 
• Cost of coverage for each employee 
• Tax Liability payroll – only to tax-exempt organizations 
• Credit information transferred to the individual – for Schedule K-1 for other employers small