Business Tax Corner: Let’s Talk About Your Employees

Congratulations you have built up your business and now can afford to hire employees to take over some of the responsibilities you have carried yourself through the initial growth period.

 

Who Are Employees?

 

Generally, employees are defined either under common law or under statutes for certain situations.

Employee status under common law. Generally, a worker who performs services for you is your employee if you have the right to control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.

Generally, people in business for themselves aren’t employees. For example, doctors, lawyers, veterinarians, and others in an independent trade in which they offer their services to the public are usually not employees. However, if the business is incorporated, corporate officers who work in the business are employees of the corporation.

If an employer-employee relationship exists, it doesn’t matter what it is called. The employee may be called an agent or independent contractor. It also doesn’t matter how payments are measured or paid, what they’re called, or if the employee works full or part time.

Statutory employees. If someone who works for you isn’t an employee under the common law rules discussed above, don’t withhold federal income tax from his or her pay, unless backup withholding applies. Although the following persons may not be common law employees, they’re considered employees by statute for social security, Medicare, and FUTA tax purposes under certain conditions.

An agent (or commission) driver who delivers food, beverages (other than milk), laundry, or dry cleaning for someone else.

A full-time life insurance salesperson who sells primarily for one company.

A homeworker who works by guidelines of the person for whom the work is done, with materials furnished by and returned to that person or to someone that person designates.

A traveling or city salesperson (other than an agent-driver or commission-driver) who works full time (except for sideline sales activities) for one firm or person getting orders from customers. The orders must be for merchandise for resale or supplies for use in the customer’s business. The customers must be retailers, wholesalers, contractors, or operators of hotels, restaurants, or other businesses dealing with food or lodging.

Statutory nonemployees. Direct sellers, qualified real estate agents, and certain companion sitters are, by law, considered nonemployees. They’re generally treated as self-employed for all federal tax purposes, including income and employment taxes.

H­2A agricultural workers. On Form W-2, don’t check box 13 (Statutory employee), as H-2A workers aren’t statutory employees.

Treating employees as nonemployees. You’ll generally be liable for social security and Medicare taxes and withheld income tax if you don’t deduct and withhold these taxes because you treated an employee as a nonemployee. You may be able to calculate your liability using special IRC section 3509 rates for the employee share of social security and Medicare taxes and the federal income tax withholding. The applicable rates depend on whether you filed required Forms 1099.

Congratulations you have built up your business and now can afford to hire employees to take over some of the responsibilities you have carried yourself through the initial growth period.

 

Who Are Employees?

 

Generally, employees are defined either under common law or under statutes for certain situations.

Employee status under common law. Generally, a worker who performs services for you is your employee if you have the right to control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.

Generally, people in business for themselves aren’t employees. For example, doctors, lawyers, veterinarians, and others in an independent trade in which they offer their services to the public are usually not employees. However, if the business is incorporated, corporate officers who work in the business are employees of the corporation.

If an employer-employee relationship exists, it doesn’t matter what it is called. The employee may be called an agent or independent contractor. It also doesn’t matter how payments are measured or paid, what they’re called, or if the employee works full or part time.

Statutory employees. If someone who works for you isn’t an employee under the common law rules discussed above, don’t withhold federal income tax from his or her pay, unless backup withholding applies. Although the following persons may not be common law employees, they’re considered employees by statute for social security, Medicare, and FUTA tax purposes under certain conditions.

An agent (or commission) driver who delivers food, beverages (other than milk), laundry, or dry cleaning for someone else.

A full-time life insurance salesperson who sells primarily for one company.

A homeworker who works by guidelines of the person for whom the work is done, with materials furnished by and returned to that person or to someone that person designates.

A traveling or city salesperson (other than an agent-driver or commission-driver) who works full time (except for sideline sales activities) for one firm or person getting orders from customers. The orders must be for merchandise for resale or supplies for use in the customer’s business. The customers must be retailers, wholesalers, contractors, or operators of hotels, restaurants, or other businesses dealing with food or lodging.

Statutory nonemployees. Direct sellers, qualified real estate agents, and certain companion sitters are, by law, considered nonemployees. They’re generally treated as self-employed for all federal tax purposes, including income and employment taxes.

H­2A agricultural workers. On Form W-2, don’t check box 13 (Statutory employee), as H-2A workers aren’t statutory employees.

Treating employees as nonemployees. You’ll generally be liable for social security and Medicare taxes and withheld income tax if you don’t deduct and withhold these taxes because you treated an employee as a nonemployee. You may be able to calculate your liability using special IRC section 3509 rates for the employee share of social security and Medicare taxes and the federal income tax withholding. The applicable rates depend on whether you filed required Forms 1099.

IRC section 3509 rates aren’t available if you intentionally disregard the requirement to withhold taxes from the employee or if you withheld income taxes but not social security or Medicare taxes. IRC section 3509 isn’t available for reclassifying statutory employees. See Statutory employees above.

If the employer issued required information returns, the IRC section 3509 rates are:

For social security taxes; employer rate of 6.2% plus

20% of the employee rate of 6.2% for a total rate of 7.44% of wages.

For Medicare taxes; employer rate of 1.45% plus 20% of the employee rate of 1.45%, for a total rate of 1.74% of wages.

For Additional Medicare Tax; 0.18% (20% of the employee rate of 0.9%) of wages subject to Additional Medicare Tax.

For income tax withholding, the rate is 1.5% of wages.

If the employer didn’t issue required information returns, the IRC section 3509 rates are:

For social security taxes; employer rate of 6.2% plus

40% of the employee rate of 6.2% for a total rate of 8.68% of wages.

For Medicare taxes; employer rate of 1.45% plus 40% of the employee rate of 1.45%, for a total rate of 2.03% of wages.

 

For Additional Medicare Tax; 0.36% (40% of the employee rate of 0.9%) of wages subject to Additional Medicare Tax.

For income tax withholding, the rate is 3.0% of wages.

Relief provisions. If you have a reasonable basis for not treating a worker as an employee, you may be relieved from having to pay employment taxes for that worker. To get this relief, you must file all required federal tax returns, including information returns, on a basis consistent with your treatment of the worker. You (or your predecessor) must not have treated any worker holding a substantially similar position as an employee for any periods beginning after 1977.

Voluntary Classification Settlement Program (VCSP). Employers who are currently treating their workers (or a class or group of workers) as independent contractors or other nonemployees and want to voluntarily reclassify their workers as employees for future tax periods may be eligible to participate in the VCSP if certain requirements are met. File Form 8952 to apply for the VCSP.

When you pay your employees, you don’t pay them all the money they earned. As their employer, you have the added responsibility of withholding taxes from their paychecks. The federal income tax and employees’ share of social security and Medicare taxes that you withhold from your employees’ paychecks are part of their wages that you pay to the United States Treasury instead of to your employees. Your employees trust that you pay the withheld taxes to the United States Treasury by making federal tax deposits. This is the reason that these withheld taxes are called trust fund taxes. If federal income, social security, or Medicare taxes that must be withheld aren’t withheld or aren’t deposited or paid to the United States Treasury, the trust fund recovery penalty may apply.

There is a mountain of rules and regulations to be adhered to in the area of employee classification and payroll tax withholding and submission to taxing authorities. Too many of my clients have dug themselves into a difficult situation because they choose to process their own payroll.

Maybe it is time to review your employees status and how the back office is preparing taxes. The last thing you need as a business owner is an ongoing headache with the IRS and the Trust Fund Recovery Penalties.

IRC section 3509 rates aren’t available if you intentionally disregard the requirement to withhold taxes from the employee or if you withheld income taxes but not social security or Medicare taxes. IRC section 3509 isn’t available for reclassifying statutory employees. See Statutory employees above.

If the employer issued required information returns, the IRC section 3509 rates are:

For social security taxes; employer rate of 6.2% plus

20% of the employee rate of 6.2% for a total rate of 7.44% of wages.

For Medicare taxes; employer rate of 1.45% plus 20% of the employee rate of 1.45%, for a total rate of 1.74% of wages.

For Additional Medicare Tax; 0.18% (20% of the employee rate of 0.9%) of wages subject to Additional Medicare Tax.

For income tax withholding, the rate is 1.5% of wages.

If the employer didn’t issue required information returns, the IRC section 3509 rates are:

For social security taxes; employer rate of 6.2% plus

40% of the employee rate of 6.2% for a total rate of 8.68% of wages.

For Medicare taxes; employer rate of 1.45% plus 40% of the employee rate of 1.45%, for a total rate of 2.03% of wages.

 

For Additional Medicare Tax; 0.36% (40% of the employee rate of 0.9%) of wages subject to Additional Medicare Tax.

For income tax withholding, the rate is 3.0% of wages.

Relief provisions. If you have a reasonable basis for not treating a worker as an employee, you may be relieved from having to pay employment taxes for that worker. To get this relief, you must file all required federal tax returns, including information returns, on a basis consistent with your treatment of the worker. You (or your predecessor) must not have treated any worker holding a substantially similar position as an employee for any periods beginning after 1977.

Voluntary Classification Settlement Program (VCSP). Employers who are currently treating their workers (or a class or group of workers) as independent contractors or other nonemployees and want to voluntarily reclassify their workers as employees for future tax periods may be eligible to participate in the VCSP if certain requirements are met. File Form 8952 to apply for the VCSP.

When you pay your employees, you don’t pay them all the money they earned. As their employer, you have the added responsibility of withholding taxes from their paychecks. The federal income tax and employees’ share of social security and Medicare taxes that you withhold from your employees’ paychecks are part of their wages that you pay to the United States Treasury instead of to your employees. Your employees trust that you pay the withheld taxes to the United States Treasury by making federal tax deposits. This is the reason that these withheld taxes are called trust fund taxes. If federal income, social security, or Medicare taxes that must be withheld aren’t withheld or aren’t deposited or paid to the United States Treasury, the trust fund recovery penalty may apply.

There is a mountain of rules and regulations to be adhered to in the area of employee classification and payroll tax withholding and submission to taxing authorities. Too many of my clients have dug themselves into a difficult situation because they choose to process their own payroll.

Maybe it is time to review your employees status and how the back office is preparing taxes. The last thing you need as a business owner is an ongoing headache with the IRS and the Trust Fund Recovery Penalties.

Call my office and my staff and I will assist you in avoiding payroll problems. If you received a letter or notice from The IRS do not hesitate with that phone call because time is costing you a degradation of your taxpayer rights and can become expensive very quickly due to penalties and interest.

If this is important to you call Patrick LeClaire @ 407-287-6638. Send me an email @ patrick@newlifetaxresolutions.com. If all else fails send a message in a bottle.

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About Patrick LeClaire

After 15 years in corporate finance and Tax Preparation, I formed a company as an Enrolled Agent. I insist on superior customer service and the highest standards available as I embark on a journey to resolve one case at a time at New Life Tax Resolution.