Reporting and Tax Problems in the Making

Any business employing people must pay them as employees subject to tax withholding or as contract labor.  For sole proprietors, the payroll story begins when you decided to employ people full time and now they’re subject to withholdings.  You must first obtain a Federal Identification Number (FIN). 

 

Under this FIN you will be reporting what you pay your employees to the IRS.  You will report your payroll liabilities and your payment to those liabilities. 

 

Once you obtain the FIN, and assuming that you had employees, you must report quarterly to both the IRS and the state.  You will need to file form 941 to the IRS every quarter as well as the state quarterly report. 

 

Form 941 basically requires that you report gross payroll for the quarter and the tax withheld, and add to it the social security matching for the employer.  This money should be sent to the IRS as the payroll is periodically made.  941 is basically a statement of account; how much the payroll liability was and how much was paid.  If there is a tax debt at the end of the quarter it should be sent with Form 941.

 

At the end of the year, you as a business owner should file Form 940.  This form is for federal employment tax.  This form interfaces with the state unemployment tax you pay and usually the rate is less than one percent of the taxable amount which is correlated to state unemployment wages.

 

Also at the end of the year, as an employer, you must file forms W-2 with the IRS.  You give a copy of this form to the employees and the IRS package is sent along with a transmittal form W-3 which basically adds up all the individual W-2's  and tells the IRS how many W-2's are filed.  Usually this form is sent to the social security administration.

If you are self employed person and you have no employees, you don't have to take a salary and give yourself a W-2 at the end of the year.  The way it works is that you calculate your net income and you calculate the income tax on that income. 

 

Then you add to that your social security that a regular employee pays.  But unfortunately you have to double the social security and Medicare amount that you calculate.  You send this amount quarterly to the IRS. 

 

You double the amount of social security and Medicare because you pay your share as an employee and then you pay the share of the employer as well.  As a self employer you wear two hats, the employee hat and the employer hat as well.

 

To understand the significance of this, think if you have a net income for the year of $100,000.  Just social security and Medicare alone before you pay a dime of income tax is about $0.15/dollar or $15,000.

 

Perhaps that explains why most people with tax problems are from the self employed group.  For one, no one withholds tax from them.  And then they have to double the amount of tax they did not pay.

 

Some self employed folks owe hundreds of thousands of back taxes to the IRS.  It is often prohibitive that drives some out of business unless they can reach a tax settlement.  The tax resolution for payroll tax problems often take form in the shape of an installment agreement, Offer in Compromise, or if you cannot pay only temporarily, the entity may be declared as currently not collectible.

 

Final word about payroll taxes is that the IRS takes the payroll tax debt very seriously, especially if it relates to trust fund; that is the tax the employer collects from the employees and never deposits with the IRS. 

 

This tax problem is so serious that they not only hold the corporation liable for this tax debt but also the stockholders personally liable for it.  They go even beyond that to hold the employee who has the authority to sign the check to be liable for this tax debt as well.

So what if you decide to treat your employees as contract labor, thus avoiding the myriads of tax problems associated with payroll?  That would have been very easy if the IRS let us do that.

 

But why would the IRS object to treating all our employees as contract labor instead as "employees”?  Well, remember that if you do that, then you would have escaped paying the matching of the Medicare and social security taxes which amounts to about 7.5%. 

 

There are other issues associated with retirement plans which may prove that converting employees to contract labor may be tantamount to getting rid of people that you must otherwise include in your retirement plan.

 

Perhaps informally the IRS knows that if you convert those people into self employed ones you may be harvesting a payroll tax problem usually associated with self employed people who in many instances are unable to pay their back taxes.  Many employers get in trouble and develop tax problems when they don't make that deposit which is usually called trust fund.  The IRS frowns upon such tax debt and exacts sometimes excessive punishment on the employers who fell into that trap.  Tax settlements are harder for payroll taxes than for other tax problems.