The home stretch of the first tax season under the tax reform law brings individuals and C corporations within sight of the April 15, 2019, filing deadline. With this deadline looming and the March 15, 2019, deadline in the near past, it’s easy to get caught up looking at deductions, tax credits, and refunds. But for business owners, particularly small business owners, tax compliance is a quarterly, monthly, weekly, and even daily consideration. In this new series we will discuss these recurring tax issues faced by small business owners, the steps that they can take to mitigate challenges that may arise, and how to take advantage of associated opportunities.
The Challenge with Employment Taxes
For many small businesses, employment taxes are one of the biggest headaches and the biggest source of tax-related risk. A business owner seldom frets about taking receipts and documents to a tax preparer who then prepares the tax return for the business owner. But it is much more difficult to manage payroll, withholding, and employee benefits on an ongoing basis while juggling the associated tax implications. Failing to manage employment tax related obligations can result in significant penalties. There is a penalty for failing to deposit Medicare and Social Security taxes in a timely manner, and for failing to pay federal unemployment taxes. There is also a penalty for failing to issue Forms W-2 on time. Misclassifying employees as independent contractors can also result in penalties and an unexpected employment tax bill. On top of this morass of federal employment tax compliance, states often impose separate rules and penalties for employment tax and withholding matters.
Employee Updates to Form W-4
So what can an employer do to stay on top of these employment tax requirements? The first step is to ensure that employee income tax withholding information is accurate and up-to-date. The changes to the standard deduction and personal exemptions under the 2017 tax reform law commonly known as the Tax Cuts and Jobs Act (TCJA) require many employees to adjust their income tax withholding amount. This means making sure employees are aware of this possibility and requesting that they update their Form W-4 information. Employees use Form W-4 to instruct an employer about the proper amount of income tax to withhold. Although employees may only consider Form W-4 information once, at the time they are hired, there are other circumstances when it should be revisited. Changes in personal or financial circumstances, as well as changes in the tax law, can affect an employee’s tax liability and withholding obligations. To assist employees with Form W-4 information, the IRS provides a withholding calculator so employees can make sure that their withholding is appropriate.
Employer Classification of Employees and Independent Contractors
The next step is to ensure that any “independent contractors” used by the business qualify as such for tax purposes. It is common for employers to classify their workers as independent contractors. Doing so benefits the employer in several ways. First, payments are not subject to payroll tax withholding, and generally are not subject to income tax withholding, either. Also, independent contractors are not considered employees for purposes of the employer mandate under the Affordable Care Act. This means that businesses are not required to offer independent contractors health insurance benefits.
But a worker’s classification by the hiring business as an independent contractor takes more than a mere assertion.
The IRS provides guidance that a business must use to classify a worker as an employee versus an independent contractor. This guidance involves a list of factors involving the degree of behavioral control, financial control, and the type of relationship that exists. If a business classifies its workers as independent contractors under this guidance, but the independent contractors are later found to be employees, there are relief provisions available that can help reduce the employment tax burden resulting from the reclassification. But this relief is not available if this guidance is not followed or if there is no reasonable basis for the worker classification.
Employer’s Payroll Tax Compliance Obligations
As employers know, payroll management isn’t as easy as sending out checks each pay period. Employers must withhold income taxes, Social Security taxes, and Medicare taxes from wages, and must deposit these amounts in a timely manner. Most employers file Form 941 quarterly to report federal income tax, Social Security taxes, and Medicare taxes withheld by the employer. But, deposits of withheld taxes are required on a monthly, semi-weekly, and sometimes next-day basis, depending on the amount owed during a specified period. Deposits generally must be made via electronic funds transfer. These deposit requirements are rigidly enforced by the IRS, and are irrespective of the time it takes to file the Form 941. Penalties for a failure to timely deposit apply even when a payment is a single day late, and range from 2 percent to 15 percent of the underpayment. A separate late payment penalty of 0.5 percent per month can also apply, which is capped at 25 percent total. Hence, the maximum amount of both penalties could reach 40 percent. Employers must vigilantly monitor these deposit requirements to ensure that cash balances are available for withdrawal upon each deposit due date.
A failure to follow these steps can also result in personal liability. The law provides for personal liability in circumstances where the failure to deposit is willful. Numerous courts have affirmed the imposition of personal liability, even when the business owner delegated withholding duties to another employee or third party, unless the third party is a professional employer organization (PEO), which essentially act as the employer for payroll tax and employee benefit purposes, and will generally be the entity held liable. In short, a failure to pay employment taxes can bring down an otherwise healthy business.
Many employers will also be required to file Form 944 annually. This form reports the annual amount of payroll taxes withheld. Additionally, Form 940 must be filed to report federal unemployment taxes. And, Forms W-2 and Form W-3, Transmittal of Wage and Tax Statement must be filed with the Social Security Administration. Each state also requires additional reporting and compliance measures.
Employers necessarily seek out various solutions to manage this complex payroll compliance process. There are software options available for do-it-yourselfers, PEOs to consider, or there are payroll service options. Finding the right option is essential for a small business as there are many steps to full compliance.
These are just a few of the employment tax related issues that small businesses face. Employment tax compliance is an area where the tax law affects businesses on an ongoing basis, not just during tax season. Payroll tax compliance is also where many of the stiffest penalties in the tax arena apply. Therefore it is essential that small business owners are aware of their employment tax responsibilities and that they take appropriate measures to ensure full compliance. For more information on these matters, please contact your local CBIZ tax professional.
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