Tax Regulations

 

Bringing your first employee into your business is a reason to celebrate. You’ve done well enough as a sole proprietor that you can’t handle the workload by yourself anymore.

It’s a major milestone for you, but it comes with a lot of paperwork that you must do correctly.

Before your first employee even shows up for the first day of work, you should have assembled all the paperwork required to keep you compliant with the IRS and other federal and state agencies.

EIN Application

If you are a sole proprietor and you’ve been using your Social Security number as your tax ID, you’ll need an Employer Identification Number (EIN). You can apply for one here.

The IRS’s EIN Assistant walks you through the process of applying for an Employer Identification Number (EIN).

Once you’ve completed the steps in the IRS’s EIN Assistant, you’ll receive your EIN right away, and can start using it to open a business bank account, apply for a business license, etc.

You’ll also need an EIN before you start paying your first employee in order to provide him or her with Form W-4. If you’ve ever worked for a business yourself, you’ve probably filled out this form. As an employer now, you should provide one to your new hire on the first day. This form will help you determine how much federal income tax to withhold every payday. If you’re not bringing in a full-time employee but, rather, an independent contractor, you won’t be responsible for withholding and paying income taxes for that individual. You’ll need to supply him or her with a Form W-9.

Payroll processing is the next step and can be complex. If you don’t have any experience with it, you’ll probably want to use an online payroll application. After you’re set up on one of these websites, you enter the hours worked every pay period. The site calculates tax withholding and payroll taxes due, then prints or direct deposits paychecks. Let us know if you want some guidance on this.

State Reporting

Don’t forget about state taxes. You will have to register with the Texas Workforce Commission so you can receive a TWC tax account number. To register online click here. You will have to file wage reports and make state unemployment tax payments online.

You also have to be in contact with the State to report a new hire (same goes if you ever re-hire someone). Click here to find out more about the new hire reporting requirements.

Form I-9

All employees are required to fill out a Form I-9 on the first day of a new job. New employees must also prove that they’re legally eligible to work in the United States. To do this, they complete a Form I-9 from the Department of Homeland Security. As their employer, you’re charged with verifying that the information provided is accurate by looking at one or a combination of documents (U.S. Passport, driver’s license and birth certificate, etc.). By signing this form, you’re stating that you’ve done that.

You can also use the U.S. government’s E-Verify online tool to confirm eligibility.

A Helping Hand

The Department of Labor has a great website for new employers. The FirstStep Employment Law Advisor helps employers understand what DOL federal employment laws apply to them and what record-keeping they’re required to do.

Please consider us a resource, too, as you take on a new employee. Preparing for a complex new set of tax obligations will be a challenge. We’d like to see you get everything right from the start.

A common way for a shareholder to withdraw tax-free cash from a closely held corporation is to borrow money from it. However, for such a tax strategy to pass muster with the IRS, the loan must be business like. The IRS has issued an audit guide on shareholder loans. This guide describes factors that determine whether withdrawals will be considered loans or taxable dividends.

IS THE SHAREHOLDER LOAN A BONA FIDE LOAN?

Whether or not the IRS will consider a disbursement to a shareholder to be a loan for tax purposes depends on whether, at the time of the distribution, the shareholder intended to repay it and the corporation intended to require repayment. “Yes” answers to the following questions can help demonstrate this intent.

• Did the shareholder provide security for the loan?
• Is the shareholder in a position (as to salary, other income, and net worth) to repay the loan?
• Did the shareholder give a certificate of debt to the corporation?
• Is there a repayment schedule or an attempt to repay?
• Did the shareholder and the company set a maturity date for the loan?
• Does the corporation charge interest?
• Does the corporation make systematic efforts to obtain repayment?
• Is there a ceiling on the amount the corporation can advance?

IRS may reclassify the shareholder loans that aren’t considered bona fide as dividends — taxable to the shareholder and nondeductible by the corporation. “Yes” answers to the following questions would indicate that distributions to a shareholder may be constructive dividends rather than loans.

• Does the shareholder control the corporation’s affairs?
• Is the controlling shareholder’s ability to repay the shareholder loan contingent on future events?
• Does the corporation have adequate earnings and profits with respect to the advances made, coupled with no history of paying dividends?

The above list is not all-inclusive. No factor by itself is determinative; The IRS looks at the factors as a whole. For more information on shareholder loans, contact us today.

If you are getting a divorce, taxes are probably not highest on your list of concerns. Still, you should consider a number of tax-related issues.

File Jointly or Separately?

For tax purposes, the law determines a person’s marital status on the last day of the tax year. Thus individuals who separate, but don’t divorce, during the year typically will need to make a choice. They will have to choose between filing jointly or separately.

Filing separately may result in the loss of valuable tax credits and deductions. For example, the American Opportunity Tax Credit is not available to a married taxpayer who files a separate return. Typically, filing jointly will result in the lowest overall tax.

One reason to consider filing separately is for protection from the other spouse’s future tax liabilities. Generally, spouses who sign joint returns have joint and several liability — meaning that they are each fully liable for unpaid tax liabilities arising out of the return. Moreover, the IRS has the right to pursue the party who is best able to pay the full amount quickly. Thus the two filers have to work out the issues of fairness between them. The “innocent spouse” rules and/or the “separate liability” election may provide protection in some circumstances.

Property Settlements in a Divorce

Dividing property in connection with a divorce generally has no immediate consequences for either spouse. However, if the spouse who receives property in the divorce settlement later sells it, there may be a gain to report for tax purposes. So, potential taxes should be a consideration in deciding which spouse will receive which property.

Note that a spouse who receives property in a divorce figures any gain on a subsequent sale of the property using the transferring spouse’s basis (e.g., cost), not the property’s value when it was received.

Example. Michelle receives 10 acres of unimproved land in her divorce settlement. Her ex-husband bought the land for $25,000. It’s now worth $100,000. If Michelle sells the land for $100,000, she will have to report a taxable gain of $75,000. This is the difference between the $100,000 selling price and the $25,000 cost basis.

Personal Residence

If a divorcing couple sells their home while they are still married, they are entitled to exclude up to $500,000 of gain from their taxable income if otherwise eligible for the exclusion. If one spouse simply transfers the ownership of the home to the other spouse as part of the divorce settlement, there is no taxable gain or loss at the time of transfer. However, should that spouse later sell the house while he or she is unmarried, only a $250,000 exclusion would be available.

Retirement Benefits

A divorce settlement often determines how the spouses will divide the retirement plan benefits between them. However, an employer may distribute retirement plan benefits to a former spouse only after receiving a court-issued document that meets the requirements for a qualified domestic relations order (QDRO). The benefits are taxable to the former spouse who receives them pursuant to a QDRO.

Dependency Exemption

The spouse who has legal custody of a child generally claims the dependency exemption. But this tax advantage is negotiable and can change from year to year. The custodial spouse can waive his or her right to the exemption, allowing the noncustodial spouse to claim it.

Tax Credits

Claiming a child as a dependent may impact other tax benefits. For example, if a child is attending college, the spouse who claims the student as a dependent can claim either the American Opportunity Tax Credit or the Lifetime Learning tax credit for tuition paid, assuming they meet the eligibility requirements. The law also allows a child tax credit of up to $1,000 annually for each qualifying dependent child under age 17.

Alimony vs. Child Support

Payments that qualify as alimony under the tax law are deductible by the paying spouse. They are taxable income to the recipient spouse. Child support payments, on the other hand, are not deductible by the paying spouse. And they are not included in the recipient spouse’s income. The IRS characterizes payments that are linked to an event or date relating to a child — such as high school graduation or a 21st birthday — as child support rather than alimony.

These are just some of the tax planning issues that could be important in a divorce situation. Contact us today, as always, we’re available for planning assistance.

Contractor versus employee – be sure you’re using the correct classifications for your staff!

You probably already know the primary difference when it comes to contractor versus employee. You only pay contractors or freelancers a fee for their work. While with employees, you’re also responsible for employment taxes and often other benefits.

Control and independence

The IRS itself states that “…there is no ‘magic’ or set number of factors that ‘makes’ the worker an employee or an independent contractor.” And you can’t use just one factor to make the determination. For example, you can’t call an individual an independent contractor simply because he or she works out of a home office instead of yours. Rather, you have to look closely at the whole relationship between your company and them. You need facts. In addition, you need to consider the “…degree of control and independence” involved, in three different categories.

Behavioral control – contractor versus employee

Do you as the employer have the right to control how the individual works? In general, there are four ways to measure that:

• Type of instructions given. Do you tell the individual how, when, and where to work? What equipment to use? Where to buy supplies and services? What sequence to follow?
• Degree of instruction. How detailed are the instructions?
• Evaluation system. How do you evaluate the worker? Do you evaluate how he/she does the work or just the end result?
• Training. Do you offer initial and periodic training, or is the individual responsible for his or her own?

Financial control – contractor versus employee

There are several questions to consider here. Does the individual:

• Pay for a significant percentage of the equipment used?
• Have a lot of unreimbursed expenses?
• Have the opportunity to make a profit or loss?
• Feel free to work for other businesses?
• Generally receive consistent wages for each pay period?

Type of relationship – contractor versus employee

How would you and the individual characterize your relationship with each other? Do you have a written contract? Do you offer employee benefits? Also, did you hire him or her expecting that the relationship would go on indefinitely? Furthermore, are the individual’s contributions to the company a “key activity” of the business?

As you can see, it’s more complicated than you might think. In addition, the IRS takes this issue very seriously, and has been known to follow up with companies where at least some of the classifications were suspected to be in error. Hence, it is important to give proper attention to this issue.

The Form SS-8

If you still can’t determine whether an individual is an employee or independent contractor after going through all the above questions, you–or someone who works for you–can complete and file an IRS Form SS-8. This is a rather lengthy document designed to help determine a worker’s employment status.

We’re always available to consult with you on various issues of tax law. Request a free consultation or call us at 832-919-8448.