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Thursday, December 13, 2018

Employee or Independent Contractor

Employee or Independent Contractor? In order for a business owner to know how to treat payments made to workers for services, he or she must first know the business relationship that exists between the business and the person performing the services. A worker’s status determines what is needed for tax preparation; what taxes are paid and who is responsible for reporting and paying those taxes. A worker performing services for a business is generally an employee or an independent contractor. If a worker is classified incorrectly, the IRS may assess penalties on the employer for nonpayment of certain taxes.


Penalties and Interest

When the IRS determines that a worker is actually an employee rather than an independent contractor, the employer is subject to penalties for failure to withhold and remit income, FICA (Social Security and Medicare) and FUTA (federal unemployment tax) taxes, interest on the underpaid amounts, and penalties for failure to file information returns. The state will also seek to collect workers’ compensation and unemployment compensation premiums for unreported wages.


Independent Contractor

An independent contractor is self-employed and is generally responsible for paying his or her own taxes through estimated tax payments. A business issues Form 1099-MISC, Miscellaneous Income, to any one independent contractor, subcontractor, freelancer, etc., to whom the business made $600 or more in payments over the course of the tax year. The business is not generally responsible for withholding income tax or FICA.


Employee

A worker treated as an employee will be issued Form W-2 for wages paid. The business hiring the worker is responsible for withholding income tax and FICA. The employer is also liable for FUTA and various state employment taxes. Also, the employee may be eligible for certain fringe benefits offered by the employer, such as health care.

Factors to Determine Worker Status

The general rules for classifying workers as independent contractors or common-law employees center on who has the right to control the details of how services are to be performed. The factors can be grouped into three categories.

1) Behavioral control. Factors that indicate a business has the right to control a worker’s behavior include the following.
Instructions that the business gives to the worker. Employers generally control when and where work is to be done, 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.
Training that the business gives to the worker. Employees may be trained to perform a service in a particular manner. Independent contractors generally use their own methods.

2) Financial control. Factors that indicate a business has the right to control the business aspects of a worker’s job include the following.
Extent of the worker’s unreimbursed business expenses. Independent contractors are more likely to incur expenses that are not reimbursed, such as fixed overhead costs that the worker incurs regardless of whether work is currently being performed.
Extent of the worker’s investment. Independent contractors often have significant investment in facilities used to perform services for someone else, such as maintaining a separate office or other business location.
Extent to which the worker makes his or her services available to the public. Independent contractors are generally free to offer their services to other businesses or consumers. They often advertise and maintain a visible business location.
Method of payment for services performed. Employees generally are guaranteed a regular wage and work for an hourly fee or a salary. Independent contractors are generally paid a flat fee for a specific job. Exceptions apply to some professions, such as accountants and lawyers who charge hourly fees for their services.
Extent to which the worker can make a profit. Independent contractors can make a profit or a loss.

3) Type of relationship between the parties. Factors that indicate the type of relationship include the following.
Written contracts that describe the relationship and intent between the worker and the business hiring the worker.
Employee-type benefits provided to worker. Employers often provide fringe benefits to employees, such as health insurance, pensions, and vacation pay.
Permanency of the relationship. Employer-employee relationships generally continue indefinitely.
Extent services performed by the worker are a key aspect of the business hiring the worker. A worker who is key to the success of a business is more likely to be controlled by the business, which indicates employee status. For example, an accounting firm hires an accountant to provide accounting services for clients. It is more likely that the accounting firm will present the accountant’s work as its own and would have the right to control or direct that work.


Incorrect Treatment of Employees as Independent Contractors

A worker who receives a 1099-MISC instead of a W-2 has two options.
1) Agree with the way the business has classified the worker, file Schedules C and SE, and pay self-employment tax on the earnings, or
2) File Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The IRS will then decide if the worker should have been treated as an employee, subject to income and FICA tax withholding. If the IRS agrees that the worker really is an employee, the employer will be liable for employment taxes. However, if the IRS determines that the worker is really an independent contractor, the worker will be liable for paying SE tax.

Example: Harold owns a restaurant and hires Jim, a gardener, to mow the lawn and weed the landscaping once a week. The contract states that Jim will arrive at the restaurant on Monday mornings, mow the lawn, pull weeds, and tend to the landscaping. In exchange, Harold agrees to pay Jim $50 for this service each week. Jim supplies his own lawnmower, weed eater, and hedge clippers. Jim decides what time he arrives and how long the job will take him. Harold does not supervise Jim in his tasks or dictate to him how they are to be done. Jim is an independent contractor.
 

Example: Jeffrey owns Jeffrey’s Gardening Service and employs three gardeners to perform services for his business. Jeffrey pays his gardeners a fixed wage and withholds taxes, FICA, and various benefits and remits those withholdings to the appropriate government agencies. In addition, Jeffrey provides his employees with the tools and equipment they need to perform their work, instructs his employees which jobs to go to, and supervises them while they are doing their work. Jeffrey’s workers are employees.


Contact Us

There are many events that occur during the year that can affect your tax situation. Preparation of your tax return involves summarizing transactions and events that occurred during the prior year. In most situations, treatment is firmly established at the time the transaction occurs. However, negative tax effects can be avoided by proper planning. Please contact Franklin P Sparkman CPA in advance if you have questions about the tax effects of a transaction or event, including the following:
• Pension or IRA distributions.
• Significant change in income or deductions.
• Job change.
• Marriage.
• Attainment of age 59½ or 70½.
• Sale or purchase of a business.
• Sale or purchase of a residence or other real estate.
• Retirement.
• Notice from IRS or other revenue department.
• Divorce or separation.
• Self-employment.
• Charitable contributions of property in excess of $5,000.


This article contains general information for taxpayers and should not be relied upon as the only source of authority. Taxpayers should seek professional tax advice for more information.

Friday, November 9, 2018

Business Owners—Taking Money Out of a Business

When taking money out of a business, transactions must be carefully structured to avoid unwanted tax consequences or damage to the business entity. Business owners should follow the advice of a tax professional to make sure financial transactions are controlled and do not cause unanticipated taxation or other negative effects.

For example, a shareholder of a corporation can make a loan to the corporation, and subsequent repayments of principal are not taxable to the shareholder. This may seem straightforward. However, if the loan and repayments are not set up and processed properly, with specific documentation in place, the IRS can reclassify the funding as nondeductible capital contributions and classify the repayments as taxable dividends, resulting in unexpected taxation. A weak loan structure can also create a danger zone where a court can “pierce the corporate veil,” resulting in personal liability for the business owner. These negative effects can occur in several different situations.

Classifications
When a business owner provides funds to the business, it can be classified as one of the following transactions.
Capital contribution.
Loan to the corporation.
Repayment of a loan from the corporation.
Expense reimbursement.
Purchase.

On the other hand, when an individual takes funds from a business, the transaction can be classified as:
Taxable dividend or distribution of profits.
Nontaxable distribution.
Nontaxable expense reimbursement.
Taxable wages.
Loan to the shareholder.
Repayment of a loan from the shareholder.

Failure to tightly control the nature of the transactions can have negative effects on the business and the business owner.

Intermingling Funds
One of the most dangerous financial mistakes a business owner can make is to intermingle funds, such as paying personal expenses from the business checking account, or paying business expenses from the owner’s personal account. This can be done with the best of intentions with the business owner making adjustments in the books to separate the business and personal transactions, but the behavior can leave openings for the IRS or courts to question the integrity of the business entity or the transactions. Failure to maintain complete financial separation between a business and its owners is one of the major causes of tax and legal trouble for small businesses.

Sole Proprietorships
A sole proprietor is taxed on self-employment income without regard for activity in the business bank account. A sole proprietor should never pay himself or herself wages, dividends, or other distributions. A sole proprietor may take money out of the business bank account with no tax ramifications.

Taking Money Out

Wages
One way for a business owner to take money out of a corporation is through wages for services performed. Wages are appropriate only for C corporations and S corporations, not for sole proprietorships or partnerships. Owners are treated as employees, payroll taxes and income taxes are withheld, and the corporation issues Form W-2, Wage and Tax Statement, to the business owner after the beginning of the year.

“Reasonable Wages”
For C corporations and S corporations, there are incentives to skew wages one way or the other for purposes of tax savings. In a C corporation, wages are deductible by the corporation but dividends are not, creating incentive for a C corporation shareholder to inflate the wages for higher deductions. In an S corporation, wages are subject to payroll taxes but flow-through income is not, creating an incentive for artificially low wages. Both C corporations and S corporations are required by law to pay “reasonable wages,” which approximate wages that would be paid for similar levels of services in unrelated companies.

Guaranteed Payments
Guaranteed payments to partners are the partnership counterpart to corporate wages. One major difference is with guaranteed payments, there is no withholding for payroll taxes or income tax. These amounts are computed and paid on the partner’s individual Form 1040.

Dividends
Dividends are generally the means by which a C corporation distributes profits to shareholders. Amounts up to the C corporation’s “earnings and profits” are taxable to the shareholder. Although flow-through income from S corporations or partnerships are often called “dividends,” they are not treated as dividends under tax rules.

Flow-Through Income—S Corporations and Partnerships
Income from S corporations and partnerships flow through to the shareholder or partner’s individual tax return. Flow-through income is reported without regard for whether or when the income is distributed to the shareholder or partner. Distributions of cash to an S corporation shareholder or partner are not taxable to the individual until the person’s cost basis reaches zero.

One-Class-of-Stock Rule
An S corporation is allowed to have only one class of stock. If an S corporation does not make equal distributions to all shareholders, this rule may be violated and the S corporation status may be terminated. The oneclass-of-stock rule must be adhered to whenever making distributions from an S corporation’s bank account.

Loans
A corporation or partnership can receive loans from shareholders or partners, and on the other hand a corporation or partnership can make loans to shareholders or partners. There is generally no taxable event when a corporation or partnership repays a loan from a business owner, and no taxable event when a corporation or partnership makes a bona-fide loan to a shareholder or partner. However, failing to adhere to necessary formalities can put these transactions in danger, allowing the IRS to step in and reclassify the transactions, resulting in taxable income for the business owners.

Limited Liability Companies (LLCs)
Taxation of an LLC falls into either a default category, or the LLC makes an election on the manner of taxation. A single-owner LLC owned by an individual is considered a “disregarded entity” and is taxed as a sole proprietorship by default. If the LLC makes an election to be taxed as a corporation, either C corporation or the S corporation rules apply. An LLC owned by more than one individual is taxed as a partnership by default. As with a single-owner LLC, a multiple-owner LLC may make an election to be taxed as a corporation.


This brochure contains general information for taxpayers and  should not be relied upon as the only source of authority.  Taxpayers should seek professional tax advice for more information. Copyright © 2017 Tax Materials, Inc. All Rights Reserved

Tuesday, October 9, 2018

Taxpayers Who Receive an IRS Notice

Read these tips for taxpayers who receive an IRS notice.

Receiving a notice from the Internal Revenue Service is usually no cause for alarm. Every year the IRS sends millions of letters and notices to taxpayers. In the event one shows up in the mailbox, here are ten things you should know.
  1.  Don’t panic. Many of these letters can be dealt with very simply.
  2.  Don’t ignore it. Most of these letters have a “reply by” date. Inaction can lead to additional interest and penalties or more aggressive action from the IRS.
  3.  Call your tax professional. Your tax professional is available to help you, is familiar with your situation, and has experience dealing with the IRS. Utilize his or her expertise. He or she will generally want to see a copy of the letter to determine the next course of action. Some letters can be resolved simply by having you contact the IRS directly. Other, more complicated issues may require you to sign Form 2848, Power of Attorney and Declaration of Representative, to allow your tax professional to deal with the IRS on your behalf.
  4.  There are a number of reasons the IRS sends notices to taxpayers. The notice may request payment of taxes, notify you of a change to your account, or request additional information. The notice you receive normally covers a very specific issue about your account.
  5.  Each letter and notice offers specific instructions on what you need to do to satisfy the inquiry.
  6.  If you receive a notice about a correction to your tax return, you should review the correspondence and compare it with the information on your return.
  7.  If you agree with the correction to your account, usually no reply is necessary unless a payment is due.
  8.  If you do not agree with the correction the IRS made, it is important that you respond as requested. Respond to the IRS in writing to explain why you disagree. Be courteous and respectful. Include any documents and information you wish the IRS to consider, along with the bottom tear-off portion of the notice. Mail the information to the IRS address shown in the lower left corner of the notice. Allow at least 30 days for a response from the IRS.
  9.  Most correspondence can be handled without calling or visiting an IRS office. However, if you have questions, call the telephone number in the upper right corner of the notice. When you call, have a copy of your tax return and the correspondence available.
  10.  Keep copies of any correspondence with your tax records. As with any tax issue, contact your tax professional to help you navigate your own unique situation.


Avoid Future Problems

You can minimize the likelihood of encountering future problems with the IRS by:
• Keeping accurate and complete records,
• Waiting to file your tax return until you receive all your income statements,
• Checking the records you receive from your employer, mortgage company, bank, or other sources of income (W-2s, 1098s, 1099s, etc.) to make sure they are accurate,
• Including all your income on your tax return,
• Following the instructions on how to report income, expenses, and deductions, and
• Filing an amended return for any information you receive after your return has been filed.

Consider filing your taxes electronically. Filing online can help you avoid mistakes and find credits and deductions that you may qualify for. Find a tax preparer whom you trust to prepare and e-file your return. An experienced tax preparer who is familiar with your personal situation is in a position to help you file a complete and accurate return. In addition, he or she will be able to advise you on the best course of action for responding to a notice should you receive one.


Taxpayer Rights

IRS employees are required to explain and protect your rights as a taxpayer throughout your contact with them.

Privacy and Confidentiality

The IRS will not disclose to anyone the information you give them, except as authorized by law. You have the right to know why they are asking you for information, how they will use it, and what will happen if you do not provide the requested information.

Professional and Courteous Service

If you believe that an IRS employee has not treated you in a professional, fair, and courteous manner, you should tell that employee’s supervisor. If the supervisor’s response is not satisfactory, you should write to the IRS director for your area or the center where you file your return.

Representation

You may either represent yourself or, with proper written authorization, have someone else represent you in your place. Your representative must be a person allowed to practice before the IRS, such as an attorney, certified public accountant, or enrolled agent. If you are in an interview and ask to consult such a person, then in most cases, the IRS agent must stop and reschedule the interview.

You can have someone accompany you to an interview. You may make sound recordings of any meetings with the IRS’ examination, appeal, or collection personnel, provided you tell them in writing 10 days before the meeting.

Payment of Only the Correct Amount of Tax

You are responsible for paying only the correct amount of tax due under the law—no more, no less. If you cannot pay all of your tax when it is due, you may be able to make monthly installment payments.

Help With Unresolved Tax Problems

The Taxpayer Advocate Service can help you if you have tried unsuccessfully to resolve a problem with the IRS. Your local Taxpayer Advocate can offer you special help if you have a significant hardship as a result of a tax problem.

Appeals and Judicial Review

If you disagree with the IRS about the amount of your tax liability or certain collection actions, you have the right to ask the Appeals Office to review your case. You may also ask a court to review your case.

Relief From Certain Penalties and Interest

The IRS will waive penalties when allowed by law if you can show you acted reasonably and in good faith or relied on the incorrect advice of an IRS employee. The IRS will waive interest that is the result of certain errors or delays caused by an IRS employee.

This brochure contains general information for taxpayers and  should not be relied upon as the only source of authority.  Taxpayers should seek professional tax advice for more information.

North Carolina and South Carolina residents and business owners are welcome at the offices of Franklin P. Sparkman, CPA Charlotte, Waxhaw, and Lancaster. A locally trusted name for accounting, bookkeeping, tax preparation for businesses and personal finances.