Category Archives: Payroll Taxes

Self-employment tax is not always inevitable

When you receive a  Miscellaneous Income Form 1099-MISC with an amount in box 7, normally you must pay self-employment (SE) tax on this income.  The current self-employment tax rate is 15.3 percent. The rate is divided into two parts: 12.4 percent for social security and 2.9 percent for Medicare.

However it is not a foregone conclusion that this tax is always owed on this type of income.  As this article points out, the SE tax only applies to “net profit (unless it’s under $400) in a tax year, derived from a trade or business carried on by an individual as a sole proprietor or partner of a partnership (IRC § 1402(a), Treas. Reg. § 1.1401-1(c)).”

So when is self-employment not subject to the SE tax?  An example best illustrates this:

I am a Certified Public Accountant.  My primary line of work is performing tax compliance services.  My neighbor sees me painting my house one day, comes over and asks if I will paint his house also for a $2000 fee.  I have never received a fee for painting anyone’s house.  I agree to paint his house and he pays me the $2000.   My neighbor is required to issue a Form 1099-MISC with $2000 in box 7.

I am required to report this as income.  However I am not required to assess and pay the 15.3 percent SE tax on this income.  This is because I do not intend to paint anyone else’s house, I do not hold myself out as being in the painting business, painting is not related to my  line of work and I have not painted other houses in the past for a fee.

If an activity is unrelated to your regular line of work and “sporadic”, it is not subject to SE tax.  So what happens if I paint 2 houses instead of one?  How about three?

Unfortunately there is no clear line in the sand here.  Each situation requires analyzing the facts and determining whether sufficient evidence exists to classify an activity not as a business but rather as a sideline activity not subject to self-employment tax.

stock-photo-15712013-self-employment-tax

S Corp Owners Salaries and Avoiding IRS Recharacterization

 


This Journal of Accountancy article on reasonable salaries with regard to S corporation owners provides some concise information on the subject.

This is a complex topic requiring analysis of many factors as outlined in the article.

S corporation owners are well-advised to evaluate and document their compensation policies at least annually to minimize their audit risk in this area.

There is a Lot of Misinformation About Taxes

There is a lot of misinformation about taxes. One of those misconceptions is the recently bantered about fact that 51% of Americans pay no Federal income taxes. Unfortunately life is complicated and so is tax policy. This article explains the “why” of this 51% figure and how it should not be used to raise taxes on middle and lower income taxpayers.. http://fb.me/Hwbfe7p7

Work, Evil and the “Rest” of It

Just received a 433 page continuing education course on Corporate Tax Planning that must be completed by May 28, 2011. I’ve gone and done it to myself again but… “Work saves us from three great evils: boredom, vice and need.” Voltaire.

Or is it “No Rest for the Wicked” Ozzy Osbourne (strike that) Book of Isaiah. If I spread it out that is only 17 pages a day. But who works like that?

Here is the course outline:

http://fb.me/JnnwJp7m

 

Taxes, Especially Payroll Taxes, are an Increasing Burden

Taxes , Especially Payroll Taxes, are an Increasing Burden for Small Businesses http://fb.me/KB23d5ji

You are Now Getting a Stimulus Check from the Government Every Payday

Obama Tax Cut Calculator Station_Trenton, NJ_1...

Theoretically speaking that is.   This is to clear up some confusion regarding the recent “tax cut” that became effective April 1, 2009.

  • You will not be getting a physical check as was done previously.  The tax reduction is reflected in your paycheck withholdings.
  • Everyone with earned income is eligible for the tax reduction (unless you have too much income).
  • The withholding tables were adjusted effective April 1st 2009 to increase the take home pay of those that are eligible.
  • The credit is $400 for single filers and $800 for married filers however it cannot exceed 6.2% of your earned income.
  • If you make too much money you do not get the credit, it is phased out beginning at $75,000 for single filers and $150,000 for joint filers.
  • The credit is “refundable” which means that even if you owe no tax but are otherwise eligible, you will get the credit and a refund check will be issued when you file your return.
  • The credit is effective for the 2009 and 2010 tax years.

Any questions?

S Corporation – Officer Wage Trap

Average salaries of faculty of :en:California ...

Average salaries of faculty of California State University faculty 2007

There has been considerable controversy and misinformation regarding S corporations and wages paid to officers of the corporation.  The controversy arises from the fact that to the extent an officer/shareholder underpays his salary, the corporation’s net income may be higher, thereby reducing  social security and medicare taxes since the net income attributable to the shareholder of an S corporation is not subject  to these taxes.  I recently represented an S corporation shareholder (not a previous client of mine) before the IRS on this very issue and the end result was a disaster to the client.

The shareholder/officer was paid approximately $15,000 – $20,000 in annual salary and the net income of the S corporation was approximately $60,000 to $70,000 over a number of years.  Here is some IRS guidance on this issue:

FS-2008-25, August 2008

Corporate officers are specifically included within the definition of employee for FICA (Federal Insurance Contributions Act), FUTA (Federal Unemployment Tax Act) and federal income tax withholding under the Internal Revenue Code. When corporate officers perform services for the corporation, and receive or are entitled to receive payments, their compensation is generally considered wages. Subchapter S corporations should treat payments for services to officers as wages and not as distributions of cash and property or loans to shareholders.

S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates.

The Internal Revenue Code establishes that any officer of a corporation, including S corporations, is an employee of the corporation for federal employment tax purposes. S corporations should not attempt to avoid paying employment taxes by having their officers treat their compensation as cash distributions, payments of personal expenses, and/or loans rather than as wages.

This fact sheet clarifies information that small business taxpayers should understand regarding the tax law for corporate officers who perform services.

Who’s an employee of the corporation?

Generally, an officer of a corporation is an employee of the corporation. The fact that an officer is also a shareholder does not change the requirement that payments to the corporate officer be treated as wages. Courts have consistently held that S corporation officer/shareholders who provide more than minor services to their corporation and receive or are entitled to receive payment are employees whose compensation is subject to federal employment taxes.

The Treasury Regulations provide an exception for an officer of a corporation who does not perform any services or performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any remuneration. Such an officer would not be considered an employee.

What’s a Reasonable Salary?

The instructions to the Form 1120S, U.S. Income Tax Return for an S Corporation, state “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.”

The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly. However, if cash or property or the right to receive cash and property did go the shareholder, a salary amount must be determined and the level of salary must be reasonable and appropriate.

There are no specific guidelines for reasonable compensation in the Code or the Regulations. The various courts that have ruled on this issue have based their determinations on the facts and circumstances of each case.

Some factors considered by the courts in determining reasonable compensation:

  • Training and experience
  • Duties and responsibilities
  • Time and effort devoted to the business
  • Dividend history
  • Payments to non-shareholder employees
  • Timing and manner of paying bonuses to key people
  • What comparable businesses pay for similar services
  • Compensation agreements
  • The use of a formula to determine compensation

Since there was really no evidence that could be found to support the low salary originally paid, the IRS recharacterized almost all of the net income of the corporation as wages for this shareholder/officer.  This resulted in penalties for failure to withhold and pay payroll taxes.  The end result is the client ended up paying about double in taxes, interest and penalties over what would have been owed had the income been classified as officer wages from the beginning.

The client consulted an attorney to consider going to court over the matter.  The attorney ironically had also been audited on the very same issue, had gone to court and lost.  So he advised the client to just bite the bullet and pay the assessment.

The IRS has been going after this issue in a big way.  If you are a shareholder/officer in an S corporation, careful consideration is required of the reasonableness of your compensation in order to avoid a possible nightmare like this down the road.

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