Worker Classification Can Be Very Costly
January 2, 2018
The number of independent contractors working in the United States has risen steadily over the last two decades. But did you know you can’t simply label a worker as an independent contractor? The facts and circumstances of the relationship determine if the worker is an employee or an independent contractor.
By hiring independent contractors, companies save time and money on payroll processing, avoid paying payroll taxes like FICA and unemployment taxes, and don’t need to purchase worker's compensation insurance or provide retirement and other benefits.
But misclassifying an employee as an independent contractor can be very costly for a business. The company will owe back payroll taxes. Payroll taxes are a top priority for the tax agencies, and the fines and penalties are horrendous!
When do these issues come up?
Typically, everything goes great until you stop paying the worker in question. The classic example is a company stops paying a worker, who goes down to their local unemployment office and files for benefits. There, they find out they're not eligible for benefits because they were self-employed. At that point, the worker will say that they were misclassified or treated incorrectly. This starts a series of problems for you as an employer.
How do I know if I’ve misclassified a worker?
Ultimately, a worker is an employee if he or she is subject to the will and control of the employer. It's not necessary for the employer to control or direct the work that's performed. It is sufficient if the employer has the right to do so.
The IRS, the state department of revenue, and the unemployment department all like W-2 employees. They can and will take issue with your worker classification. In revenue ruling 87-41, the IRS developed a 20-factor test to determine if an employee has been misclassified as an independent contractor. Kaiser Tax has represented many companies in worker classification audits.
Here are a few of the 20 factors that get businesses into trouble fast.
- The company pays or reimburses the independent contractor for expenses. You should never pay for an independent contractor’s expenses--NONE WHATSOEVER. To be truly an independent contractor, the worker must have the ability to lose money. If the worker doesn't have business expenses, they can't lose money, and therefore they are clearly your employee. Instead, simply pay the independent contractor more money and have them pay for their own expenses.
- The worker is paid hourly and on a regular schedule such as weekly, biweekly, or monthly. It is much better to pay independent contractors on a project basis. The independent contractor can submit a progressive billing based on completion of the project so they don't have to wait for the project to be complete to be paid. They could take payments after a project is 20%, 40% or 50% completed and take progressive payment. Or, you could pay a commission or flat fee.
- Workers perform services mostly on your premises. Government agencies assume if the worker is performing services at your location and with your equipment, they are employees. Have the worker perform services outside your premises at least some of the time.
- You have a long-term, continuous relationship with the worker. Consider putting together a series of contracts that each last 6 to 12 months. The period is short and you can always have another contract once the current one expires. This avoids the continuous relationship problem.
- You don’t allow workers to work outside your company. You don't want independent contractors working exclusively for your business. That points to an employee/employer relationship
How can I avoid misclassifying a worker?
Kaiser Tax recommends you work with a professional to design an independent contractor agreement. Always have the independent contractor agreement signed by both parties and follow the agreement. The independent contractor must complete a W-9 form. We suggest not paying a contractor until you have received a completed W-9 from them. Use getting paid as leverage to getting that form completed.
Lastly, treat all similar workers in the same manner. They're all either employees or independent contractors. Do not have some of each. Issue independent contractors 1099s each year by January 31. It's always better to pay a business entity versus an individual. Consider having your independent contractors form an LLC and have a contract between your company and their LLC.
A note for corporations
By federal statute, any person who owns 2% or more of a corporation is an employee. You cannot be an independent contractor for a company in which you have an ownership interest. This also applies to your spouse, kids, and parents. In other words, all family members are employees of a corporation you have an ownership interest in.
Many companies pay independent contractors to avoid paying benefits and payroll taxes. If your company does this, you must be very careful to design and follow an independent contractor agreement that can hold up under audit. The consequences of misclassifying a worker are huge. Remember an ounce of prevention is worth a pound of cure. For help with a worker misclassification audit or tips for hiring an independent contractor the right way, contact Kaiser Tax today.
The S-Corp Shareholder Health Insurance Conundrum
November 7, 2017
If you’re are a S corporation shareholder and your corporation pays for your health insurance, it’s time for you to listen up. While the rules on reporting health insurance have not changed, small business owners often misunderstand them. Kaiser Tax is here to help you make sense of the health insurance reporting rules so Uncle Sam doesn’t’ come calling.
How do health insurance benefits work for S-corp shareholders?
S corporations often offer a range of health insurance benefits, including medical, dental, and long-term care insurance. The corporation usually pays for the insurance premiums for the shareholders’ benefit. The corporation can deduct what it pays in premium as an ordinary business expense. That’s the good news.
The bad news is that the premium the corporation pays for is a taxable fringe benefit for the shareholder and family members. It is added to their wages on form W-2. To be clear, this only includes the company-paid portion of premiums paid for the shareholder, spouse, and dependents. These additional wages are not subject to FICA or unemployment taxes, but should be included in box 1 of shareholders’ W-2s.
Does that mean S corporation shareholders do not get a deduction for health insurance?
Do not panic, you’re actually still eligible for an above-the-line, self-employed health insurance deduction on your individual tax return. You need to follow the three steps to ultimately get a deduction for health insurance premiums.
Step 1: The corporation takes a deduction for the premiums as an ordinary business expense, which lowers your corporate profits.
Step 2: The corporation adds the premium amount to the shareholder’s wages, which increases their W-2 amount.
Step 3: The shareholder takes the Self Employed Health Insurance deduction on their individual returns.
This is the only way an S corporation shareholder can deduction health insurance premiums. The IRS has made it very clear: Follow the three-step process or lose the deduction.
So, what employees does all this apply to?
Employees who own more than 2 percent of corporate stock are subject to these rules. A common pothole for a company is when to apply the family attribution rules. Family attribution rules consider an individual the owner of the stock of their spouse, children, grandchildren, and parents. So if Dad owns 100 percent of an S corporation and Junior is simply an employee, the health insurance premiums paid on Junior’s behalf should still be included in Junior’s wages reported on his W-2 through the family attribution rules.
What do you need to do?
If you’re working with a payroll processing company, it’s important that you let them know the amount of the company-paid health insurance for the shareholder(s) before year-end. They don’t know what they don’t know. We have seen this missed dozens of times, and your payroll processing company will charge a big fee to fix this mistake if you failed to share your company-paid premium with them. Even worse, if not done properly, you will lose a large deduction, which hurts even more. With the cost of health insurance these days, you do not want to miss out on this deduction.
Let’s walk through an example. Let’s say Bob Lee owns 100 percent of Lee Consulting Inc., a S corporation. During 2017, Lee Consulting Inc. paid $5,000 in health insurance premiums to cover Bob’s health insurance. Bob’s $70,000 salary is included in boxes 1, 3, and 5 on his W-2, per usual. Since Bob Lee owns more than 2 percent of the S corporation as a shareholder, his $5,000 in health insurance premiums should also be included in box 1 of his W-2. This would bring the total in box 1 to $75,000. Bob Lee will then take the Self Employed Health Insurance deduction on his individual tax returns in the amount of $5,000.00. See below for a snapshot of Bob Lee’s W-2.
Health insurance rules for S corporations is complex, which is why it’s always a good idea to ask a CPA for expert advice. If you have questions about the health insurance deduction you may be entitled to, contact Kaiser Tax today.
Halftime Adjustments Help You Win the Tax Game
October 24, 2017
One thing I really like about the fall is watching pro football. It makes Sundays very exciting, and what a fun game it is. Football a great spectator sport.
Have you ever noticed that a team that performs poorly during the first half of the game often comes out after halftime and makes the necessary adjustments to ultimately win the game? What do they talk about during halftime to make it seem like you’re watching a totally different team?
In the tax world, we’re at about halfway point. We're less than six months away from your next tax deadline. Now's the time to huddle up with your team, review your tax plan, and make any necessary adjustments to help you win the tax game.
Leave Tax Preparers on the Bench
Everyone wants to win the tax game. Nobody likes paying more than their fair share to Uncle Sam. Most people work with tax preparers. Tax preparers are reactive professionals. They come in after the year has closed and do their best with the information you have provided to them. They try to make the best results they can.
Think of a tax preparer as your two-minute drill. The tax preparer has a limited playbook, is often rushed, and simply hopes the clock doesn't run out or that you turn over the ball.
A Tax Strategist Can Be Your Tax MVP ers.
Everybody wants to win and wants their team to win. Good teams have a game plan. The game plan is discussed and communicated to all the players. It's important everybody is on the same page.
Do you think your football team would win if they did not study film, practice, and game plan for their next opposite? Probably not.
The same thing happens with your taxes. The best chance for you to win the tax game is between now and the end of the year. It's time for you to huddle up with your tax professional, review your plan, and make the necessary adjustments so you can be a winner.
No one likes surprises or to discover opportunities that were once there are no longer there because time’s run out. Now is the time for you to make those adjustments, become a winner, and beat Uncle Sam at his own game. Contact Kaiser Tax today to draft a tax strategist to your team.
To Fend Off Uncle Sam, Pay Yourself First
September 21, 2017
Your Uncle Sam is a greedy old man. He's always taking money from you and is never satisfied with your contribution to the cause. What can you do to get even? Stop paying Uncle Sam and pay yourself instead!
Pay Yourself First with Retirement Plan Contributions
Stop giving Uncle Sam more than you need to by paying into your retirement plan. Lots of taxpayers use IRAs, which are nice retirement plan products, but the contribution limits are low at $5,500 for people under age 50 and $6,500 for people 50 years old and older.
The real opportunity is for business owners, who have a variety of retirement plans options to choose from. Many retirement plans allow for up to $54,000 of contributions, which is a lot more than you can contribute to an IRA. What you want to do is set up a retirement plan, harvest some of your profits, and keep them out of the reach of old Uncle Sam. You’re simply moving money from one hand (your business checking account) to your other hand (your retirement accounts). It's still your money, but you're getting a large tax deduction for doing so.
Retirement Contributions for Business Owners
As a business owner, your retirement plans can evolve and change as your business evolves and changes. Typically, this happens when you add employees. An employer-sponsored plan where the employer makes the bulk of contributions, such as a SEP, a Keogh, or a Profit Sharing plan, are great if you only employ family members.
However, once you start adding non-family member employees, your retirement planning options may need to change. Switching to popular plans like 401(k) and SIMPLE make more sense. In these plans, the employee makes most of the contributions, not you the employer.
If you’d like to start a 401(k) or SIMPLE retirement plan for 2017, you must do so by October 1 of this year. Don't miss out on this great opportunity to stuff some money aside, shelter it from Uncle Sam, and build your future.
Retirement Contribution Timelines
You have until March 15 of the year after to make employer contributions to retirement plans. If your company files an extension, you have until September 15 to do so. We often recommend filing a business tax extension to buy more time to make retirement contributions. Real Estate agents are a classic example of this as they are typically cash poor in the spring but have lots of cash in the summer.
You can make contributions after the year closes and still take it as a deduction for the previous year. For example, if you wanted to make an employer contribution to a retirement plan for 2017, you can make that contribution after December 31 and it will still be counted as a deduction for 2017.
But There's a Trap
The fact that you can contribute after the close of the year doesn't mean it will always work out for you. You must have the money you plan to contribute in your business account on December 31. If the money isn't there and you plan to use 2018 profits to fund the contribution, you may be caught short. If you're planning to contribute after the close of the year, make sure you have the money in your business account at year end.
Defined Benefit Plans for Successful Companies
Now, some businesses are very fortunate and make their owners a ton of money. A great opportunity for them is to set up a defined benefit plan. Think of it as an old-time pension plan like our parents used to have when they worked for an employer and upon retirement, received a pension that paid out as long as they were alive.
With a defined benefit plan, the company has an obligation to make payments for your lifetime. An actuary reviews your plan and determines how much money your company needs to fund to be able to meet that future obligation.
Because of the anticipated expenditure, the contributions for a defined benefit plan are HUGE. The limit is $215,000 per year. That's correct—your company could be putting $215,000 annually into a defined benefit plan, sheltering that money from taxation, keeping that money out of Uncle Sam’s hands, and building your future.
To recap, a great way to protect your money from Uncle Sam is simply put it away for your future. Don't allow the government to continue to take money from you. As you become more successful and your tax bracket increases, the most impactful way to shelter money is to simply put money into retirement plans. Contact Kaiser Tax to learn more about your retirement plan options.
Health Reimbursement Arrangements (HRA) Make a Comeback-Savior for Small Businesses
August 22, 2017
Many small business owners have canceled their group health insurance reimbursements because the annual premium increases have priced them right out of the market. Some other small business owners would like to offer health insurance reimbursements, but are simply unable to do so. And there's another group of small business owners who have reimbursed their employees for their own individual health insurance in the past, but can no longer continue to do so under the Affordable Care Act.
All of this means that tax-free health insurance benefits have become a real problem for small employers. It's hard to compete against large companies if you do not offer a competitive health insurance package, but Kaiser Tax has great news! Health reimbursements, known as HRAs, are making a comeback. That's great news for small business owners in Minnesota.
How does a health reimbursement arrangement (HRA) work?
Effective January 1, 2017, a small employer can adopt a qualified small employer health reimbursement arrangement. A small employer is a company with fewer than 50 full-time employees during the previous year that does not offer group health insurance. That’s a fairly broad definition.
In a health reimbursement arrangement, a small employer can reimburse their employees for individual health insurance and out-of-pocket medical costs. The annual reimbursement maximums are $4,950 for individuals and $10,000 for families.
Health reimbursement arrangement (HRA) benefits for employers
Health reimbursements allow small employers to control costs through the maximum reimbursement amount. Employers can set up the reimbursement to have lower reimbursement amounts if they choose to.
For example, perhaps an employer sets up their reimbursement to have a maximum of $3,000 for an individual and $7,000 for a family. The employer can control the reimbursement amount they pay employees without worrying about annual premium increases as they would with a group health reimbursement.
Another benefit is that employers do not need to pick an insurance company or group reimbursement. No matter the reimbursement, somebody's going to be unhappy. A health reimbursement eliminates that factor. Plus, the health reimbursement is a tax-deductible expense to the business.
Health reimbursement arrangement (HRA) benefits for employees
Now, let's look at it from the employee side. The reimbursement for health insurance and out-of-pocket costs are all tax-free for employees. Everybody loves tax-free benefits. Additionally, they have freedom of choice, as they're not stuck with their employer's reimbursement. The employee picks the health insurance reimbursement that suits them best. It gives great flexibility.
As you might guess, there are some rules, complications, and requirements to this plan. You must have a reimbursement in writing and give employees written notice at least 90 days before the reimbursement starts. Employees must provide proof that they have minimum essential health insurance.
Special considerations for corporations and partnerships
We like health reimbursement arrangements and have used them several different ways with different entities. For sole proprietors, it works well if you have a family member who is a bona-fide employee. Two classic examples are family farms or husband-wife real estate teams.
C-corps also benefit greatly from health reimbursement arrangements. Shareholders can take full advantage of tax-free benefits. But S-corp shareholders and partners in partnerships have special rules that also include their family members. If you're an S-corp shareholder or partner in a partnership, the plan is still pretty good. Ultimately for the shareholder and the partner, you'll get tax-free benefits out of the reimbursement for health insurance. But the reimbursement for out-of-pocket expenses is a taxable fringe benefit for S-corps shareholders, partners and their family members. Compared to group health benefits, health reimbursement is still a pretty good option for these types of businesses.
If you're looking to offer health benefits to your employees, take a look at the health reimbursement arrangements (HRA)and give us a call at 952-646-9282. We can go through the requirements and set you up on the right path.
Can Rental Income Be Tax-Free?
August 1, 2017
Of course, our client was wondering about the tax consequences of doing so and if renting his condo was worth the effort after the IRS came calling. I was happy—delighted, actually—to inform my client that this rental income would be tax-free.
Our client was stunned. He asked his question again and wondered if we understood what he was asking. We did, and then went on to explain that under Internal Revenue Code 280(a), a taxpayer can rent out a dwelling for 14 days or fewer every tax year and not report it as income.
Yes, you read that correctly: under the Internal Revenue Code, if you rent a dwelling unit for 14 days or fewer during a calendar year, that income is completely tax-free. My client was absolutely astounded and delighted to hear that he wouldn’t have to pay tax on his Super Bowl rental income.
Tax-Free Rental Income for corporate shareholder
So, how does a corporate shareholder receive and use code section 280(a) to get tax-free rental income? Here are a few ideas for you.
Your corporation rents your house for a training, annual picnic, or holiday party and pays you—the homeowner—fair rental value. Consider a company retreat to your cabin up north or your condo in Florida. You have greater opportunities for tax free rental income if you own more than one residence. The great news is you can get up to 14 days of tax-free rent per residence. It even gets better as a residence includes some boats, mobile homes and any dwelling unit that has basic living accommodations, which includes a sleeping area, a toilet, and cooking facilities.
The company itself reports the rent as an ordinary, necessary business expense, which will reduce its corporate profit and save you some taxes. At the same time, you receive the rental income to you personally, and it is tax free. So, you'll be getting the best of both worlds. Your corporation gets a deduction, lowering your corporate profits and saving tax, while at the same time you receive rental income that is non-taxable under code section 280(a).
A couple of things to keep in mind here. We need to point out that the company use of your residence needs to be for meetings and not entertainment purposes. It's very important that you come up with and document a fair rental value. Make sure you as the homeowner invoice the corporation for the rent. In turn, the corporation should issue you a 1099-MISC for the rental income you receive. You need to handle the 1099-MISC properly on your individual income tax returns to make sure it's tax-free.
Tax-free rental income under Internal Revenue Code 280(a) is a great reimbursementning opportunity for corporations and their shareholders to get tax-free rental income. To take advantage of this great opportunity, contact Kaiser Tax today.
Use Your Business Entity to Create a Tax-Free Educational Assistance Program
July 13, 2017
We all know the cost of higher education is skyrocketing. We want to give you a tax strategy that willwork for your kids who are age 21 and older. They may be entering MBA programs, law school, or medical school. Or, perhaps your child is entering college later in life.
Did you know your business could pay up to $5,250 per year for educational assistance? It can, and it's simply wonderful. This education assistance is deductible to your business as a normal and necessary business expense. This means tax savings for you and at the same time, the assistance is a non-taxable fringe benefit to your employees, including your adult children who work for you. An educational assistance program pays for typical things such as tuition, fees, books, and supplies. It does not cover meals, lodging, and transportation.
Educational Assistance Program Questions
Kaiser Tax is often asked if educational assistance needs to relate to your business. That’s another wonderful part of this program: No, it does not. Let's say you own a retail store and your daughter is going to medical school. Under a qualified educational assistance program, your company can pay $5,250 per year for her medical schooling. The educational assistance program allows you to pay for classes that have nothing to do with your business.
Kaiser Tax also gets asked how many hours per year does a child need to work in your business to be eligible for this benefit. The good news is the Internal Revenue Code does not require your child to work a certain number of hours before they can become eligible. This means your child can work for you part time and still be eligible for this benefit.
Educational Assistance Program Requirements
This all might sound too good to be true. You hire your kids, you pay them to work for you, and you get to pay $5,250 tax-free for education. You must think there are some requirements or pitfalls, and you are correct. There are some.
At the company level, educational assistance is a qualified reimbursement. There must be a written reimbursement that spells out the benefit and who is eligible. The benefit must be offered to all “eligible” employees. You must consider the number of employees who might be eligible and what the potential costs may be to offer assistance to all of them.
If that cost is still favorable, there are several important requirements regarding your kids. Your child must be 21 years or older and a legitimate employee of your business. They cannot be more than a 5 percent owner of your business, and they cannot be your dependent for tax purposes. That's why these programs work best for children who are a little older and on their own.
If you can jump through these hoops, an educational assistance program is a great way to help your kids with higher education costs in the most tax-favored way possible. While this is a great strategy to help with the education costs for your kids, remember that everybody loves tax-free benefits. An educational assistance program is a wonderful recruitment and retention tool for other employees. To get help on your business’s educational assistance program, contact Kaiser Tax today.