Running a small business is not easy and the IRS does not make it any easier. I’ve listed six things that inexperienced small business owners may not even realize but the IRS expects them to know.
1. Reporting New Hires
You probably know that employers need to verify that each new employee is legally eligible to work in the United States by completing the I-9 form but you may not know that the IRS also requires employers to report each new hire to a state new hire registry. Employers have to report the employee name, address, social security number and the date of hire.
The new hire reporting helps states speed up child support collection. If a new employee with a garnishment wonders how the State found him so fast, this reporting process is how they do it. If you use a payroll service provider, ask them to report the new hires for you electronically. In Indiana, click on this link to access the New Hire Reporting Center.
If an employer fails to notify the State, the fine can be up to $25 per newly hired employee, and if the employer intentionally fails to report based on an agreement between the employer and employee, the penalty can be up to $500 per newly hired employee.
2. Backup Withholding for Vendors
If you have independent contractors or vendors that you issue a 1099 to and if they do not supply a valid SSN you are expected to withhold 28% of the payment and pay that money to the IRS. Most often employers issue 1099’s for rents, commissions, non-employee compensation for services like cleaning or IT support and royalties among others. Most often the 1099’s are issued for sole proprietors and independent contractors.
The preferred form for a vendor to supply the information needed for the employer is the W-9 form. It is simple form with space for the name, type of organization, address and Social Security Number or Employer Identification Number.
Before the Affordable Care Act (ObamaCare) was passed, one of the many controversial parts of it was a requirement for all vendors to be subject to backup withholding and to be issued 1099’s. It was a method to ensure vendors were paying tax to the IRS similar to the way payroll tax withholding ensures employees are paying tax. The idea was eventually dropped because of the administrative nightmare it would cause especially for small businesses, but I expect to see the idea come up again in the future as a way to increase revenue for the federal government.
There are no specific penalties for not collecting W-9’s from vendors. The IRS only states that employers are subject to penalties.
3. New W-4 for Exempt Employees
Employers know that every new hire must complete a W-4 Employee Withholding Allowance Certificate to help determine the correct amount of income tax to withhold on the employee’s paycheck. If an employee wants to change their withholding allowance, the employer should require the employee to complete a new W-4. Most employers don’t know that the IRS requires them to collect a new W-4 every year from employees claiming an exemption from withholding.
An employee can claim an exemption from payroll withholding on the W-4 form if he or she had no income tax liability last year and expects no federal income tax in the current year. If the employer does not receive a new W-4 from the employee every year by February 15th, the employer must begin withholding from the employee’s paycheck based on the last W-4 form without the exemption or withhold at the single rate and no exemptions. This should quickly prompt the employee to complete a new W-4 once they see how much their paycheck decreases.
Most penalties apply to employees who complete a fraudulent W-4 to avoid withholding but the IRS states that employers are subject to penalties for not collecting W-4’s from their employees.
4. Ensure Payroll Taxes are Paid
If a small business owner decides that payroll is too time consuming or too complicated to handle on their own and they decide to outsource payroll to a third-party, the small business owner is still responsible for making sure payroll taxes is paid. The IRS recommends that you enroll in the U.S. Treasury Department’s Electronic Federal Tax Payment System (EFTPS) to monitor your account and ensure that timely tax payments are being made for you.
If the small business owner trusts someone to process their payroll and the payroll tax deposits are not made due to fraud or incompetence, the business owner is still responsible for making the payments plus paying penalties and interest.
5. The difference between an Employee and an Independent Contractor
If a small business owner controls how and what work a worker performs the worker is an employee and not an independent contractor. That means the small business owner must withhold income taxes and pay social security, medicare and unemployment tax on the workers wages. If the worker is an independent contractor, the worker is responsible for paying their own taxes.
Both the federal and state government are really cracking down on the classification of independent contractors. If a small business owner classifies a worker as an independent contractor but the government says they are an employee, the small business owner will be liable for the income tax withholding regardless of whether the employee paid income tax.
If you feel that you may be inaccurately classifying your employees as independent contractors, the IRS has a program called Voluntary Classification Settlement Program (VCSP) to give you an opportunity to correct your error and reduce your tax liability.
6. EIC Notification
The IRS states that employers must notify employees with no payroll withholding that they may be eligible for a tax refund because of the EIC (Earned Income Credit). This is a link to a notice that explains the EIC to the employees.
The notice must be handed directly to the employee or send it by first-class mail to the employee’s last known address. Posting the notice on an employee bulletin board will not meet the notification requirements.
Please contact me if you are a small business owner and feel you need help making sure you are in compliance with both State and Federal tax regulations. I will be happy to help you. When it comes to the IRS, what you don’t know can hurt you.
Go to this IRS publication http://www.irs.gov/pub/irs-pdf/p15.pdf if you would like more information on what the IRS expects employers to know.
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