New small business owners could be making several payroll mistakes without even realizing it. It could cost them fines and penalties from the IRS or their state revenue department.
Third Party Sick Pay
Third party sick pay is money paid by a disability insurance provider directly to an employee due to an illness or injury. Aflac insurance is one of the most well-known vendors, but large health insurance companies, like Humana, offer supplemental insurance and the rules apply to them and any 3rd party insurance provider.
What some small business owners may not realize is that under certain circumstances, the money paid to the employee is taxable income to the employee as earnings. The employer must report the earnings and withhold payroll taxes. The benefits paid by the third-party vendor and the taxes withheld should be reported on the employee’s W2.
IMPORTANT. If the employer paid for the premiums on behalf of the employee, the employer is also responsible for paying the employer’s share of the payroll taxes.
Form 8922, Third-Party Sick Pay Recap is a new requirement from the IRS for 2014. Employers must report the amount of 3rd party sick pay paid to their employees by a third-party insurer.
Like most IRS regulations, there are exceptions and exemptions that I won’t detail here, but if you paid for any third-party benefits for your employees, you should check with your payroll provider or accountant.
Any fringe benefit an employer provides to an employee is considered a form of payment, is subject to employment tax and must be included in their pay unless the benefit is on the list of IRS exclusions. The exclusion list is long and somewhat confusing. You can find the list here.
If your business is an S Corp or you have highly compensated employees, you will want to consult with your payroll provider or accountant. The IRS makes several exceptions to the exclusion list for S Corp and highly compensated employees.
Here is a list of some of the employee fringe benefits that are subject to some type of tax and your new small business might be neglecting to report correctly.
- The value of the personal use of a company provided vehicle.
- Adoption assistance is not subject to income tax but is subject to payroll tax.
- Off-site athletic facilities not owned by the employer.
- Cell phones issued for primarily personal use.
- Non-cash achievement awards greater than $1,600 in value.
- Education assistance if you do not have a written plan to cover only your employees.
- Lodging on the employer’s site that is not required by the employer.
- Non-deductible moving expenses.
Every year, one of my previous employers would hand out Christmas hams to all of the employees. Our payroll department would add the value of those $20 or so hams to our W-2. The IRS has made it clear that those small amounts do not need to be reported. The IRS calls them de minimis benefits. They are something of such little value that the administration would add an unreasonable burden to the payroll department. The de minimis rule would also apply to small gift cards, break room donuts, company picnics, etc.
The main sticking point about independent contractor vs employee is if a person is an employee, the employer is responsible for withholding and paying the employee payroll taxes and the employer portion of the taxes. If the person is an independent contractor, then the worker must keep track of paying their payroll taxes themselves.
The way to tell if a person is an independent contractor is to ask three questions.
- How much does the company control how the worker does their job?
- How much does the company control how and when the worker is paid?
- What type of relationship does the worker have with the company?
Even the IRS admits that there is no “magic formula” to determine when a person is an independent contractor. If you have any doubts, I would recommend asking your accountant so you can both agree on a plan of action in case you are ever challenged by the IRS or your state revenue department.
Are there any common payroll mistakes I missed? Please comment below.