Small businesses historically have created 70 percent of all jobs in the U.S. With such a high percentage of the workforce, employee-related tax challenges for small-business owners are inevitable. Here are four common tax pitfalls, and what you can do about them.
Personal Use of Company Cars
Many small-business owners and some employees drive cars or trucks owned or leased by their companies. This arrangement lets the company deduct the costs of the vehicle. But employees -- including owners -- are viewed by the IRS as gaining a taxable benefit for their personal driving. How is this valued?
The tax law gives companies several options for how to value the personal use, including:
- Report all of the value of vehicle usage, and let the employees deduct their business use. While this is the easiest option for the company, it isn’t helpful for employees.
- Report the fair market value of the personal usage: what the employee would have to pay a third party for the same benefit.
- Figure the value of personal usage based on an annual lease value.
Each of these methods for valuing personal usage is analyzed in IRS Publication 15-B.
Should you hire an employee or engage an independent contractor when you need additional help? There are tax and practical considerations to this decision. Taxwise, it’s considerably less costly to use an independent contractor. With this in mind, the question of worker classification -- as an employee or independent contractor -- is high on the IRS’s audit list. And states also look closely at worker classification when workers seek unemployment benefits or workers’ compensation.
The problem is that you can’t simply attach a label to a worker and automatically make it stick. The government says that if you have sufficient control over the worker -- if you have the right to say when, where, and how the work gets done -- then the worker is an employee. The determination depends on behavior and financial issues, as well as the relationship of the parties, according to the IRS rules for worker classification.
What to do:
- Look at how other companies within your industry classify their workers. If there is a long-standing industry practice of treating certain workers as independent contractors, that can help you decide how to classify your workers.
- Have independent contractors sign agreements acknowledging that they are responsible for their own taxes. These agreements won’t bind the IRS, but they can help show that both you and your contractors view the arrangement as other than employer-employee.
- Be consistent. Treat all workers doing the same type of work in the same manner.
- Issue Form 1099-MISC to workers you treat as independent contractors.
Recent Court Decisions Increase Uncertainty
The U.S. Tax Court and federal courts are continually deciding thorny tax questions. Do these decisions affect you? It depends.
One key issue now moving through the courts concerns the constitutionality of the Patient Protection and Affordable Care Act (“Obamacare”). One U.S. district court has said that the U.S. has no constitutional basis to mandate that each person buy health coverage, and has concluded that the entire act, including various tax provisions (such as the small-employer health-care credit), is unconstitutional. No one is quite sure what this will mean for the tax provisions within the Act.
Another case, Quality Stores, Inc., decided last year, said that severance benefits were not wages for the purposes of payroll taxes. The IRS, as well as some courts, continue to disagree. Some practitioners have been advising companies with laid-off workers that paid FICA and other payroll taxes on severance benefits to file refund claims, even though the issue isn't settled. Why? Because refund claims generally must be filed within three years of the original return filing date. The IRS has indicated it will not give refunds at this time. Companies that paid severance benefits in the past several years should discuss this issue with their CPAs or other tax advisors.
Cash Flow Problems
Small businesses may experience cash-flow problems from time to time. Not having sufficient cash means deciding which creditors to pay first.
It’s vital for small-business owners to pay the government first when it comes to certain payroll taxes and excise taxes. The income taxes and employees’ share of FICA that you withhold from their pay is considered “trust-fund” money. Excise taxes you collect in the course of your business, such as a gas station’s collection of excise taxes on gasoline sales, are also trust-fund money.
You have collected the money in trust, and as a responsible person, you must pay it to the government. If you don’t, you can be held 100 percent personally liable for the unpaid amount, plus penalties and interest -- even if your business is incorporated or is a limited liability company. Your entity does not protect you from this tax obligation.
The IRS has helpful information about the trust-fund recovery penalty. If you’re facing a cash crunch with unpaid trust-fund taxes, meet with your financial advisor to figure out the best way to handle the situation.