Barbara Weltman, Attorney, Small Business Administration Contributor
If you want to grow your business, you probably need to hire employees to help you. Becoming an employer and expanding your staff entails many responsibilities, one of which is overseeing to payroll taxes. Unfortunately, there are many myths about these taxes. Here is the reality:
1. Myth: Transforming employees into independent contractors to save on payroll taxes is easy.
Reality: You probably know that it costs less to use an independent contractor than to have an employee on staff. The reason: the cost of payroll taxes, along with insurance and benefits apply only for employees. But don’t think you can simply reclassify a worker who’s been your employee as an independent contractor. The IRS, as well as other government agencies, are on the lookout for just such action. The classification of a worker depends on many factors, most of which boil down to a matter of control. Essentially, if you have the right to say when, where and how work gets done, you’re likely dealing with an employee. The IRS uses three categories of factors to assess the degree of control: behavioral, financial and type of relationship. Many states use an ABC test:
■ The worker is free from the control and direction of the hirer in connection with performing the work.
■ The worker performs work outside of the usual course of the hiring entity’s business.
■ The worker is usually engaged in an independently established trade, occupation or business of the same nature as the work performed for the hiring entity.
2. Myth: All tax-free benefits are exempt from payroll taxes.
Reality: Receiving tax-free fringe benefits means that employees do not have to pay income tax on what they receive. However, it does not mean that employers are off the hook for payroll taxes. For example, 401(k) contributions made by employees through salary reductions are still subject to FICA. And adoption assistance is exempt from income tax withholding because the benefit is tax free to employees but is still subject to FICA and FUTA taxes. You can find a list of various fringe benefits and their tax treatment for employment tax purposes in Table 2-1 in IRS Publication 15B.
3. Myth: You can pay employment taxes with your quarterly employer tax return.
Reality: In general, you must deposit federal income taxes withheld and both the employer and employee share of FICA with the US Treasury using the Electronic Federal Tax Payment System (EFTPS). Also, deposits are required for FUTA tax for the quarter within which the tax due is more than $500.
4. Myth: Outsourcing to a payroll service provider relieves you of liability.
Reality: Rather than handling payroll in-house, many businesses use an outside payroll service provider to handle the chore of computing payroll taxes, withholding them from employees’ paychecks, remitting payroll taxes to the government and filing employment tax returns. What happens if a payroll provider fails to remit your money to the government? Or it fails to timely file employment tax returns? Unfortunately, you’re still on the hook for these obligations. You may have a lawsuit against the
payroll service provider for theft, breach of contract or other bad action. You can even file a complaint with the IRS if you suspect your payroll service provider of improper or fraudulent activities regarding the deposit of your taxes or the filing of your returns. But it doesn’t relieve you of your obligations to the government.
5. Myth: Incorporating relieves you of liability for unpaid employment taxes.
Reality: You may think that having incorporated your business or formed a limited liability company (LLC), you have complete personal liability protection. You don’t. If you are a person responsible for withholding, accounting for or depositing withheld employee taxes (their income tax withholding and their share of FICA) and you willfully fail to do so, you can be held personally liable for all of these taxes, plus interest. This is called a trust fund recovery penalty and it can be applied to business owners even if they have corporations or LLCs.
In addition to any federal payroll tax obligations, you may also have state-level employment taxes to consider. Find out more about federal employment taxes from the IRS. Check with your state tax or revenue department to learn about your obligations on the state and local levels.
Barbara Weltman is an attorney, prolific author with such titles as J.K. Lasser’s Small Business Taxes, J.K. Lasser’s Guide to Self-Employment and Smooth Failing as well as a trusted professional advocate for small businesses and entrepreneurs. She is also a blog contributor for the SBA.
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