Small Businesses and the IRS

There are many different considerations when paying tax for small business organizations for an owner. Structuring a business in such a way as to minimize taxes and personal liability is one of the most important steps a business owner must take. Generally speaking, there are 4 types of business taxes; Taxes on Income, Individual Self-Employment tax, employment taxes for any workers/employees, and excise taxes which are specific to different industries.

Income Tax

All businesses, with the exception of partnerships, must file income tax returns for the business every year or they will receive a penalty for tax evasion.

For business formed as partnerships, an “information return” is filed instead of an actual annual tax return.

Self-Employment Tax

For individuals who are self-employed, the tax imposed in usually a social security and Medicare tax.

Self-Employed taxpayers file a Schedule SE as part of their 1040 and include earnings and other applicable information.

Employment Taxes

For individuals who have employees, the employer has specific tax responsibilities and payment obligations. Employers must pay social security and Medicare taxes, Federal income tax withholding and Federal unemployment (FUTA) taxes.

Excise Tax

Specific Excise Tax must be paid for business that are engaged in the following:

  • Manufacture or sell specific products
  • Operate specific kinds of businesses
  • Use specific kinds of equipment, facilities, or products
  • Receive payment for specific services

How to Classify Employees

It is important to establish whether employees of a business are actually considered “employees” or “independent contractors” for tax purposes(for more information contact a business tax attorney.)

Since employers must pay social security and Medicare taxes, Federal income tax withholding and Federal unemployment (FUTA) taxes for employees but not for independent contractors, the classification of workers can be an important business decision.

As part of a determination over whether an individual is an employee of an independent contractor, a series of factors related to the degree of control an employer has over the individual as well as the general independence of the individual.

Important areas to look at include:

  • Behavioral – does the employer actually control the way the individual does their job?
  • Financial – are all financial aspects of individual’s job controlled by that specific employer?
  • Type of Relationship – “employee” benefits such as pension plans, vacation days, etc?

Payroll Taxes

There are two types of payroll taxes that employers may be subject to: withholdings from the employee or withholding from the employer for each employee.

Pay-As-You-Earn (“PAYE”) and Pay-As-You-Go (“PAYG”) – refers to the employer withholding taxes from each employee as the employee earns income.

Employer Funds – taxes may also be paid directly from the funds of an employer on a fixed price per employee basis or based on a percentage of employee earnings.

The Trust Fund Recovery Penalty

Employers who fail to properly withhold taxes for employees are penalized by being charged the Trust Fund Recovery Penalty, as assessed by the IRS.

The Trust Fund Recovery Penalty is assessed to employers after they are found liable for the failure to withhold taxes properly. A 4180 Interview is conducted, and the findings hold the individual or business liable to the IRS for 100% of the unpaid taxes plus interest.

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