S Corp Shareholder Health Benefits

Q. A 2% shareholder of an s corporation is also an emploeye.  The corporation offers health insurance under a premium only 125 cafeteria plan.  Is the shareholder/employee eligible to participate?  If so should the corporation’s contribution be reported as wages?

A. There are lots of good articles already on the web about 2% shareholders of S corporations. These would of course be secondary resources on the topic but they can provide coverage from the perspective of those who work in this field every day.

The key is that the IRS considers an S corp to be a partnership when dealing with employee fringe benefits.  If the company pays for the health insurance of a 2% shareholder, it is allowed to take a deduction for that benefit.  The full amount of that premium would be considered taxable income to the shareholder/employee.  So…yes, a shareholder can participate in the plan, but cannot get pre-tax treatment like the rest of the employees would under a section 125 or “cafeteria plan”.

Some states do not allow single person health plans to be purchased as a business.  If the 2% shareholder is the only shareholder in the S corp, then perhaps he should consider hiring his spouse to enable them to purchase a business plan.  Otherwise, health insurance must be purchased as an individual and can only be deducted once it passes 7.5% of AGI on the tax return if the individual itemizes.

The IRS published a bulletin about this topic that goes into much more detail.  It is IRB 2008-2 and can be found here.

Filing Status? What is that?

Q. My payroll person told me that the filing status on the W-4 doesn’t necessarily mean the same thing as my marital status.  Is that true?  What is filing status?

A. Filing status on the W-4 and filing status on your tax return are not necessarily the same thing.  The W-4 drives withholding only.  The withholding formulas issued by the IRS come in only two flavors, married and single.  Any other situation is handled by the number of allowances claimed.  Other situations include head of household, children and multiple jobs.  In certain situations, if married folks claim married on their W-4s, they will not have enough withholding.  By switching over to the single withholding formula, additional withholding takes place.  Some companies use the W-4 to determine the marital status of their employees.  This is not a good policy. In fact, if an employer receives a lock-in letter for a specific employee, he/she may be directed to withhold at Single with zero allowances regardless of the marital status of the employee.

On your tax return, the rules are different.  You are only allowed to claim married if you are in fact married.  If you are married, you cannot claim single.  There is a special status called married filing separately for those who wish to use it.  Certain situations may warrant this for better tax treatment.  The key here is that your marital status on the last day of the tax year determines your status for the tax return for that year.

I hope this helps.

Publication 15 is Out!!

Hooray!!  The annual update to the document every employer is anticipating finally occurred. Okay, maybe not all employers were as excited to see this as I was.  Publication 15 should be every employer’s best friend.  This document contains instructions on everything from obtaining an Employer Identification Number (EIN) to withholding, to employer taxes.

How does a business determine if it has employees or contractors? Read page 8 section 2.

What if I want to hire a family member for an employee?  Read page 9 section 3.

How does the IRS define wages?  What is included?  Read page 10 section 5.

How much do I withhold from my employees’ wages?  Read page 39 and 40 if you want to use a formula.  Reference pages 41-60 if you wish to use the charts.  You could also use PaycheckCity.com for this since all the values have already been programmed into all the calculators for the last 10 years.

Have you considered employer costs like FUTA (unemployment)?  Read page 30 section 14.

Do you get the hint yet that this is a very important document?  Some of the most frequent questions I get from employers through the American Payroll Associations member hotline are related to supplemental pay.  This could be bonuses, commissions, overtime pay etc.  There are specific instructions in Publication 15 for the right way to withhold from these types of payments.

Each state that has required withholding will have a similar document.  Employers should also find and download a version of the state document to make sure they understand specific requirements for their state that may be different than the federal information.

Rent, Is It Taxable?

Q. We have an employee who is working on an extended assignment (1+ years) in another state.  This is not the state of his residence. My company is paying his apartment rent.  Is this taxable income to the employee?

A. That is a very good question.  In these turbulent economic times, employees are more apt to accept unique arrangements like this just so they can keep their job.  I see two issues at work here.  First, what amount of time is required before the employment state considers him a resident?  Second, is the employee living on-site at a business location.  Why do these questions matter?

Because I’m in Arizona and you did not mention which states are involved, I will use an Arizona example.  According to Arizona Income Tax Procedure (ITP) 92-1, if an employee is in the state for longer than 9 months, he is considered a resident.  Your employee is probably considered a resident of the state where he is working as well.  That means, he has technically relocated.  Unless he is residing on the premises of your business location (like a storage unit manager), any rent or mortgage that you pay on his behalf is taxable income to that employee and must be included in wages on the W-2.  He may also be subject to tax withholding in the state where he originally resided.  Check with a local tax advisor or CPA for details and guidance.  A good summary of this issue can be found in the Guide to Fringe Benefits, Publication 15-b from the IRS.

On a side note, if you read this page, you will see the minimum amount of time required to pass before an employee needs to have Arizona withholding. In your example, the employee is staying in the state much longer than the required 60 days.  Therefore, you would definitely have to withhold if this situation occurred in Arizona.  As you can see, withholding requirements normally begin much earlier than residency rules.  Check with the state that applies to your situation to see its requirements.

Relief For Small Employers

An IRS news release today reminds small employers of an alternate form available to reduce the burden of quarterly payroll tax filing.  It is called Form 944. If you have less than $1000 of annual employment tax liability, you can file this form.  For the rest of employers, Form 941 is required.  This is a newly updated and extended form that must be filed quarterly for companies that are too big for Form 944.  The record keeping requirements are much more onerous.

The problem has been a lack of education on the part of the IRS regarding who can actually file Form 944.  Even more confusion surrounds anyone who wishes instead to stick with the 941.  To have less than $1000 of annual liability, you would need to have taxable payroll of less than $6535.94.  This is an extremely small business who is likely not going to be keeping up with the latest IRS rules.  The IRS must notify the employer that they are eligible for the annual form.  Unless notification occurs, they again are stuck with the 941 anyway.  Why confuse the issue?

I propose completely doing away with the 944 and keeping everyone on the same reporting form.  It is really no easier to complete the 944. It is simply completed once per year instead of 4 times per year.  If there are questions from small businesses relating to payroll procedures, they need to seek out assistance to stay in compliance with employment tax rules.  By adding another form and relying on the IRS to notify employers in a timely manner that they qualify for the annual form, the government is nearly keeping anyone from using it anyway.

Form 944 is yet another reason why employers should be utilizing the services of a professional company for processing of payroll.  Whether this be a small local/regional provider, or the employer’s CPA, it is much too difficult to keep track of regulation changes and obscure tax nuances.  After all, unless you are in the payroll business, it is much more important to stay current with issues and customer needs surrounding your own business.

Where Do I Pay the Unemployment?

Q. I have been asked to find regulations similar to the state withholding reciprocity rules for unemployment.  I have a payroll person at one of our business units, who every time an employee is on a temporary assignment in another state she changes their SUI state to that state.  This is causing big issues not only for the employee but for those of us who process the SUI returns.  Any help you may be able to provide will be greatly appreciated.

A. The answer to your question can actually be found in the unemployment statutes of the states involved in your scenarios. Generally, all states but Minnesota follow guidelines that establish a reciprocity-like arrangement for employers where unemployment tax is paid to the state where the employee works. If the employee works in multiple states, then UI tax is paid to only one state. The general order for choosing the UI state is (check with the states involved for specifics):

1. Where does the employee perform most of his/her work?
2. Where is the employee based?
3. From which state is the employee’s work controlled?
4. If none of the above apply, use employee’s residence state.

The state you select doesn’t change unless the employee is making a permanent move in which case there are predecessor state rules involved.  This is a very common question for employers who operate in multiple states.

Working From Home

Q. I am looking to expand my business into other states.   I don’t want to rent full offices in case it doesn’t work out so my sales reps will work from home doing phone sales. What issues am I going to have to pay these guys?

A. Congratulations on your business growth!  There is one important detail to remember when you start operating from other states.  Because these are employees, you have established a business presense or “nexus” in that state.  That means, in order to properly compute your payroll, you will need to open a withholding and unemployment account in each of those states.  Depending on how the business is set up, this may also open you up to property, sales and income tax liability in those states.  Hopefully, you have retained the services of a CPA and/or hired a competent payroll person to process and handle this situation.

Small companies are especially prone to making decisions that increase their tax and payroll complexity beyond the original intention.  The moral of the story here is to research the issues prior to making the decision.  From a sales perspective, maybe this makes sense.  However, because of the increased record keeping and filing requirements, perhaps it is not the best decision.  Utilizing technologies such as VOIP, VPN and Web Conferencing, your sales reps can make calls directly from your main location.  In my opinion, hiring local talent is another way to have better control over the activities of your employees.  As your company expands and other requirements such as distribution or call centers become needed, then the establishment of nexus in other states would make better economic sense.

Learn About Payroll

Q.  I just started a new job and my employer wants me to do the payroll too. How do I learn some more about it so I don’t mess it up?

A. Thank you for looking for more education.  So many people think that payroll is nothing more than taking out taxes.  The payroll process has grown so complex in the last 15 to 20 years that it takes some serious education and study to keep up with everything.  There are several places you can look for payroll education.

1. I don’t know what state you are in, but there is likely a local chapter of the American Payroll Association close to you.  You can find the one closest to you using this chart.  Local chapter meetings allow you to network with your payroll peers and gives you a chance to ask questions as you learn.
2. The American Payroll Association itself has courses and books available that can guide you through issues you may be having.  They also offer an email list-serve and member hotline that can be useful resources as well.
3. PayrollTalk.com is a good resource.  It is a free online forum for discussion payroll topics.  Everything from tax calculation, to international payroll, to handling complaints is discussed.  You can read and search other posts or add your own after registering.  There are already several thousands members of this community who actively discuss payroll issues each day.
4. PaycheckCity.com can help you learn about the effect of different pay frequencies and W-4 values on your paycheck.  It can even be used for training your employees how to read their paycheck and the impact on take home pay of making changes to their W4.
5. Your local community college likely offers a class or two about payroll.  If not, payroll is often included as part of the accounting curriculum.
6. Publication 15 is the document published by the IRS that spells out fairly clearly your responsibilities as an employer for paying withholding taxes from employees.

Where Do I Put The Money?

Q. I’m a new employer and have started withholding taxes from my workers checks.  Where do I put the money?

A. Definitely don’t put it under your mattress!  Publication 15 from the IRS is what I like to call the Employer’s Tax Bible. Every employer whether new or seasoned should look through that document each year.  Within its pages, you will see a schedule of how often you must remit the taxes you withhold from employee checks to the IRS.  The section that relates to your question is chapter 11 “Depositing Taxes”.  The frequency depends on the total amount of tax liability you report.  Certain employers can remit their totals with their quarterly 941.  Certain employers must make a deposit monthly.  Still others get semi-weekly treatment.  The largest employers have a next-day obligation for deposits. You can make your deposits using the EFTPS system, or take a paper coupon and check to the bank. If you are using a payroll service, they can likely handle the deposits for you.

All money withheld from employee checks must remain in trust once it comes out.  The employee is relying on you to put their tax payments into an account and pay it for them.  Then, once per year when they file their taxes, those payments will count toward their tax liability.  Many employers recently have been convicted of not paying these taxes and instead running with them or spending them on business or personal expenses.  You don’t what to join that crowd.  Here is a link of some of the cases where employers didn’t pay over the money they withheld.

New Business Starting

Q. Dear Mr. Kerch,
I have read your blog with interest. I will soon start a new business. I will sell advertising to small service-oriented businesses. I expect to recruit agents to sell this service at the local level in small communities. I do not wish to be classified as an employer and thus want to structure the business and my relationship with these local agents in a manner consistent with this goal. I have read the IRS publication employee vs. sub-contractor (19, I think) a few times. It has succeeded in convincing me that there are a myriad of ways in which to fail in my goal. How do I best find and screen the right professional to help me not only set up this enterprise but also review my internal systems of fee collection, commission payment, the provision of agent network working tools, and management of agent network so as not to trigger an IRS determination of employer status? Also, I will need a salesforce software tool (salesforce.com?) and also software for paying commissions.
Ideas?

A.  The document used in determining the type of relationship is actually form SS-8.  In my opinion, the key factor in determining whether the relationship is employee/employer or between contractors is the level of control.

• Are you going to direct the methods used by the reps?
• Will you supply sales leads?
• Will you supply materials and/or training?
• Will you dictate schedules?
• Are the agents allowed to sell other products besides yours to clients they visit?
• Do your reps bid on an area?
• Do you bill the clients and pay the reps based on collections or do they collect and remit to you?

Unfortunately, the main goal of most companies when this question arises is the avoidance of both employment taxes and workers compensation insurance.  Essentially, if you don’t have employees, you don’t pay unemployment tax.  But, if one of these agents files a claim for unemployment if the relationship does not work out, and it is determined that you were actually an employer, heavy fines will be the result.  In fact, the same result will occur if the IRS determines you were actually an employer and did not pay any employment taxes for these individuals.

There is no fee for completing form SS-8 and filing it with the IRS.  Because this is a big audit area and probably a big contributor to the tax gap (estimated unpaid taxes), the IRS is probably going to consider your agents to be employees 99% of the time.

The questions you ask regarding structure are good questions and probably best answered by finding an industry group that closely aligns with your desired business.  Some examples are the NFIB and the NASP. Certains CPAs and business consultants who specialize in your industry can help you with specifics about the type of software that is best for CRM (customer relationship management) and payments to your agents.  Good luck with the new business.  Make sure you have a competent tax adviser around to help you take advantage of all the legal ways to reduce your taxes.  You don’t want to miss any deductions that are due to you.