Archive for FICA
January 6, 2013 John R. Dundon II Employment Tax, FICA, Paying Taxes, Payroll Tax Problems, Self Employ, Small Business, Sole Proprietor, Sub-chapter S, Tax Guidance & Preparation, Tax Problems & Requests Contrary to the manufactured ‘news’ dribbling out of the main stream media to sell advertising, last week the IRS published updated employer’s withholding guidance clearly stating that employers are to now withhold Social Security tax at the rate of 6.2 percent of wages rather than the previous rate of 4.2 percent in place for the past two years.
Alas THOSE OF US IN THE ‘MIDDLE CLASS’ WITH JOBS ARE ALL PAYING MORE TAX!!
June 4, 2012 John R. Dundon II Appeals & Audit Resolution, Audit Reconsideration, Business Expense, Employee Business Expense, Employment Tax, FICA, Payroll Tax Problems, Self Employ, Small Business, Sub-chapter S, Tax Guidance & Preparation, United States Treasury In my dealings with the US Treasury Department regarding worker classification disputes I have learned that although in reality there may be shades of gray distinguishing between what constitutes an employee and what constitutes an independent contractor the US Treasury has some very specific positions. Here are four that will hopefully help you make the correct determination and avoid future problems:
1. A relationship between an employer and an employee exists when the person for whom the services are performed has the right to control and direct the individual who performs the services, not only as to what is to be done, but also how it is to be done. It is not necessary that the employer actually direct or control the individual, it is sufficient that the employer merely has the right to do so. The designation of a worker as an agent, sub-contractor or independent contractor is irrelevant if the relationship of employer and employee exists. The degree of importance of each factor varies depending on the occupation and the factual context in which the services are performed.
2. A worker who is required to comply with another person’s instructions about when, where and how he or she is to work is ordinarily an employee. This control factor is present if the person or persons for whom the services are performed have the right to require compliance with instructions. Some employees may work without receiving instructions because they are highly proficient and conscientious workers or because the duties are so simple or familiar to them. Furthermore, instructions, that show how to reach the desired results, may have been oral and given only once at the beginning of the relationship.
3. Lack of significant investment by a person in facilities or equipment used in performing services for another indicates dependence on the employer and, accordingly, the existence of an employer-employee relationship. The term “significant investment” does not include tools, instruments, and clothing commonly provided by employees in their trade; nor does it include education, experience or training.
4. A person who can realize a profit or suffer a loss as a result of his or her services is generally an independent contractor, while the person who cannot is an employee. “Profit or loss” implies the use of capital by a person in an independent business of his or her own. The risk that a worker will not receive payment for his or her services, however, is common to both independent contractors and employees and, thus, does not constitute a sufficient economic risk to support treatment as an independent contractor. If a worker loses payment from the firm’s customer for poor work, the firm shares the risk of such loss. Control of the firm over the worker would be necessary in order to reduce the risk of financial loss to the firm. The opportunity for higher earnings or of gain or loss from a commission arrangement is not considered profit or loss.
February 7, 2012 John R. Dundon II Accounting Method, Business Expense, Business Income, Car expense, Depreciation, Disallowed Expenses, Employee Business Expense, Entity Classification, FICA, Health Insurance, Hobby, Home Office, Husband/Wife, Medicare, Net Operating Loss, NOL, Passive Activity, Self Employ, Small Business, Social Security, Social Security Tax, Sole Proprietor, Start up costs, Sub-chapter S, Tax Guidance & Preparation, Tax Problems & Requests The sole proprietorship or Limited Liability Corporation (LLC) is in my opinion the easiest type of business entity to set up and begin operating. It is not separate from its owner with the income and expenses reported on IRS Form 1040 Schedule C.
Some people have instant success with a venture that is profitable from the very beginning. However it is more common to be unprofitable in the first 24 to 36 months of operation. If you are loosing money it is important to remember that you MUST REPORT A PROFIT IN 2 OUT OF THE PREVIOUS 5 TAX YEARS TO AVOID BEING CONSIDERED BY THE IRS TO BE REALLY ENGAGED IN A HOBBY. For more details on the specifics of hobby versus business see my post at: http://johnrdundon.com/how-to-determine-what-is-a-business-vs-what-is-a-hobby/
When it comes to losses the other thing to keep in mind is that they can be limited basically in three different ways:
1. By the amount of your investment or basis limitation;
2. By the amount you have at risk or at-risk limitation; and
3. By the passive activity loss limitation.
Basis limitations do not apply to sole proprietors as they would with an S corporation shareholder or partner in a partnership. A sole proprietorship is predominantly financed by the proprietors own assets. Two obstacles must be overcome before a Schedule C loss is deductible as addressed in this particular order:
1. The at-risk limitations of IRC Sec. 465; and
2. The passive activity loss limitations of IRC Sec. 469.
The at-risk limitations apply before any loss is limited due to lack of material participation which is a threshold criteria of a passive activity. The proprietor’s at-risk limitation is calculated on IRS Form 6198. If a taxpayer cannot verify a material-participation level with respect to the Schedule C activity, then being at-risk for the loss is essentially immaterial. The at-risk concept is one that looks at the source of funds for the business. Usually sole proprietors would not be at-risk when:
• The business was financed with non-recourse loans – except for holding real property;
• A valid guarantee or stop-loss agreement is in force; or
• Amounts borrowed for use in the business are from a person with an interest in the business, other than a creditor, or who is
related to a person having an interest in the business under IRC Sec. 465(b)(3)(C).
Most all small businesses with gross receipts of $1 million or less are allowed to use the cash method of accounting (Rev. Proc. 2001-10). New proprietors generally begin using the cash method of accounting immediately. An existing business may qualify to change its accounting method by filing IRS Form 3115 – Application for Change in Accounting Method with its tax return under the automatic consent procedures. When changing from an accrual to a cash method of accounting usually a negative IRC Sec. 481(a) adjustment is deducted in the year of the change and a positive IRC Sec. 481(a) adjustment is generally reported in income over a four-year period.
Office-in-home deduction items are detailed separately on IRS Form 8829 Expenses for Business Use of Your Home rather than on the expense lines for rent, utilities, interest, etc.
Proper deduction of vehicle expenses includes a decision for utilizing the cents-per-mile deduction or the actual method. Both methods require maintaining a mileage log and an understanding
of which miles are business miles.
Additionally, an understanding of depreciation methods available, which includes knowing the weight of the vehicle, are important. IRC Sec. 179 deductions are limited to income, but regular depreciation, including bonus depreciation, can actually assist in creating or increasing an net operating loss (NOL).
Generally severance payments made to terminated employees have been held by the US Tax Court to be FICA wages because the definition of “wages” for FICA purposes found in the Internal Revenue Code is so broad. “Wages” include all remuneration or money paid for employment with 23 listed statutory exceptions to the definition.
A federal district court case case I blogged about before, US v. Quality Stores, Inc. from the western district of Michigan provides a FICA exception for one small area of severance pay. Specifically, the federal court found a FICA exception for severance pay which constitutes “supplemental unemployment compensation benefits” within the meaning of Section 3402(o) of the Internal Revenue Code defined as amounts paid to an employee because of an employee’s involuntary separation from employment resulting directly from a reduction in work force, the discontinuance of a plan or business operation.
When you retire from employment and your separation is not the direct result of a reduction in work force or operational shut-down your retirement is usually NOT considered involuntary and as such your severance pay can be subject to FICA taxation if you have not hit the income threshold for the tax year.
Furthermore it is important to note that the IRS disagreed with the Quality Stores decision described above. On June 18, 2010, the IRS issued an opinion which refers to the Quality Stores decision by stating “the decision is not binding precedent,” and “the opinion runs counter to (a) Federal Circuit Court of Appeal’s 2008 decision.” Which means in plain terms from my perspective that the IRS will dedicate resources to defending their position on this matter the next time a case like Quality Stores comes up. In other words chances are really good that your severance payment will more likely than not be subject to FICA tax.
Protective refund claims are filed to preserve a taxpayer’s right to claim a refund when the taxpayer’s right to the refund is contingent on future events like future litigation, and may not be determinable until after the statute of limitations expires. Without a protective refund claim, taxpayers will only have a three-year statute of limitations in which to seek a refund.
For example as I’ll describe below a taxpayer who paid FICA tax in 2009 on severance pay will only be eligible to receive a refund of these payments until April 15, 2013, unless the taxpayer files a protective refund claim.
A protective claim can be either a formal claim or an amended return (1040X, 1120X, etc.) for credit or refund. A protective claim does not have to state a particular dollar amount or demand an immediate refund. However, to be valid, a protective claim must:
• Be in writing and be signed;
• Include the taxpayer’s name, address, social security number or
individual taxpayer identification number, and other contact
information;
• Identify and describe the contingencies affecting the claim;
• Clearly alert the IRS to the essential nature of the claim; and
• Identify the specific year(s) for which a refund is sought.
Generally, the IRS will delay action on the protective claim until
the contingency is resolved. Once the contingency is resolved, the IRS may obtain additional information necessary to process the claim and then either allow or disallow the claim.
Taxpayers can mail a protective claim for refund to the address listed in the instructions for Form 1040X, under Where To File.
Here is an example of when a protective refund claim is in order. In February 2010, a federal district court in U.S. v. Quality
Stores, Inc., (DC MI 2/23/2010) 105 AFTR 2d 2010-1110, ruled
that severance payments made to terminated employees by a company going out of business were not “wages” subject to FICA. The Court said that “…where severance payments are intended to serve the same purpose as social security benefits, i.e., support for workers in lieu of a lost ability to earn wages, the collection of social benefit taxes on the wage-replacement benefits makes
little sense.” The Court believed that the severance payments were in effect supplemental unemployment compensation benefits, not taxable remuneration for the employees’ services or wages and reasoned that the severance payments were not subject to taxation for FICA purposes.
The IRS has indicated it will appeal the decision, and will continue to deny claims for a refund of FICA tax paid on severance payments. The IRS continues to rely on CSX Corp. v. U.S., (Ct of Fed Cl 4/1/02) 89 AFTR 2d 2002-1935, that severance payments are “wages” for FICA tax purposes, there is no statutory
exception to exclude them from taxation, and they are not “supplemental unemployment benefits” because they are not conditioned on eligibility for, or receipt of, state unemployment benefits.
Taxpayers should file protective claims to preserve their right to
receive a refund if Quality Stores is upheld on appeal on the off chance that we experience clarity as to whether severance packages are subject to FICA tax.
In February 2010, a federal district court in U.S. v. Quality Stores, Inc., (DC MI 2/23/2010) 105 AFTR 2d 2010-1110, ruled that severance payments made to terminated employees by a company going out of business were not “wages” subject to FICA. The Court said that “…where severance payments are intended to serve the same purpose as social security benefits, i.e., support for workers in lieu of a lost ability to earn wages, the collection of social benefi t taxes on the wage-replacement benefits makes little sense.”
The Court believed that the severance payments were in effect supplemental unemployment compensation benefits, not taxable remuneration for the employees’ services or wages. Therefore, the Court reasoned that the severance payments were not subject to taxation for FICA purposes.
The IRS has indicated it will appeal the decision, and will continue to deny claims for a refund of FICA tax paid on severance payments. The IRS continues to rely on CSX Corp. v. U.S., (Ct of Fed Cl 4/1/02) 89 AFTR 2d 2002-1935, that severance payments are “wages” for FICA tax purposes, there is no statutory exception to exclude them from taxation, and they are not “supplemental unemployment benefits” because they are not conditioned on eligibility for, or receipt of, state unemployment benefits.
Taxpayers should file protective claims to preserve their right to receive a refund if Quality Stores is upheld on appeal. Protective refund claims are filed to preserve a taxpayer’s right to claim a refund when the taxpayer’s right to the refund is contingent on future events (e.g., future litigation), and may not be determinable until after the statute of limitations expires. Without a protective refund claim, taxpayers will only have a three-year statute of limitations in which to seek a refund.
A taxpayer who paid FICA tax in 2007 on severance pay will only be eligible to receive a refund of these payments until April 15, 2011, unless the taxpayer files a protective refund claim. A protective claim can be either a formal claim or an amended return (1040X, 1120X, etc.) for credit or refund. A protective claim does not have to state a particular dollar amount or demand an immediate refund. However, to be valid, a protective claim must:
• Be in writing and be signed;
• Include the taxpayer’s name, address, social security number or individual taxpayer identification number, and other contact information;
• Identify and describe the contingencies affecting the claim;
• Clearly alert the IRS to the essential nature of the claim; and
• Identify the specific year(s) for which a refund is sought. Generally, the IRS will delay action on the protective claim until the contingency is resolved. Once the contingency is resolved, the IRS may obtain additional information necessary to process the claim and then either allow or disallow the claim. Taxpayers can mail a protective claim for refund to the address listed in the instructions for Form 1040X, under Where To File. This post written by Erik Lammert and published on National Association of Tax Practitioners web site
July 9, 2010 John R. Dundon II Children, Employee Business Expense, Employment Tax, Family, FICA, Paying Taxes, Payroll Tax Problems, Personal Service Corporation, Self Employ, Small Business, Social Security Tax, Sole Proprietor, Tax Guidance & Preparation School’s out and many students now have a summer job. Some students may not realize they have to pay taxes on their summer income. Here are the six things the IRS wants everyone to know about income earned while working a summer job.
All employees fill out a W-4, Employee’s Withholding Allowance Certificate, when starting a new job. This form is used by employers to determine the amount of tax that will be withheld from your paycheck. If you have multiple summer jobs you will want to make sure all your employers are withholding an adequate amount of taxes to cover your total income tax liability. To make sure your withholding is correct, use the Withholding Calculator on IRS.gov.
Whether you are working as a waiter or a camp counselor, you may receive tips as part of your summer income. All tip income you receive is taxable income and is therefore subject to federal income tax.
Many students do odd jobs over the summer to make extra cash. Earnings you received from self-employment are subject to income tax. These earnings include income from odd jobs like baby-sitting and lawn mowing.
If you have net earnings of $400 or more from self-employment, you will also have to pay self-employment tax. This tax pays for your benefits under the Social Security system. Social Security and Medicare benefits are available to individuals who are self-employed the same as they are to wage earners who have Social Security tax and Medicare tax withheld from their wages. The self-employment tax is figured on Form 1040, Schedule SE.
Food and lodging allowances paid to ROTC students participating in advanced training are not taxable. However, active duty pay – such as pay received during summer advanced camp – is taxable.
Special rules apply to services you perform as a newspaper carrier or distributor. You are a direct seller and treated as self-employed for federal tax purposes if you meet the following conditions:
You are in the business of delivering newspapers.
All your pay for these services directly relates to sales rather than to the number of hours worked.
You perform the delivery services under a written contract which states that you will not be treated as an employee for federal tax purposes.
Generally, newspaper carriers or distributors under age 18 are not subject to self-employment tax.
The American Jobs and Tax Loopholes Act, currently in Congress, would subject to Self Employment Taxes (FICA, FUTA, SUTA) all distributions from S Corporations which are “personal service” corporations. This is HUGE. This is not good for the small business owner. If you thought your taxes were high now you’re going to be in for a surprise.
A personal service corporation is a corporation whose principal activity for tax year is the performance of personal services. Personal services include any activity performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health, law, and the performing arts. The services must be substantially performed by employee-owners.
John R. Dundon, EA – 720-234-1177
May 19, 2010 John R. Dundon II Business Expense, Employment Tax, FICA, IRS Audit, IRS Enforcement, IRS Examination, Payroll Tax Problems, Self Employ, Small Business, Social Security, Social Security Tax, Sole Proprietor, Sub-chapter S, Tax Guidance & Preparation, Tax Problems & Requests, Wage Garnish The IRS and Department of Labor have joined forces to reduce employer misclassification of workers. Last fall, the IRS began auditing 6,000 companies to determine if they have misclassified workers as independent contractors or properly classified the workers as employees and paid the required employment taxes.
If an individual who has been treated as an independent contractor for tax purposes is notified that his/her worker status is actually that of an employee, the IRS will often require corrections to that person’s prior returns. Such a determination impacts the reporting of income and deductions, which in turn affects earned income credit, AMT, and any deductions based on adjusted gross income (AGI).
Individual workers who were not treated as employees most likely filed as self-employed, reported income and deductions on Schedule C, Profit or Loss From Business, and paid self-employment (SE) tax on the net result. These individuals are now required to report the income and expenses as an employee, so many of the deductions that were taken as business expenses on Schedule C will be lost.
Because their expenses must now be reported as employee business expenses on Form 2106, Employee Business Expenses, and carried to Schedule A, Itemized Deductions, the deduction often vanishes when subjected to the 2-percent of AGI limitation.
Reclassification from a self-employed individual to an employee also affects adjustments to income on Form1040, U.S. Individual Income Tax Return. One such adjustment is the deduction on Form 1040, Line 27, for one-half of the self-employment (SE) tax paid. As an employee, that deduction is eliminated, as well as any other deduction originally allowed as a self-employed individual, such as a deduction for self employed health insurance (Line 29), or a self employed SEP, SIMPLE, or other qualified retirement plan contribution (Line 28).
Instead of paying self-employment tax, the employer and employee are each responsible for paying one-half of the total FICA and Medicare tax.
Usually, FICA and Medicare tax is taken out of each paycheck and calculated on the gross amount of wages, as reported on Form W-2 and on Line 7 of Form 1040. If the individual is still employed, he/she needs to pay any of the current year’s federal income tax withholding (FITW), based on the current year wages, before the end of the tax year. If the individual is no longer employed, the employer is ultimately responsible for payment of the FITW and needs to arrange for reimbursement, if any, from the reclassified employee. If the employer pays the FITW, the employee’s gross wages reported on Form W-2 need to include the amount of withholding paid by the employer.
Since this reclassification is generally determined after the individual has been paid for the services rendered, both the employer and the reclassified employee are responsible for paying a portion of any FICA and Medicare on the reclassified wages.
The employee portion of FICA and Medicare is reported on Form 8919, Uncollected Social Security and Medicare Tax on Wages, and attached to either an original or amended return.
For tax years prior to 2007, use Form 4137, Social Security and Medicare Tax on Unreported Tip Income. Cross out the word tip(s) and replace it with the word wage(s). This form is attached to Form 1040 or Form 1040X, as applicable.
If a refund is due the employee, the normal statute of limitations applies. Therefore, any original or amended return must be filed within three years of the due date of the original return or within two years after the date the tax is paid, whichever is later.
After Form 8919 (or Form 4137) is processed, this income will be reported to the Social Security Administration as wages earned.
Note: The employer portion of the employment taxes is reported on Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund. For more information, see Pub. 4341, Information Guide for Employers Filing Form 941or Form 944, Frequently Asked Questions About the Reclassification of Workers as Employees.
A complete copy of Notice 989, Commonly Asked Questions When IRS Determines Your Work Status is Employee, is available at www.irs.gov/pub/irs-pdf/n989.pdf.
May 19, 2010 John R. Dundon II Business Expense, Employment Tax, FICA, Paying Taxes, Payroll Tax Problems, Self Employ, Small Business, Social Security, Social Security Tax, Sole Proprietor, Sub-chapter S, Tax Guidance & Preparation, Tax Problems & Requests, Tax Relief A corporate officer who performs substantial services for the corporation and receives compensation is considered to be an employee. The corporation should issue a Form W-2 reporting the compensation as wages and withhold proper amounts for federal income tax, FICA, and FUTA purposes. Recently, the IRS Small Business/Self-Employed Division issued a memorandum providing guidance to IRS agents when a corporation fails to treat an officer as an employee. If the corporation fails to issue a W-2, it may be eligible for relief under one of several avenues.
First, the corporation may be allowed to classify the officer as a non-employee under §530 of the Revenue Act of 1978 if all of the following conditions are met:
The corporation didn’t treat the individual as an employee.
Federal employment tax returns were filed on a basis consistent with the employer’s treatment of the worker as a non-employee.
The corporation had a reasonable basis for not treating the individual as an employee. This condition is difficult to overcome because §§3401(c), 3121(d)(1), and 3306(i) for purposes of income tax, FICA, and FUTA withholding, respectively, define an officer of a corporation as an employee for employment tax purposes.
The corporation didn’t treat any individual in a substantially similar position as an employee.
Secondly, §3509 reduces an employer’s liability for income tax withholding and the employee portion of the FICA taxes where the employer unintentionally failed to deduct and withhold those taxes because it treated the employee as a non-employee. That liability is reduced to 1.5 percent of the employee’s wages for income tax withholding and 20 percent of the employee’s portion of the FICA tax.
However, if the employer failed, without reasonable cause, to comply with applicable information reporting requirements consistent with the treatment of the employee as a non-employee, those percentages are doubled. If the employer intentionally disregarded the deduction and withholding requirements, it is liable for the full tax and the lower §3509 rates do not apply.
Example: Axel is an officer of Flying High Co., an S corporation, for which he performed substantial services and received compensation in 2008. Flying High Corp treated Abe as an independent contractor, but did not issue him either a Form W-2 or Form 1099-MISC. Instead, Flying High Corp treated Axel’s payments as a distribution and issued him a Schedule K-1. The lower rates of §3509(a) will be used as long as Flying High did not intentionally disregard the reporting requirements. If no K-1 or other appropriate information return was issued to Axel, still assuming no intentional disregard on the part of Flying High, the higher §3509(b) rates will be used to compute the tax.
Example: Fastrack Corp. knows that officers who perform services for a corporation are employees by statute. Bernie, an officer of the corporation, performs substantial services, but the corporation deliberately structures his pay as distributions or loan repayment in lieu of a salary or wages. Fastrack Corp. has intentionally disregarded the rules and regulations and does not qualify for the lower §3509 rates.
The IRS memorandum notes that reliance on the preparer is not always reasonable cause. The taxpayer must show he received advice from his counsel, that he relied on it in good faith, and that any such reliance was reasonable.
The §3509 rates do not reduce the employer’s liability for the employee’s portion of the FICA taxes for statutory employees described in §3121(d)(3) (i.e., certain agent- or commission-drivers, those who sell life insurance full time, home workers, and traveling or city salespersons).
If an individual could be classified as either a corporate officer under §3121(d)(1) or a statutory employee under §3121(d)(3), then the §3509 reductions of the employer’s liability for the employee’s portion of the FICA taxes do not apply.
Similarly, if the individual could be classified as either a common law employee under §3121(d)(2) or a statutory employee under §3121(d)(3), then §3509 reductions of the employer’s liability for the employee’s portion of the FICA taxes would be inapplicable.
To sum up the rule for corporate officers, §3509 reductions apply unless the officer could also be classified as an agent- or commission-driver, a full-time life insurance salesperson, a home worker, or a traveling or city salesperson.
If a corporate officer could also be classified as an employee under §3121(d)(3), then the §3509 rates apply only to the employer’s liability for income tax withholding and not to the employer’s liability for the employee’s portion of the FICA taxes.
IRS agents who do not allow the reduced tax rates must develop facts to support their position, and address those facts in their examination report. The IRS cannot issue an assessment for any unpaid employment taxes until after:
It has issued a Notice of Determination of Worker Classification
(NDWC); and
The taxpayer has either exhausted its Tax Court remedies/failed to pursue them, or signed an appropriate waiver of restrictions on assessment.
Tax Information