CHAPTER 2: EMPLOYER TAX INTRODUCTION
Let us lay down a few ground rules.
As a business owner, you should know all of this already. For those that do not, this chapter will be a nice (or not so nice) nudge to get your affairs in order. If you do not have your employer “tax ducks in a row”, the IRS will certainly find out.
Getting your business “house” in order is the first step to correcting your tax debt.
We will go through:
- The requirements for having an EIN
- Withholding from employees’ wages
- Depositing taxes
- Reviewing definitions of employees and taxable versus nontaxable wages
References in this chapter to “income tax” are specifically referencing federal income tax, not state or local taxes.
In many instances, specifics have been left out of this discussion. The goal of this chapter to provide a baseline of information about employment taxes so that we are all on the same page. Different employee classifications, reporting standards, etc. may differ in certain circumstances.
Payroll Tax Basics
When you pay your employees through payroll, you do not pay them all the money they have earned. As their employer, your responsibility is to withhold (except FUTA), deposit, report, and pay the following employment taxes: Federal income tax, social security tax, Medicare tax, and FUTA tax. The income tax, social security, and Medicare must be directly withheld from each paycheck.
All three of these taxes are to be paid, by you, to the U.S. Treasury. Your employees are trusting that you will pay those withheld taxes to the U.S. Treasury through federal tax deposits. This is the main reason that these withheld taxes are called trust fund taxes.
If these three taxes are not withheld or are not deposited or paid to the U.S. treasury, you may be assessed the Trust Fund Recovery Penalty (see Chapter 5: The Nasty Things the IRS Legally Can Do to You). This is a penalty that can be assessed to you individually. Yes, you read that correctly. The IRS can pierce through the corporate and business veil to assess penalties directly to individuals.
Employer Identification Numbers (EIN)
If you are required to report employment taxes, you need an Employer Identification Number (EIN).
The EIN is a nine-digit number that is issued by the IRS. The digits are arranged as follows: 00-0000000 and are used to identify the tax account of employers and certain others who have no employees.
Your EIN is to be used on all items that you send to the IRS and the Social Security Administration to identify that it is coming from your business.
You can apply for an EIN by these methods:
- Online: irs.gov/ein
- Fax or Mail to the IRS: Form SS-4
- By Phone (for businesses created outside the U.S.) – 267-941-1099
Rules and general tips for EINs.
- Do not use an SSN in place of an EIN.
- You should only have one EIN for each business.
- If you have more than one and are not sure which one to use, call 800-829-4933.
- If you take over another employer’s business, do not use that employer’s EIN.
- If you have applied for an EIN, but your EIN hasn’t been issued by the time a return is due, file a paper return and write “Applied For” and the date you applied for in the space shown for the EIN number.
Who Are Employees?
There are four types of workers, but in the sub-contracting industry, there are mainly two types of workers that you will deal with. Knowing the distinction between the types of workers will help you determine how you treat payments you make to them:
- An independent contractor
- A common-law employee
Those who offer their services to the general public. Also, you (the person for whom services are performed) do not have the right to control the means and methods of accomplishing the work performed.
How to treat payment: They are not your employees; therefore, you pay them as if they are a separate business. They are required to pay their own taxes.
Those who perform services for you and to which you have the right to control what will be done and how it will be done. This is regardless if you give the employee freedom of action, but that you can control the details of how the services are performed. It does not matter if they work full or part time.
How to treat payment: These are employees. You must pay them like typical employees, withholding taxes as part of the trust fund.
*Special Note: As a rule of thumb, you will generally be liable for income tax, social security tax and Medicare tax if you do not deduct and withhold these taxes because you treated an employee as a nonemployee.
Wages and Other Compensation
There are many different components of wages and compensation and some include specific rules, but we will keep this extremely basic.
Wages subject to federal employment taxes generally include all pay you give to an employee for services performed, by cash or other forms: salaries, vacation allowances, bonuses, commissions, deferred compensation, and taxable fringe benefits.
If your business pays employees in a form other than cash, you are said to have paid them “in kind”. This could include goods, lodging, food, clothing, or services. Most often, the fair market value of the “in kind” payment at the time they are provided is what is subject to federal income tax withholding and social security, Medicare, and FUTA taxes.
*Special Note: The exception comes in the form of reimbursable business expenses that the employee paid on behalf of the business. These are reimbursed, tax free back to the employee.
Are They Taxable?
There are several different payments to employees that may or may not be taxable. I have specified a few common ones below:
Meals and Lodging
Not taxable income and not subject to taxes if they are furnished for the employer’s convenience and on the employer’s premises.
Lodging is treated the same as meals if it is for the employer’s convenience and on the employer’s premises as a condition of employment.
“Convenience of the employer” means that you have a valid reason for providing these items, other than to provide additional compensation to the employee.
Health Insurance Plans
Not taxable if the business pays the cost of an accident or health insurance plan for employees, including an employee’s spouse and dependents.
This exclusion includes qualified long-term care insurance policies.
*Special Note: The exception to this is that the value of insurance benefits for 2% or more S Corporation owners must be included in wages.
Health savings accounts (HSAs) and medical savings accounts (MSAs).
Not taxable, if the business contributions to an employee’s HSA or Archer MSA if at the time of payment, it is
- Reasonably assumed it will be excluded from income to the employee and
- Made under a salary reduction arrangement in a section 125 cafeteria plan.
Payments made through regular payroll deduction will be taxable.
Medical Care Reimbursements
Not taxable, generally, if medical care reimbursements are paid for under an employer’s self-insured medical reimbursement plan.
Taxable Fringe Benefits
Taxable fringe benefits include cars you provide, flights on aircraft you provide, free or discounted commercial flights, vacations, discounts on property or services, memberships in country clubs or other social clubs, and tickets to entertainment or sporting events.
In general, the amount to include in an employee’s wages is the amount by which the fair market value of the benefits is more than the sum of what the employee paid, plus any amount the law excludes.
Nontaxable Fringe Benefits
Other than the taxable fringe benefits above, these are nontaxable: services provided to your employees at no additional cost to you, qualified employee discounts, a company car for business use, minimal value fringes (i.e. occasional cab ride or meals when an employee works overtime).
Additionally, there are qualified nontaxable transportation fringes, an on-premises gym or athletic facility operated by the business, and qualified tuition reduction benefits.
Taxable. This includes any amount you pay under a plan to an employee who is unable to work because of sickness or injury.
Taxable. Vacation pay is taxable as if it were a regular wage payment. When vacation pay is in addition to regular wages for the vacation period (for example, an annual lump-sum payment for unused vacation leave), treat it as a supplemental wage payment.
*Special Note: If the vacation pay is for a time longer than your usual payroll period, spread it over the pay periods for which you pay it
Withholding from Employees’ Wages
**Updated W-4 for 2020 – The IRS redesigned Form W-4 for the 2020 tax year. Employees who have submitted Form W-4 in any year before 2020 are not required to submit a new form merely because of the redesign.
The Form W-4 is used to calculate tax withholding from employees’ wage, and you should have one on file for each employee. This form should be completed by all new employees when they start work, and their first wage payment should reflect the Form W-4.
Completing Form W-4
It is likely that an employee will seek your guidance on how to complete Form W-4. A few words of wisdom you can provide them:
- Tax withholding amounts should be based on filing status, income (including income from other jobs), deductions, and credits.
- Do not base withholding amounts on a fixed percentage or amount; however, they may specify additional withholding by a specific dollar amount each pay period.
- Employees that will file as Married Filing Jointly and have a spouse that also works, or employees that have more than one job, should account for their higher tax rate through Step 2 of the 2020 Form W-4.
- Form W-4 claiming exemption from withholding is effective when given to the employer, but only effective for that calendar year. A new Form W-4 must be provided each year to keep that withholding status.
- You must withhold taxes on the wages of nonresident alien employees.
- Nonresident aliens are required to complete Form W-4, as well as not claim exemption from withholding and must withhold as if they are single regardless of actual filing status.
- When requested by the IRS, you must make original Forms W-4 available for inspection by an IRS employee.
- In some cases, the IRs may issue a “lock-in letter” to an employer to specify an employee’s permitted filing status and instructions on withholding.
- If you receive a Notice of Levy on Wage, Salary, and Other Income, you must withhold amounts as described in the form instructions.
Social Security and Medicare Taxes
You are required to withhold social security and Medicare taxes from your employees’ wages and pay the employer’s share of these taxes. Certain types of wages and compensation are not subject to social security, such as employer contributions to a 401(k) plan, health insurance premiums, workers compensation, and so on.
For 2020, the social security tax rate is 6.2% for the employee (must be withheld) and 6.2% from the employer for a 12.4% total. Social security has a wage base limit of $137,700.
For 2020, the Medicare tax rate is 1.45% for the employee (must be withheld) and 1.45% from the employer for a 2.9% total. Once employees have made $199,999 in any given year, you must withhold 0.9% additional Medicare tax on wages at and above $200,000. This additional Medicare tax is only imposed on the employee side.
*Special Note: Withhold social security and Medicare taxes to nonresident alien employees as you would for a U.S. citizen or resident alien.
Generally, you must deposit all federal income tax withheld and both employer and employee portions of social security and Medicare taxes.
You must make all federal tax deposits using the EFTPS online:
When to Deposit Taxes
There are two deposit schedules: monthly and semiweekly. The deposit schedule is based on the total tax liability you reported on during a lookback period, not based on how often you pay your employees.
Form 941 Filer
If you are a Form 941 filer, your deposit schedule for a calendar year is determined from the total taxes reported on Form 941, line 12, in a 4-quarter lookback period that begins July 1 and ends June 30:
- July 1 – Sept 30
- Oct 1 – Dec 31
- Jan 1 – Mar 31
- April 1 – June 30
Based on that 4-quarter lookback period, if you:
- Reported $50,000 or less of taxes for the lookback period, you are a monthly schedule depositor.
- Reported more than $50,000 of taxes, you are a semiweekly schedule depositor.
Form 944 Filer
If you are a Form 944 filer for the current year or either of the preceding 2 years, your deposit schedule for a calendar year is determined from the total taxes reported during the second preceding calendar year (either the Form 941 or Form 944 for that year).
- Reported $50,000 or less of taxes for the lookback period, you are a monthly schedule depositor.
- Reported more than $50,000, you are a semiweekly schedule depositor.
Form 945 Filer
If you are Form 945 filer, your deposit schedule is determined from the total taxes reported on line 3 of your Form 945 for the second preceding calendar year.
Make the Deposit
Monthly Schedule Depositor – deposit all employment taxes on payments made during the month by the 15th day of the following month.
Semiweekly Schedule Deposit
- Deposit all taxes on payments made on Wednesday, Thursday, and/or Friday by the following Wednesday.
- Deposit all taxes for payments made on Saturday, Sunday, Monday, and/or Tuesday by the following Friday.
*Special Note: If you accumulate taxes of $100,000 or more on any day during a deposit period, regardless if you are a monthly or semi-weekly schedule depositor, you must deposit the taxes by the next business day after you accumulate the $100,000.
When to Deposit – Special Notes:
- In general, if the total amount of tax for the year reported on Form 945 is less than $2,500, you are not required to make deposits during the year.
- Separate deposits are required for nonpayroll and payroll income tax withholding.
- Never combine deposits for Forms 941, Form 944, and Form 945 tax liabilities.
- If you are a semiweekly schedule depositor, and a pay date falls in different calendar quarters, you will need to make separate deposits for each liability.
- If a payment is required to be made on a “non-business day” (Saturday, Sunday, and legal holidays), it is considered timely if it is made by the close of the next business day.
- To have deposits be on time, submit your deposit to EFTPS by 8 p.m. Eastern time the day before the deposit due date. Same-day wire payment options are also available.
- If you deposited more than the right amount of taxes for a quarter, you choose on Form 941 for that quarter (of Form 944 for the year) to request a refund or credit.
With 941’s, there are three common penalties, the ‘Late Deposit Penalty’, the ‘Failure to File Penalty’, and the ‘Failure to Pay Penalty’. Finally, if you get assessed the Trust Fund Recovery Penalty, it is a big whammy. Let us go through all of those.
*Special Note: In general, penalties will not apply if any failure was due to reasonable cause and not to willful neglect. With 941
Late Deposit Penalty
A penalty may be assessed if you do not make required deposits on time or if you make deposits for less than the required amount, in the amount of:
- 1-5 days late = 2% penalty
- 6-15 days late = 5% penalty
- 16 or more days late = 10% penalty
- 10 days or more after first IRS notice = 15% penalty
These are determined using calendar days, starting from the due date of the liability.
Failure to File Penalty
If you file the quarterly Form 941 late, there is a Failure to File Penalty, in the amount of:
- 5% per month
- 25% cap
- Minimum of $135 or 100% of tax due, whichever is less
Failure to Pay Penalty
Lastly, if you do not pay, you will be assessed an extra penalty in the amount of:
*This 25% cap applies cumulatively to Failure to Pay and Failure to File.
Trust Fund Recovery Penalty (TFRP)
Please see Chapter 5: Nasty Things the IRS Legally Can do To You
“Averaged” FTD penalty
Additionally, the IRS may assess an “averaged” Failure to Deposit (FTD) penalty of 2 – 10% if you are a monthly schedule depositor and failed to properly if your tax liability equaled or exceeded $2,500.
The IRS may also assess an “averaged” Failure to Deposit (FTD) penalty of 2 – 10% if you are a semiweekly schedule depositor and your tax liability equaled or exceeded $2,500 and you:
- Completed Form 941, line 16, instead of Schedule B (Form 941
- Failed to attach a properly completed Schedule B (Form 941); or
- Improperly completed Schedule B (Form 941) by, for example, entering tax deposits instead of tax liabilities in the numbered spaces.