Print Posted by National Association of Tax Professionals on 09/24/2014

Payroll Taxes for the Small Business Owner – A guide to the special tax provisions that small business owners should know about payroll taxes

Payroll Taxes for the Small Business Owner – A guide to the special tax provisions that small business owners should know about payroll taxes

Payroll taxes are a big cost of doing business, and any way you can save money is always worth looking into. One way to save on payroll taxes is to use an accountable plan. Under this plan, you save money on payments you make to employees for reimbursements of expenses or advances made in anticipation of such expenses.

The great advantage of an accountable plan is that it saves the employer money because reimbursements made to the employee do not have to be counted as wages to that employee. For this reason, the employer does not have to pay any of the related payroll taxes on those amounts, nor is the employee’s reimbursement reduced by FICA taxes. It’s a win-win situation. 

In order to have an accountable plan, you must have a written document that meets the following three requirements:

Business Connection. The plan pays reimbursements and allowances only for deductible business expenses. This might sound obvious, but it needs to be included in the document. The business must observe this requirement at all times.

Adequate Substantiation. The plan requires substantiation of the expenses being reimbursed. The employee accounts for the expenses by submitting a written report to the company that details and substantiates the time, place, amount, and business purpose for every expense.

Employees Must Return Any Extra Advances. The plan must require the employee to pay back any advances that exceed the business expenses he or she incurred. If extra amounts are not paid back to the employer, they are treated as wages to the employee, subject to payroll tax withholding. This would defeat the entire purpose of having an accountable plan in the first place.  It’s never too late to set up an accountable plan and begin enjoying the tax savings right away.

With the advent of e-filing, the IRS will no longer send business taxpayers certain tax packages through snail mail. The IRS made this decision due to the continued growth of e-filing as well as to help reduce costs. Some forms that will no longer be mailed include:

Form 940, Employer’s Annual Federal Unemployment Tax Return 

Form 941, Employer’s Quarterly Federal Tax Return 

Form 944, Employer’s Annual Federal Tax Return 

Form 2290, Heavy Highway Vehicle Use Tax Return 

Form 5500, Annual Report/Report of Employee Benefit Plan

Many businesses find it cost effective to outsource their payroll functions to a third-party payroll company. It is important to ensure that the company you are partnering with is reputable, because ultimately it’s your responsibility to pay federal tax liabilities. If the third-party fails to make your federal tax deposits, the IRS may assess penalties and interest that you, the employer, will be responsible for paying.

When working with a third-party, choose a payroll service that uses the Electronic Federal Tax Payment System (EFTPS). This way, you can log onto the system and verify that the tax deposits were made on time.

Also, be sure to list your address on the account, so that the IRS will send all correspondence directly to you, keeping you informed.

If you are a corporate officer of an S corporation performing services for the corporation, you must pay yourself a reasonable salary. The IRS has not defined reasonable compensation in the code or regulations. However various courts have ruled on this issue based on the facts and circumstances of each case. 

Some of the factors the courts look at to determine reasonable compensation include training and experience, duties and responsibilities, time and effort devoted to the business, dividend history, payments to non-shareholder employees, timing and manner of paying bonuses to key people, what comparable businesses pay for similar services, compensation agreements, and the use of a formula to determine reasonable compensation. 

S corporations should not attempt to avoid paying employment taxes by having their officers treat their compensation as cash distributions, payments of personal expenses, and/or loans rather than as wages. The IRS could reclassify these amounts as compensation to the shareholder/employee resulting in additional taxes and penalties for the S corporation.