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Accounting - Potential payroll pitfalls

image Leann Ussery, CPA, Tax Manager Armstrong, Vaughan & Associates, P.C., Universal City, TX

AUSTIN - Your focus is your company’s growth, but you might be jeopardizing that growth if you’re not aware of various payroll pitfalls. Voluntary compliance with IRS regulations can save hours of time and thousands of dollars in penalties and assessments in the event of an audit, so it’s important to understand how to avoid these issues before that happens.

 

 

 

Contractor vs. Employee
    Be sure to properly classify your employees and contract laborers.  Work responsibilities vary significantly from company to company, so there is no clear definition of who is an employee and who isn’t, but there are some general guidelines.
•    Contract Laborers are hired by the job, not the hour, with no expectation of on-going employment.  They generally have their own tools and frequently have other employment. 
•    In contrast, employees are subject to more control by the employer in terms of when and how they work; tools are generally provided by the employer; and they receive benefits such as paid time off, training, job evaluations, and/or expense reimbursements.
•    The IRS is suspicious of classifications showing any individual as both an employee and an independent contractor, so avoid this red flag whenever possible. 
•    Payroll reporting is a hassle, yes, but filing Forms 1099 to your employees is not a substitute.  An employer who misclassifies employees as independent contractors bears the risk of employment taxes, penalties and interest. 
•    To correct classification errors, the Voluntary Classification Settlement Program is available to offer some relief.  Eligible participants pay just 10% of applicable payroll taxes without penalties or interest and are no longer subject to employment tax audits regarding reclassified employees on any prior years.

Partnership Compensation

    If your business files as a partnership, partners should not receive traditional wages except in rare cases but could receive guaranteed payments as outlined in a written partnership agreement. 
•    Guaranteed payments are compensation to partners for services or use of capital or property.  Amounts of these payments are determined without regard to partnership income and are generally fixed.  Payments should not include any payroll withholding but will be taxed as self-employment income on the partner’s individual income tax return. 
•    Cash payments to partners designated as distributions of earnings are not deductions for the partnership, nor do they increase taxable income to the partner.

S Corporation Owner Wages
If your business files as an S Corp, your shareholder-employee compensation is of great interest to the IRS since it is the only portion of your income that is subject to the self-employment tax. 
•    Under-paying yourself may be considered unjustified tax avoidance if the shareholder-employee is also taking tax-free distributions of earnings. 
Shareholder wages are paid in the same way other employee wages are paid, net of applicable withholding.
•    If S Corp income is significant and shareholder wages are not comparable, the IRS may recharacterize any distributions and levy payroll taxes and penalties.  To reduce risk, use industry standards to determine shareholder wage rates. 
 
Auto Allowance and Other Taxable Fringe Benefits
    Providing an auto allowance to employees for business use of their personal vehicles is a fringe benefit that provides incentives to employees and a tax deduction for the company.  Other taxable fringe benefits include adoption assistance, dependent care assistance in excess of federal limits, unsubstantiated expense reimbursements, and educational or mileage reimbursements in excess of standard federal rates.
    These fringe benefits paid to owners or employees should be treated as additional compensation to the employee, subject to payroll tax.  If paid to independent contractors, the total amount paid including fringes should be reported on Form 1099.  
    Classification issues, owner-compensation, and taxable fringe benefit reporting are just a few of the potential dangers of payroll, so contact your payroll professional for help in navigating payroll tax compliance and reporting.

     Leann Ussery, CPA is tax manager of corporate/partnership returns and focuses on the tax needs of small-to-mid sized entities, including entities with multi-state tax issues.  Leann joined Armstrong, Vaughan & Associates, PC in 2008 after graduating from Angelo State University with an MBA in Accounting.  She can be reached at 210-658-6229.


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Kim Estes austineditor@constructionnews.net