Payroll taxes involve a variety of difficult issues for the small business owner, which center around determining who is a taxable employee, what compensation is taxable, which payroll taxes apply, and when and how to make the tax payments.
If your business has an employee, you must deal with payroll tax responsibilities. Employers generally must withhold taxes from employees' pay and deposit the withheld amounts with the appropriate tax agencies. And, as an employer, you must pay certain taxes based on the amounts that you pay your workers.
The taxes that you must withhold, together with those that you must directly pay, comprise your payroll taxes. These include federal, state, and perhaps local income taxes, Social Security and Medicare taxes, federal and state unemployment taxes, and, in some states, disability insurance taxes.
Keep in mind, regardless of whether you employ others, you can expect to owe some payroll-type taxes on income that you receive from your business.
The key to managing your payroll tax obligations involves the following considerations:
- which workers are taxable employees
- what type of compensation is taxable
- which payroll taxes apply
- what payroll tax returns must be filed and what payments must made
- whether self-employment taxes apply to your business income
Who Are Your Taxable Workers?
Before you can calculate your payroll tax liabilities, you must first determine which of the people who work for you, if any, are "employees" for whom you must withhold and pay taxes.
Each federal and state law imposing a payroll tax has its own definition of the types of workers to which the tax applies. However, as a practical matter, the basic governing standard under all of these laws is whether the individual who performs services for you is properly characterized as an employee, as opposed to an independent contractor, under so-called "common law rules."
In general, these common law rules say that your workers must be treated as employees if you have the right to direct and control the way they do their work, rather than merely the results of the work. However, consider the following:
- Distinguishing common-law employees from contractors can be difficult, since every working relationship must be judged on its own particular facts. There are a number of tools that can help you, including the IRS's 11-factor test, the IRS safe-haven rules, and the opportunity to get an IRS ruling on the issue.
- Some independent contractors are taxable as employees, if they perform certain types of duties.
- Some employees may be treated as nontaxable contractors, namely, real estate agents and direct sellers.
Part-time and temporary workers. If your workers are properly classified as being employees, the fact that they may work for you only on a part-time or temporary basis or that they may be minors generally won't relieve you from the obligation to withhold and pay taxes on their wages. Again, the key issue is whether the workers are common-law employees, and that determination is unaffected by the number of hours the workers put in or by their age.
You take on a significant risk if you improperly treat an employee as an independent contractor.
The risk is that the IRS and your state tax authorities will hit you with penalties that at a minimum make you personally liable for paying, with interest, both the taxes you should have paid and the taxes you should have withheld. So, if you have any doubts as to the proper classification of a worker, consult your accountant or other tax professional. Or, request an IRS determination of the worker's correct classification.