What’s the Difference Between Form W-2 and Form 1099-MISC?

Posted on December 8, 2011 by Wayne Davies

I’m following up last week’s post — W2 vs 1099 – Does It Matter? – with another timely post on year-end payroll reports. If you own a business and are paying people who perform services for you (and with the January filing season just around the corner), it’s crucial that small biz owners understand the difference between Form W-2 and Form 1099-MISC.

What is Form W-2?
Form W-2 is issued to employees at the end of the year. You must give each employee this form by January 31 of the following year. It contains critical payroll information that each employee needs to file his/her personal income tax return, such as gross wages, salaries and other forms of compensation; federal income tax withholdings; Social Security tax withholdings; Medicare tax withholdings; state and/or local income tax withholdings; retirement plan contributions, such as payments into the employee’s 401(k) plan or other employer sponsored plan; other employee benefit information.

Without a W-2, an employee cannot properly prepare or file his/her federal or state personal income tax return. So it is extremely important that you prepare this form in a timely manner. Once an employee receives the W-2, he can file his tax return and get his long-awaited tax refund check from the IRS.

Not only must you issue the W-2 to the employee by January 31, but you must also send a copy of the W-2 to the Social Security Administration, along with a special report called Form W-3, by February 28. Form W-3 serves as a summary report, providing totals for the various dollar amounts listed on the W-2′s.

What is Form 1099-MISC?
Form 1099-MISC must also be issued to recipients by January 31, but this form is given to independent contractors rather than employees. Here’s another significant difference between W-2′s and 1099′s – a W-2 must be issued to every employee regardless of how much wages he/she received. Even if an employee worked only a few hours and made just $50, you must still give him a W-2. In contrast, a Form 1099-MISC is only required if the recipient received $600 or more in non-employee compensation during the year.

A 1099-MISC that is issued to an independent contractor typically reports only one dollar amount – the total annual payments made to that individual are shown in Box 7. You should not have withheld any taxes from those payments. By definition, an independent contractor is self-employed and is responsible to calculate and pay his own income taxes (both federal and state), as well as his own self-employment taxes (the self-employed person’s version of Social Security and Medicare taxes).

The world of year-end payroll reporting is complicated. Obviously, an article of this length can only provide the big picture. If you have questions about whether to issue W-2′s or 1099′s to your workers, please give me a call at 260-459-3858 or hit reply and send me an email.

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W2 vs 1099 – Does It Matter?

Posted on November 30, 2011 by Wayne Davies

Do you own a small business and pay workers to perform services for you? If so, are you wondering whether it matters whether you give them a W-2 or a 1099-MISC? Read on to find out.

The short answer to this question is simple: It matters a lot. And there’s a lot at stake here, so do not take this issue lightly.

The question of what tax reporting form to give your workers is just the tip of the iceberg of a huge issue known as “employee vs. independent contractor.” If your workers are employees, they should receive a Form W-2. If they are independent contractors, they should receive a Form 1099-MISC.

Why does it matter? It matters because if you’ve been paying your workers as employees, you should have been issuing paychecks and withholding income taxes (federal and state) as well as payroll taxes (Social Security and Medicare tax) from those paychecks. You should have also been paying these taxes to the appropriate government agencies over the course of the year. Depending on the amount of withholdings, you can be required to make payments weekly, monthly or quarterly. In addition, if you have employees you should also be calculating and paying federal and state unemployment tax, which can also be due every quarter.

If your workers are independent contractors instead of employees, then you don’t withhold taxes and you don’t make the above-mentioned payroll tax payments. Instead, you simply pay the agreed-upon amount to the contractor, and he/she is responsible for any federal and/or state taxes due on that income.

There’s also a lot at stake in terms of your expenses. If you pay your workers as employees, you must also pay your share of payroll taxes (Social Security, Medicare and unemployment taxes). If your workers are paid as contractors, you do not incur any payroll tax liability. There is also much more paperwork and administrative expense involved with employee compensation. There’s much more number-crunching, and you must make numerous payroll tax payments on time or be subject to late payment penalties and interest.

So it is obviously to your advantage to make payments to contractors instead of employees. Unfortunately, however, you cannot decide how to treat your workers based on your expenses. In fact, that should not be a deciding factor at all. The IRS frowns upon businesses that treat workers as contractors simply to save money. Instead, you must determine the true classification of a worker apart from expense considerations, and if you’re unsure how to do that, give me a call or send me an email and I’d be glad to help you sort this out.

If you’d like to read up on this issue, here’s a good resource to get you started:
http://www.irs.gov/businesses/small/article/0,,id=99921,00.html

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Self-Employed Tax Questions: How Much Income Tax Will I Pay On My Self-Employment Income?

Posted on November 17, 2011 by Wayne Davies

If you’re self-employed (which means you are a sole proprietor and file Schedule C as part of your personal income tax return), are you wondering how much federal income tax you may have to pay? This article will help you sort this out.

1. If you have a loss in your small business, you’ll pay zero federal income tax. By a loss, I mean that your expenses are greater than your income, as reported on Schedule C. In fact, having a loss may reduce your income tax, as it can usually be used to offset other sources of income, if you have any.

2. Let’s take a more positive approach here and assume you have profit from your business. Again, the starting point is Schedule C. If your income (i.e. sales or revenue) is greater than your expenses, you have profit, and that Schedule C profit gets added to any other sources of income you report on Form 1040. So you must realize that the amount of tax you’ll pay on self-employment income depends on whether you have any other income, such as investment income (interest or dividends or capital gains) or wages/salary that you or your spouse receive from an employee job. All your income, including the Schedule C profit, gets added together and is called “Total Income” on Form 1040.

3. You then get to subtract various deductions from your Total Income to arrive at “Adjusted Gross Income.”  These deductions are also found on Form 1040, page 1, and include things like IRA contributions, health insurance, moving expenses, and 50% of your self-employment tax.

4. Next, you get to take the Standard Deduction or Itemized Deductions (on Schedule A), as well as Exemptions for yourself, your spouse, and any dependents such as your children. After subtracting these amounts, you finally arrive at the key number that determines how much federal income tax you’ll pay – Taxable Income. You pay federal income tax on this amount based on the tax tables, which operate on the basic principle that the more you make, the more tax you pay on higher levels of income. These tax tables start out at 10% and go up from there – there are also brackets of 15%, 25%, 28%, 33% and 35%.

As you can see, what seems like a simple question (How much income tax will I pay on my self-employment income?) does not have a simple answer. In order to answer this question, you must know how much taxable income you have, and that requires you to go through the same calculations that are done on your personal income tax return. But that’s how our tax system works, and this is the reason why many self-employed people get help from a tax professional not only at tax time, but throughout the year.

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What Is The Best Time of Year to Incorporate?

Posted on November 10, 2011 by Wayne Davies

As 2011 winds down, it’s time to think seriously about year-end tax strategies.

For example, if you’re a sole proprietor, have you considered incorporating your small business or self-employment activity?

If so, maybe you’ve been wondering, “Does it matter what time of year I form a corporation?”

From a legal standpoint, any time is the best time. The sooner you incorporate, the sooner you make the move from the world of unlimited liability to the world of limited liability.

From a tax savings standpoint, any time is the best time. The sooner you incorporate, the sooner you will start putting more money in your own pocket and less in Uncle Sam’s.

But from a **tax reporting** standpoint, there is one time of year that stands out as best: January 1st.

Why is that?

Assuming you have a sole proprietorship (or other entity, such as a partnership) that is up and running as of January 1, and assuming you then incorporate that existing entity on any date other than January 1, you face the possibility of filing not one but two business income tax returns for that year.

Here’s an example to clarify this important point…

Let’s say you’ve been operating your sole proprietorship for a few years, and in early 2012 you decide to incorporate. In January you get around to starting the paperwork, but life gets in the way and you finally get it done in late February. By the time your state processes the Articles of Incorporation, the start date of your new corporation is March 1.

For 2012, you must file a Schedule C for the period of January 1 through February 28, when your business was still a Sole Proprietorship. And you must also file a corporate income tax return for March 1 through December 31.

Maybe that’s no big deal. Maybe you enjoy filing one business income tax return so much, filing a second one doesn’t bother you. And it may be that the inconvenience of filing two tax returns in 2012 is far outweighed by the legal and tax advantages of incorporating.

Keep in mind, too, that 2012 will be the only year you have to do this “double duty”. In 2013 you will only have to file the corporate income tax return.

But if you are thinking about incorporating, the best time to do it, from a tax paperwork standpoint, is as of January 1. Only then do you have a “clean break” from the old sole proprietorship to the new corporation.

This timing issue can also be relevant if you decide to make the switch late in the year. If the effective date of the incorporation is November 15, you will have to file a Schedule C for January 1 through November 14, and a corporate return for November 15 through December 31. In that scenario, you should ask yourself, “Do the benefits of incorporating outweigh the convenience of waiting until January 1?”

So before you decide when to incorporate, take a moment to reflect on the tax reporting consequences of incorporating on January 1 vs. any other date.

Sometimes it may make sense to wait a few weeks (as in the second example), and sometimes it makes sense to “do it now”, especially when January 1 is nearby.

Looking for more tips on the benefits of incorporating? Check out my 3-volume ebook, the Small Business Tax Reduction Guide.

And my 10-week Small Business Tax Deduction Coaching Program is another great resource to determine the potential tax savings of incorporating; you’ll also learn everything you need to know to paperwork-wise to make it happen.

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Is Our Tax System Corrupt?

Posted on November 3, 2011 by Wayne Davies

Here’s an intriguing statement from a recent article in Time magazine:

“Most Americans believe that the federal tax code is highly complex and fundamentally corrupt.”

Certainly our tax code is “highly complex.”  There’s an understatement.

As the article indicates: “The federal code (plus IRS rulings) is now 72,536 pages in total. The code itself is 16,000 pages.”

Wow. That’s a lot of pages. Enough to make my head spin, and deciphering this code is what I do for a living!

But what about the second part of this statement – “the federal tax code is fundamentally corrupt”. 

What do you make of that?  Would you agree? 

But back to the complexity of our beloved tax system. Even though we regularly hear talk in Washington of “tax simplification”, I don’t see any evidence that our tax code is getting less complex.

Do you?

I do see plenty of evidence of increasing complexity.

Every year. 

Every time Congress and the President pass yet another tax bill, what happens?

Tax simplification? Or more tax complexity? 

Here’s the link to the Time magazine article mentioned above. I found it fascinating.

http://www.fareedzakaria.com/home/Articles/Entries/2011/10/20_Complexity_Equals_Corruption.html

Check it out and let me know what you think.

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Self-Employed Tax Questions: What Federal Taxes Do I Have To Pay?

Posted on October 27, 2011 by Wayne Davies

If you are running your small business or self-employment activity as a sole proprietorship, are you wondering what federal taxes you are required to pay? Read on to find out.

Here’s an overview of the three most common types of federal taxes for which the typical self-employed person can be liable:

1. Federal income tax. Your self-employment profit is subject to federal income tax. By “profit” I mean the extent to which your income exceeds your expenses, as shown on Schedule C, which is the form you use to report your income and expenses. The “bottom line” from Schedule C is transferred to page 1 of Form 1040 and is therefore added to all your other sources of income for the year.

How much income tax will you pay on your self-employment (SE) income? The answer to that question depends on a number of related factors – your total income from all sources (including the SE income as well as income from your spouse, if you are married and filing jointly), your deductions and exemption amounts, and the amount of taxable income as reported on your personal income tax return, Form 1040.

2. Self-Employment (SE) tax. If you have Schedule C profit of $400 or more, you will also be liable for self-employment tax. SE tax is the Social Security and Medicare taxes that all sole proprietors must pay on their self-employment income. Normally it is 15.3% of your Schedule C profit.

You also get a deduction for 50% of your SE tax on page 1 of Form 1040, so the actual amount of SE tax ends up being somewhat less than 15.3%. Also, in 2011, the law temporarily reduced the SE tax to 13.3% — but as of this writing, the rate is scheduled to revert back to 15.3% in 2012.

The SE tax is calculated and reported on Schedule SE, and the total SE tax is then transferred from Schedule SE to page 2 of Form 1040 and is added to your income tax liability to determine your total federal tax liability for the year.

3. Employment taxes. If you have no employees, then you have no employment taxes. But if you do hire any employees, you will be responsible to pay the following employment taxes: federal income tax withholdings; Social Security and Medicare taxes (both the employee’s share and the employer’s share); and federal unemployment taxes. The frequency and amount of these employment tax payments can vary greatly. IRS Publication 15 is a good resource to learn more about your responsibilities as an employer.

Keep in mind that being a sole proprietor does complicate your personal income tax return, and that many of the tax forms required are not for the numerically faint of heart. It is usually best to hire a competent tax professional well versed in the world of self-employed tax issues.

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Self-Employed Tax Questions: What Tax Forms Are Needed For the Self-Employed?

Posted on October 27, 2011 by Wayne Davies

Are you a newly self-employed and need to know what tax forms you must file on your income tax return? Read on to find out.

By “self-employed”, I am referring to a person who is compensated for selling goods and/or services as an independent contractor or freelancer. I am not referring to an employee who receives a Form W-2 at the end of the year from his/her employer.

Another common term used for the self-employed person is “sole proprietor”. And since you are a sole proprietor, there are specific tax forms that you must include as part of your personal income tax return. Here they are:

Schedule C. Profit or Loss From Business (Sole Proprietorship). This is where you begin. This form is used to report income received (aka “sales” or “revenue”) and expenses incurred (aka “business deductions”) in the course of operating your small business or self-employment activity. There is also a scaled down version of Schedule C for very small businesses – it’s called Schedule C-EZ.

Form Schedule SE. Self-Employment Tax. This is used to calculate the self-employment tax, which is your version of the Social Security and Medicare taxes paid by employees.

Form 4562. Depreciation and Amortization. This is for reporting depreciation expense, the Section 179 deduction, and amortization expense. These expenses are related to the purchase of business assets such as office equipment and furniture, machinery, vehicles, buildings and intangible assets such as goodwill.

Form 8829. Expenses for Business Use of Your Home. This is for calculating the infamous home office deduction. Many self-employed people have been reluctant to take this deduction for fear that it increases the odds of an IRS audit. I say if you can take it, take it!

Form 1040-ES. Estimated Tax for Individuals. This is not actually part of your Form 1040, but you will use this form to make quarterly estimated tax payments during the year (assuming your business is profitable). Since our tax system is based on the concept of “pay as you go”, you should not wait until the end of the year to pay your income tax and/or self-employment tax all at once.

There are other forms that may or may not be required, depending on your particular situation. But this list is enough to get you started, as these are the most commonly used forms for the typical self-employed person. Many dollar amounts are transferred from one form to another, and many of these forms are not for the numerically challenged. So while it is certainly wise to familiarize yourself with these forms, it is probably best to obtain professional help if you’re just starting out and want to make sure that your income tax return is prepared correctly.

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Small Business Tax Questions: How Much Tax Will I Pay On S Corporation Profits?

Posted on October 27, 2011 by Wayne Davies

If you own a profitable S corporation, are you wondering how much income tax you’ll pay on those profits? This article will answer that question.

S corporation profits are reported on Schedule K-1. This K-1 is prepared as part of the corporation’s federal income tax return, which consists of Form 1120S, the K-1, and any other tax forms needed to complete the return.

A Schedule K-1 is prepared for each shareholder of the corporation. If you own 100% of the corporation’s stock, then there will be only one K-1, issued to you, and it will show you as the one responsible for reporting 100% of the corporation’s profit. If you have two shareholders, each owning 50% of the corporation’s stock, then there will be two K-1′s, one for each shareholder, showing that each shareholder is responsible for 50% of the corporation’s profit.

What do I mean by the phrase “responsible for reporting 100% (or 50%) of the corporation’s profit”? Generally speaking, S corporations do not pay federal income tax on the corporation’s profit. Instead, the shareholder(s) are liable for the federal income tax on corporate profits by reporting those profits on their personal income tax return. So if you own stock in an S corporation, you should receive a K-1 every year and you must report the income from that K-1 on your personal income tax return. And it is critical that you do so, because the IRS also receives a copy of that K-1 and will be expecting to see that K-1 profit on your personal tax return.

So, how much federal income tax will you pay on your S corporation profits? The answer to that question is simply this: whatever your marginal federal income tax rate happens to be. If you are in the 15% tax bracket, you’ll pay 15% on the K-1 profits.  If you are in the 25% bracket, you’ll pay 25%. And so on.

Here’s another critical fact of S corporation tax law: you will pay federal income tax on your K-1 profit whether or not you have actually received that profit as a cash distribution. The corporation is not required to distribute the profits to the shareholders. That is really up to the corporation. But the point is, even if the corporation doesn’t pay you the profit, you must still report that profit on your personal income tax return, and you are therefore required to pay the tax on the profit whether or not you have received it. This is one of the most overlooked aspects of S corporation taxation, so please do not ignore this important fact.

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Why Do Some Small Businesses Pay Less Tax?

Posted on October 27, 2011 by Wayne Davies

Can I make a rather bold statement? 

Here it is: Given the same amount of profit, not all businesses pay the same amount of taxes.

Think about that.

It’s probably something that you’ve always wondered about, maybe were even a bit suspicious about. Well, if you always thought that some people pay less tax than you (even though they make the same amount of income), you are correct.

Why is that?

Is it fair? Is it right? Is it legal?

Yes, it is legal for one business owner to pay less tax than another business owner, even though both have the same income.

And why does this happen? I’m going to answer this question by telling you about the easiest (and perhaps the most overlooked) tax-reduction strategy on the books. Many small business owners are paying too much tax, simply because they own the “wrong” type of business.

I’m not talking about “type” in the sense of whether you own a carpet cleaning business vs. a pet store. I don’t mean what kind of industry your business is. I don’t mean whether you are a manufacturer, a wholesaler, a retailer, or a service business. I’m talking about whether your business is a sole proprietorship, a partnership, a C corporation, an S corporation, or a limited liability company (LLC).

There are several “types” of business ownership, from a legal entity standpoint. And you have got to get this right, or you will pay literally thousands of dollars more in taxes than you should. The simple fact is, there are significant differences in the amount of taxes that each of these business “types” usually pay.

Sole proprietors are especially vulnerable to overpaying their taxes simply because they are sole proprietors. So if you are a sole proprietor (you file Schedule C), I must ask you this question: Have you ever done an analysis of the tax consequences of operating your business as a partnership, a corporation, or an LLC? This is known as the Choice of Entity analysis, and this analysis is a great place to start on the journey of small business tax reduction. It could be the best thing you ever do for yourself and your business.

As 2011 comes to a close, this is the ideal time to take a close look at the pros and cons of incorporating your business. And, if you have already incorporated, this is the ideal time to make sure you have the best kind of corporation for your particular situation. You should be asking yourself this question: C Corp, S Corp, or LLC – which one is best for me?

Choice of Entity is so important, it is the first topic we cover in my new Small Business Tax Deduction Coaching Program. If you’d like to get the help you need to sort out this critical issue and make a decision that can save you thousands of dollars in taxes, today is the perfect time to enroll – for details on how to enroll, Click Here.

In case you were wondering, my Tax Deduction Coaching Program is 10 weeks long, so if you enroll today, you’ll be done by the end of the year and you’ll get the help you need to make the right Choice of Entity by January 1, 2012. You’ll also receive in-depth coaching on how slash your taxes with my “Top 10″ Small Business Tax Deductions; and you’ll also get access to my proprietary list of  “434 Legal Tax Deductions for Small Biz Owners & The Self-Employed” — this is the info you need to reduce your taxes in 2011 and beyond!

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Self-Employed Tax Questions: Should I Buy A Company Car?

Posted on October 20, 2011 by Wayne Davies

Here’s an excellent question that I received from a reader recently:

“Thank you for your newsletters. I am about to purchase a car, and I am trying to decide whether to make it a company car. My consulting business is a single-owner pass-through LLC, incorporated 3 years ago. Business mileage would be around 30-40%.”

By default, a single-member LLC is taxed as a sole proprietorship, unless you choose to be taxed as a C Corporation or an S Corporation by filing the appropriate paperwork with the IRS. I thought I should mention that because if you haven’t elected to be treated as a corporation for tax purposes, your LLC will continue to be treated as a sole proprietorship.

So I’m going to answer your question based on the assumption that your business is a LLC that will continue to be taxed as a sole proprietorship.

Having said that, I’m not sure there is any tax benefit to making this vehicle “a company car.” Whether or not you put title to the car in the name of the LLC, you have the same options regarding how to deduct expenses for the vehicle. You can use the Mileage Rate Method or the Actual Expense Method, and either way, your vehicle expenses are deductible to the extent your car is used for business. If you use the Actual Expense Method, you would get a deduction for 30-40% of the actual expenses of operating the vehicle. If you use the Mileage Rate Method, you multiply the number of business miles by the IRS mileage rate (which is 55.5 cents per mile as of July 1, 2011).

As a sole proprietor, you report the vehicle deduction on Schedule C, Line 9.

There really is no additional tax benefit to buying the car in the name of the business. In fact, from a paperwork standpoint, doing so could unnecessarily complicate things. You’ll have to make sure that vehicle ownership and registration paperwork is done in the name of the LLC. And if you finance the purchase, it is unlikely that the lender will put the loan in the name of the business. Most lenders want a small business owner to be personally liable for the debt.

One final comment: you mentioned that business use is 30-40%. If you choose to use the Actual Expense Method and if the business use of the vehicle is 50% or less, you can only depreciate the vehicle using straight-line depreciation. You cannot take the Section 179 deduction or use one of the accelerated depreciation methods. Of course, it’s always wise to do an analysis of the Mileage Method vs. the Actual Expense Method, but when the business use percentage is this low, it may be that the Mileage Method results in a higher deduction.

For more info on how to determine the deductibility of your car expenses, check out this article:
http://selfemployedtaxdeductionstoday.com/small-business-tax-deductions-how-much-car-expense-is-tax-deductible/

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