Masonry Magazine October 1985 Page. 11
TAX TRAPS FOR THE SMALL AND MID-SIZED BUSINESS
Most businesses begin small as sole proprietorships or partnerships. Since sole proprietors or partners are not employees, payroll taxes are of little concern. But as the business grows and the need for additional workers heightens, payroll taxes become a major consideration. Here are some tax recordkeeping tips that could help you avoid devastating consequences in your business operation.
By ANATOLE G. RICHMAN and THOMAS R. PORTER
The management of a large corporation has a distinct advantage over its small and mid-sized business counterpart. This advantage is the ability to delegate responsibility to various department heads within the corporation's structure. The large corporation will typically have a tax department responsible for avoiding the tax traps highlighted in this article. Small to mid-sized businesses, however, generally do not have in-house tax departments; hence, the owner/operator of the business is responsible for tax decisions as well as other management duties. This article is specifically addressed to such an owner/operator. Since the small business manager must perform countless duties in the management of the business, the tax pitfalls mentioned in this article are often overlooked sometimes with disastrous consequences.
Hiring-Employees or Independent Contractors (IRC § 3121)
Most businesses begin small, i.e., as a sole proprietorship or partnership. Since sole proprietors or partners are not employees, payroll taxes are of no concern when the only people working in the business are the sole proprietors or partners. As the business grows, however, the need for additional workers heightens. The question that must be asked by the business owner/operator is whether an employee is needed to fill the void or whether an independent contractor will suffice. The distinction between an employee and an independent contractor is critical for payroll tax purposes. Employers are liable to withhold, report and pay payroll taxes on wages paid to employees. However, amounts paid to independent contractors are not subject to payroll taxes.
The key consideration in the determination of the employee/independent contractor issue is that of control (or lack thereof) over the employee/independent contractor. The more control that the business owner/operator has over the way in which the person performs his work, the greater the likelihood that the person is an employee and not an independent contractor. Therefore, most persons that work for small to mid-size businesses are employees and not independent contractors. Given the beneficial payroll tax status of the independent contractor, some business owners/operators are tempted to classify employees as independent contractors. This temptation should always be resisted. The Internal Revenue Service (IRS), upon examination of the payments to the "independent contractor," will usually reclassify these payments as wages paid to employees. The amount of payroll taxes that become due and payable as a result of this reclassification can be devastating not to mention the penalties and interest on the amount due (see below).
Anatole G. Richman is a partner in Laventhal & Horwath and a member of the American Institute of Certified Public Accountants.
Thomas R. Porter is a member of the Virginia and District of Columbia Bars, and has a master of science degree in industrial engineering from Georgia Tech.
Reprinted with permission from the Newsletter of the Forum Committee on the Construction Industry, American Bar Association.
Payroll Taxes (IRC § 6672)
The payroll tax concerns of a business owner/operator do not end with the proper classification of workers as employees. The proper withholding, reporting and payment of payroll taxes is vital to the the continued success of a business. The IRS can impose severe penalties on the employer for failure to properly fulfill its tax obligation. The most significant of these penalties is a 100 percent penalty for willful violation of the payroll tax requirement.
For example, if the amount of payroll taxes not paid is $10,000, the 100 percent penalty of $10,000 can be imposed upon any natural person, as opposed to a corporation required to comply with the payroll tax laws. Therefore, the penalty will be assessed against the corporate officer and not the corporation. The corporate shield, which would normally protect the shareholder/officer from personal liability, will not afford such protection in this case. Willful attempts to evade the payment of employment taxes can also subject the employer to criminal penalties, including imprisonment up to five years.
Other payroll tax penalties, although not as frightening as the 100 percent penalty, are much more common. The most common of these penalties are for failure to file payroll tax returns timely and for failure to make deposits of payroll taxes when due. The penalty for failure to file timely federal payroll tax reports is currently 5 percent of the net tax that should have been reported. The penalty for failure to make timely payroll tax deposits when due is currently 5 percent of the amount that was not deposited when due.