Month: July 2022

If you own an unincorporated business, you likely pay at least three different federal taxes. In addition to federal income taxes, you must pay Social Security and Medicare taxes, also called the self-employment tax.

Self-employment taxes are not insubstantial. Indeed, many business owners pay more in self-employment taxes than in income tax. The self-employment tax consists of

• a 12.4 percent Social Security tax up to an annual income ceiling ($147,000 for 2022) and
• a 2.9 percent Medicare tax on all self-employment income.

These amount to a 15.3 percent tax, up to the $147,000 Social Security tax ceiling. If your self-employment income is more than $200,000 if you’re single or $250,000 if you’re married filing jointly, you must pay a 0.9 percent additional Medicare tax on self-employment income over the applicable threshold for a total 3.8 percent Medicare tax.

You pay the self-employment tax if you earn income from a business you own as a sole proprietor or single-member LLC, or co-own as a general partner in a partnership, an LLC member, or a partner in any other business entity taxed as a partnership. (There is an exemption for limited partners.)

You don’t pay self-employment tax on personal investment income or hobby income. For example, you don’t pay self-employment tax on profits you earn from selling stock, your home, or an occasional item on eBay.

The tax code bases your self-employment tax on 92.35 percent of your net business income. 
That means your business deductions are doubly valuable since they reduce both income and self-employment taxes. In contrast, personal itemized deductions and “above-the-line” adjustments to income don’t decrease your self-employment tax.

Some types of income are not subject to self-employment tax at all, including

• most rental income,
• most dividend and interest income,
• gain or loss from sales and dispositions of business property, and
• S corporation distributions to shareholders.

You calculate your self-employment taxes on IRS Form SE and pay them with your income taxes, including your quarterly estimated taxes.

If you have questions about the self-employment tax, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• July 12, 2022

You have read horror stories about how the IRS audits business owners and deems their 1099 independent contractors W-2 employees—and then assesses tens (or hundreds) of thousands of dollars in back payroll taxes, interest, and penalties.

Are you one of those horror stories?

Okay, let’s say you are one of them. You know that you are an IRS target because you have workers who really should be employees, but you treat them as independent contractors. And you are afraid that if you change now, the IRS will see that change, audit your prior years, and charge big bucks for your mistake.

What should you do? Keep the workers as independent contractors and hope the IRS doesn’t catch on? Or amend your past returns to show the misclassified workers as employees?

Depending on how many workers you have misclassified, and the number of years involved, that amendment process could be cost prohibitive.

The Pennies-on-the-Dollar Come-Clean Program

The come-clean program, which should have you paying just pennies on the dollar, is the IRS Voluntary Classification Settlement Program (VCSP) for business owners who want to change their worker classification on a going-forward basis.

Not everybody qualifies for the VCSP. To be eligible to participate in the VCSP, you must meet the following requirements:

1. Reporting consistency. You must have timely filed the previous three years’ federal tax returns for your workers (that is, 1099s) consistent with your treatment of the workers as independent contractors.
2. Not currently under audit. You cannot currently be under employment tax audit by the IRS, or under worker classification audit by the Department of Labor or by any state government agency.

Benefits of the VCSP Settlement Agreement

If you decide to participate in the VCSP, you must agree to treat the class or classes of workers covered by the agreement as employees for future tax periods. In exchange, you will receive the following most-favorable benefits:

• Reduced employment tax liability. You pay only 10 percent of the employment tax liability that would have been due on compensation paid to the workers for the most recent tax year. (Pennies on the dollar for one year—about 3.3 percent of what that likely would have been for the past three years.)
• No interest or penalties. You will not be liable for any interest and penalties. (Okay, knock that 3.3 percent down to something like 0.93 percent.)
• Audit protection for misclassifications in prior years. You will not be subject to an employment tax audit for prior years with respect to the workers covered by the VCSP. (Priceless.)

If you have misclassified workers, there is very little downside to participating in the VCSP—except, of course, that you will have to treat the workers covered by the VCSP agreement as employees on a going-forward basis.

If you would like to discuss your 1099 workers, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• July 8, 2022

Making gifts to promote your business is complicated by time, inflation, and poor tax legislation.

For example, a client recently brought this up: “To stay in touch and promote my business, I buy dozens and dozens of Starbucks $5 gift cards and send them monthly to my prospects and referral sources. Can I write off the $5 cards?”

You’ve probably heard the expression “between a rock and a hard place.” That’s where this client’s Starbucks gift cards fall. The law is going to treat her $5 Starbucks cards as business gifts.

Thus, if she gives a card to a referral source every month, her cost is $60 for the year ($5 x 12), but she may not deduct more than $25 for business gifts made to the same person. Ouch!

There’s a ridiculous $4 exception to the gift rules. The law exempts from the business gift rules and calls it advertising when you give to a customer or a prospect an item

• that costs you $4 or less,
• on which you have your name clearly and permanently imprinted, and
• that is one of a number of identical items distributed generally by you.

Here’s why this is ridiculous: The $4 rule was enacted in 1962, many years before Starbucks came into being. Further, if you applied the consumer price index calculator to that $4 amount, it would inflate to $39 today. The $25 total gift amount inflates to $241.

If you have questions about the gift rule, please don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• July 6, 2022