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Tax Considerations When Hiring Household Help

If you employ someone to work for you around your house, it is important to consider the tax implications of this type of arrangement. While many people disregard the need to pay taxes on household employees, they may do so at the risk of paying stiff tax penalties down the road.

Household Employee Defined

Household employees include housekeepers, maids, babysitters, gardeners, and others who work in or around your private residence as your employee. Repairmen, plumbers, contractors, and other business people who provide their services as independent contractors, are not your employees. Household workers are your employees if you can control not only the work they do but also how they do it.

If a worker is your employee, it does not matter whether the work is full-time or part-time or that you hired the worker through an agency or from a list provided by an agency or association. It also does not matter whether you pay the worker on an hourly, daily or weekly basis or by the job.

If the worker controls how the work is done, the worker is not your employee but is self-employed. A self-employed worker usually provides his or her own tools and offers services to the general public in an independent business.

Also, if an agency provides the worker and controls what work is done and how it is done, the worker is not your employee.

  • You pay Kate an hourly wage to babysit your child and do light housework four days a week in your home. Kate follows your specific instructions about household and childcare duties. You provide the household equipment and supplies that she needs to do her work. Kate is your household employee.
  • You pay Nick to care for your lawn. Nick also offers lawn care services to other homeowners in your neighborhood and provides his own tools and supplies, He hires and pays any helpers he needs. Neither Nick nor his helpers are your household employees.

USCIS Form I-9: Employment Eligibility Verification

When you hire a household employee to work for you on a regular basis, they must complete USCIS Form I-9, Employment Eligibility Verification. It is your responsibility to verify that the employee is either a U.S. citizen or an alien who can legally work. Once this is determined, you then complete the employer part of the form.

It is unlawful for you to knowingly hire or continue to employ a person who cannot legally work in the United States. Keep the completed form for your records. Do not return the form to the U.S. Citizenship and Immigration Services (USCIS).

Employment Taxes

If you have a household employee, you may need to withhold and pay Social Security and Medicare taxes, or you may need to pay federal unemployment tax or both. If you pay cash wages of $2,200 or more in 2020 to any one household employee, then you will need to withhold and pay Social Security and Medicare taxes. Also, if you pay total cash wages of $1,000 or more in any calendar quarter of 2019 or 2020 to household employees, you are also required to pay federal unemployment tax.

If neither of these two contingencies applies, you do not need to pay any federal unemployment taxes; however, you may still need to pay state unemployment taxes. Please contact the office if you’re not sure whether you need to pay state unemployment tax for your household employee. A tax professional will help you figure out whether you need to pay or collect other state employment taxes or carry workers’ compensation insurance.

Social Security and Medicare Taxes

Social Security taxes pays for old-age, survivor, and disability benefits for workers and their families. The Medicare tax pays for hospital insurance. Both you and your household employee may owe Social Security and Medicare taxes. Your share is 7.65 percent (6.2 percent for Social Security tax and 1.45 percent for Medicare tax) of the employee’s Social Security and Medicare wages. Your employee’s share is 6.2 percent for Social Security tax and 1.45 percent for Medicare tax.

You are responsible for payment of your employee’s share of the taxes as well as your own. You can either withhold your employee’s share from the employee’s wages or pay it from your own funds.

Do not count wages you pay to any of the following individuals as Social Security and Medicare wages:

  1. Your spouse.
  2. Your child who is under age 21.
  3. Your parent. (Exception. You should count wages to your parent if they are caring for your child and your child lives with you and is either under age 18 or has a physical or mental condition that requires the personal care of an adult and you are divorced and have not remarried, or you are a widow or widower, or you are married to and living with a person whose physical or mental condition prevents him or her from caring for your child.)
  4. An employee who is under age 18 at any time during the year.

However, you should count these wages to an employee under 18 if providing household services is the employee’s principal occupation. If the employee is a student, providing household services is not considered to be his or her principal occupation.

Maximum Taxable Earnings

If your employee’s Social Security and Medicare wages reach $137,700 in 2020, then do not count any wages you pay that employee during the rest of the year as Social Security wages to figure Social Security tax. You should, however, continue to count the employee’s cash wages as Medicare wages to figure Medicare tax. Meals provided at your home for your convenience and lodging provided at your home for your convenience and as a condition of employment are not counted as wages.

Help is Just a Phone Call Away

As you can see, tax rules for hiring household employees are complex; therefore, professional tax guidance is highly recommended. This is an area where it’s better to be safe than sorry so if you have any questions at all, please contact the office to set up a consultation

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What Is Form 1099-NEC?

Starting in tax year 2020, payers must complete Form 1099-NEC, Nonemployee Compensation to report any payment of $600 or more to a payee. There is a new form that only applies to business taxpayers who pay or receive nonemployee compensation.

Generally, payers must file Form 1099-NEC by January 31. For 2020 tax returns, however, the due date is February 1, 2021. Be advised that there is no automatic 30-day extension to file Form 1099-NEC although an extension to file may be available under certain hardship conditions.

Nonemployee compensation may be subject to backup withholding if a payee has not provided a taxpayer identification number to the payer or the IRS notifies the payer that the taxpayer identification number provided was incorrect.

Backup withholding refers to situations when the person or business paying the taxpayer doesn’t generally withhold taxes from certain payments. It applies to most kinds of payments reported on Forms 1099 and W-2G. There are, however, situations when the payer is required to withhold a certain percentage of tax to make sure the IRS receives the tax due on this income. This is known as backup withholding.

A taxpayer identification number (TIN) can be one of the following numbers:

  • Social Security
  • Employer identification
  • Individual taxpayer identification
  • Adoption taxpayer identification

If you have questions on nonemployee compensation, contact our office for more information.

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Exiting a Business: Which Option Is Right for You?

Selecting your business successor is a fundamental objective when planning your exit strategy and requires a careful assessment of what you want from the sale of your business and who can best give it to you.

There are only four ways to leave your business and the more you understand about each one, the better the chance is that you will leave your business on your terms and under the conditions you want. With that in mind, here’s what you need to know about each option:

1. Liquidate It

In a liquidation the owners sell off their assets, collect outstanding accounts receivable, pay off their bills, and keep what’s left, if anything, for themselves. The primary reason liquidation is considered as an exit plan is that a business lacks sufficient income-producing capacity apart from the owner’s direct efforts and apart from the value of the assets themselves. For example, if the business can produce only $75,000 per year and the assets themselves are worth $1 million, no one would pay more for the business than the value of the assets.

Service businesses in particular are thought to have little value when the owner leaves the business. Since most service businesses have little “hard value” other than accounts receivable, liquidation produces the smallest return for the owner’s lifelong commitment to the business. Smart owners guard against this. They plan ahead to ensure that they do not have to rely on this last-ditch method to fund their retirement.

2. Sell It to A Third Party

While a sale to a third party too often becomes a bargain sale – and sometimes the only alternative to liquidation – this option just might be your best way to cash out if the business is well prepared for sale. In fact, you may find that this so-called “last resort” strategy just happens to land you at the resort of your choice.

Although many owners don’t realize it, most or all of your money should come from the business at closing. Therefore, the fundamental advantage of a third-party sale is immediate cash or at least a substantial up-front portion of the selling price. This ensures that you obtain your fundamental objectives of financial security and, perhaps, avoid risk as well.

A second unanticipated advantage in selling to a third party is the ability to frequently receive substantially more cash than your CPA or other business appraiser anticipated because the market place is “hot.” Finally, this may be the best option for a business that is too valuable to be purchased by anyone other than someone who has access to a considerable source of money.

If you do not receive the bulk of the purchase price in cash, at closing, however, your risk will suddenly become immense. You will place a substantial amount of the money you counted on receiving in the unpredictable hands of fate. The best way to avoid this risk is to get all of the money you are going to need at closing. This way any outstanding balance payable to you is “icing on the cake.”

3. Transfer of Ownership to Your Children

While most business owners want to transfer their business to their children, few end up doing so for various reasons. There are however, advantages that are worth considering. For example, transferring your business to your children can provide financial well-being for younger family members unable to earn comparable income from outside employment, as well as allow you to stay actively involved in the business with your children until you choose your departure date. It also affords you the luxury of selling the business for whatever amount of money you need to live on, even if the value of the business does not justify that sum of money.

On the other hand, this option also holds the potential to increase family friction, discord, and feelings of unequal treatment among siblings. Parents often feel the need to treat all of their children equally. In reality, this is difficult to achieve. In most cases, one child will probably run or own the business at the perceived expense of the others.

At the same time, financial security also may be diminished, rather than enhanced, and the very existence of the business is at risk if it’s transferred to a family member who can’t or won’t run it properly. In addition, family dynamics in general, may also significantly diminish your control over the business and its operations.

4. Employee Stock Option Plans (ESOP)

If your children have no interest or are unable to take over your business, there’s another option to ensure the continued success of your business: The Employee Stock Ownership Plan (ESOP).

ESOPs are qualified retirement plans subject to the regulatory requirements of the Employee Retirement Income Security Act of 1974 (ERISA). There’s one important difference however; the majority (more than half) of their investment must be derived from their own company stock.

Whether it’s due to lack of interest on your children’s part, an economic downturn or a high asking price that no one is willing to pay, what an ESOP does is create a third-party buyer (your employees) where none previously existed. After all, who more than your employees have a vested interest in your company?

ESOPs are set up as a trust (complete with trustees) into which either cash to buy company stock or newly issued stock is placed. Contributions the company makes to the trust are generally tax deductible, subject to certain limitations and because transactions are considered stock sales, the owner who is selling (you) can avoid paying capital gains. Shares are then distributed to employees (typically based on compensation levels) and grow tax free until distribution.

If your company is a stable, well-established one with steady, consistent earnings, then an ESOP might be just the ticket to creating a winning exit plan from your business.

If you need assistance figuring out which exit strategy is best for you and your business, please don’t hesitate to contact the office. The sooner you start planning, the easier it will be.

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Taking Early Withdrawals From Retirement Accounts

While taking money out of a retirement fund before age 59 1/2 is usually not recommended, in certain cases, it may be unavoidable, especially during times of economic crisis. If you need cash and have a retirement fund you can tap, here’s what you need to know.

Background

When retirement plans such as the 401(k) were introduced, company pensions were still the norm. Today, however, very few companies offer pensions anymore and most people rely entirely on social security and whatever savings they’ve accumulated in their retirement account to get them through their golden years.

For many people, retirement accounts are their most significant source of cash, but because they were created to help you save money for your retirement years, withdrawals before retirement age (59 1/2) are discouraged. In fact, early withdrawals from traditional and Roth IRAs are subject to an additional 10 percent tax, unless an exception applies. Exceptions to the additional 10 percent tax apply for early distributions include the following:

  • Beneficiary or estate on account of the IRA owner’s death
  • Totally and permanently disabled
  • Distributions made as part of a series of substantially equal periodic payments for your life (or life expectancy) or the joint lives (or joint life expectancies) of you and your designated beneficiary
  • Qualified first-time homebuyer
  • Qualified expenses for higher education
  • Medical insurance premiums paid while unemployed
  • Unreimbursed medical expenses that are not more than a certain percentage of your adjusted gross income
  • Distributions due to an IRS levy of the IRA under section 6331 of the Code
  • A qualified reservist distribution, or
  • A qualified disaster distribution (certain rules apply)

Relief Under the CARES Act of 2020

Due to the coronavirus pandemic, there is additional relief for taxpayers experiencing economic hardships. The Coronavirus Aid, Relief, and Economic Security (CARES) Act helps eligible taxpayers in need by providing favorable tax treatment for withdrawals from retirement plans and IRAs and allowing certain retirement plans to offer expanded loan options.

Coronavirus-related withdrawals or loans can only be made to an individual (or the individual’s spouse) if they are diagnosed with the virus SARS-CoV-2 or with COVID-19 by a test approved by the Centers for Disease Control and Prevention or a test authorized under the Federal Food, Drug, and Cosmetics Act.

The individual must also experience adverse financial consequences as a result of the following conditions:

  • Quarantine. The individual, individual’s spouse or a member of the individual’s household (someone who shares the principal residence) is quarantined, furloughed, laid off, has work hours reduced, is unable to work due to lack of childcare, has a reduction in pay (or self-employment income), or has a job offer rescinded or start date for a job delayed, due to COVID-19.
  • Business closures or reduced hours. Closing or reducing hours of a business owned or operated by the individual, the individual’s spouse, or a member of the individual’s household, due to COVID-19.

Coronavirus-related Withdrawals from Retirement Accounts

Under the CARES Act, individuals eligible for coronavirus-related relief may be able to withdraw up to $100,000 from IRAs or workplace retirement plans before Dec. 31, 2020, if their plans allow. In addition to IRAs, this relief applies to 401(k) plans, 403(b) plans, profit-sharing plans, and others.

Coronavirus-related Loans from Retirement Accounts

Loans are not available from an IRA. Individuals who were eligible to take coronavirus-related withdrawals until September 22, 2020, were able to borrow as much as $100,000 (up from $50,000) from a workplace retirement plan if their plan allows.

For eligible individuals, plan administrators can suspend, for up to one year, plan loan repayments due on or after March 27, 2020, and before January 1, 2021. A suspended loan is subject to interest during the suspension period, and the term of the loan may be extended to account for the suspension period. Taxpayers should check with their plan administrator to see if their plan offers these expanded loan options and for more details about these options.

Tax Treatment of Coronavirus-related Withdrawals

The distributions generally are included in income ratably over a three-year period, starting with the year in which you receive your distribution. For example, if you receive a $12,000 coronavirus-related distribution in 2020, you would report $4,000 in income on your federal income tax return for each of 2020, 2021, and 2022. However, you have the option of including the entire distribution in your income for the year of the distribution.

In summary, coronavirus-related distributions:

  • May be included in taxable income either over a three-year period (one-third each year) or in the year taken, at the individual’s option.
  • Are not subject to the 10 percent additional tax on early distributions that would otherwise apply to most withdrawals before age 59 1/2,
  • Are not subject to mandatory tax withholding, and
  • May be repaid to an IRA or workplace retirement plan within three years.

Questions?

Before withdrawing funds from a retirement account please call the office and speak to a tax professional. While you may be able to minimize or avoid the 10 percent penalty tax using one of the exceptions listed above including those under the Cares Act, remember that you are still liable for any regular income tax that’s owed on the funds that you’ve withdrawn and you may be liable for more tax than you anticipated when filing future tax returns.

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Charitable Business Deductions

You’re already giving, now make it tax deductible:

Tax breaks for charitable giving aren’t limited to individuals, your small business can benefit as well. If you own a small to medium-size business and are committed to giving back to the community through charitable giving, here’s what you should know.

1. Verify that the Organization is a Qualified Charity

Once you’ve identified a charity, you’ll need to make sure it is a qualified charitable organization under the IRS. Qualified organizations must meet specific requirements as well as IRS criteria and are often referred to as 501(c)(3) organizations. Note that not all tax-exempt organizations are 501(c)(3) status, however.

There are two ways to verify whether a charity is qualified:

  • Use the IRS online search tool; or
  • Ask the charity to send you a copy of their IRS determination letter confirming their exempt status.

2. Make Sure the Deduction is Eligible

Not all deductions are created equal. In order to take the deduction on a tax return, you need to make sure it qualifies. Charitable giving includes the following: cash donations, sponsorship of local charity events, in-kind contributions such as property such as inventory or equipment.

Lobbying. A 501(c)(3) organization may engage in some lobbying, but too much lobbying activity risks the loss of its tax-exempt status. As such, you cannot claim a charitable deduction (or business expense) for amounts paid to an organization if both of the following apply:

  • The organization conducts lobbying activities on matters of direct financial interest to your business.
  • A principal purpose of your contribution is to avoid the rules discussed earlier that prohibit a business deduction for lobbying expenses.

Further, if a tax-exempt organization, other than a section 501(c)(3) organization, provides you with a notice on the part of dues that is allocable to nondeductible lobbying and political expenses, you cannot deduct that part of the dues.

3. Understand the Limitations

Sole proprietors, partners in a partnership, or shareholders in an S-corporation may be able to deduct charitable contributions made by their business on Schedule A (Form 1040). Corporations (other than S-corporations) can deduct charitable contributions on their income tax returns, subject to limitations.

Cash payments to an organization, charitable or otherwise, may be deductible as business expenses if the payments are not charitable contributions or gifts and are directly related to your business. Likewise, if the payments are charitable contributions or gifts, you cannot deduct them as business expenses.

Sole Proprietorships. As a sole proprietor (or single-member LLC), you file your business taxes using Schedule C of individual tax form 1040. Your business does not make charitable contributions separately. Charitable contributions are deducted using Schedule A, and you must itemize in order to take the deductions.

Partnerships. Partnerships do not pay income taxes. Rather, the income and expenses (including deductions for charitable contributions) are passed on to the partners on each partner’s individual Schedule K-1. If the partnership makes a charitable contribution, then each partner takes a percentage share of the deduction on his or her personal tax return. For example, if the partnership has four equal partners and donates a total of $2,000 to a qualified charitable organization in 2019, each partner can claim a $500 charitable deduction on his or her 2019 tax return.

A donation of cash or property reduces the value of the partnership. For example, if a partnership donates office equipment to a qualified charity, the office equipment is no longer owned by the partnership, and the total value of the partnership is reduced. Therefore, each partner’s share of the total value of the partnership is reduced accordingly.

S-Corporations. S-Corporations are similar to Partnerships, with each shareholder receiving a Schedule K-1 showing the amount of charitable contribution.

C-Corporations. Unlike sole proprietors, partnerships, and S-corporations, C-Corporations are separate entities from their owners. As such, a corporation can make charitable contributions and take deductions for those contributions.

4. Categorize Donations

Each category of donation has its own criteria with regard to whether it’s deductible and to what extent. For example, mileage and travel expenses related to services performed for the charitable organization are deductible but the time spent on volunteering your services is not.

Here’s another example: As a board member, your duties may include hosting fundraising events. While the time you spend as a board member is not deductible, expenses related to hosting the fundraiser such as stationery for invitations and telephone costs related to the event are deductible.

Generally, you can deduct up to 50 percent of adjusted gross income. Non-cash donations of more than $500 require completion of Form 8283, which is attached to your tax return. In addition, contributions are only deductible in the tax year in which they’re made.

5. Keep Good Records

The types of records you must keep vary according to the type of donation (cash, non-cash, out of pocket expenses when donating your services) and the importance of keeping good records cannot be overstated.

Ask for – and make sure you receive – a letter from any organizations stating that said organization received a contribution from your business. You should also keep canceled checks, bank and credit card statements, and payroll deduction records as proof or your donation. Furthermore, the IRS requires proof of payment and an acknowledgment letter for donations of $250 or more.

Questions about charitable donations? Help is just a phone call away.

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