Mom & Pop's

More Dangerous Money

I just talked about payroll "trust fund" taxes and the need to make sure they are paid and reported on time. I forgot, however, to mention that the same applies to sales tax.

Sales tax isn't your money. You collect it from your customers and send it in for them. If you are required to charge sales tax, you need to create procedure to track this money and not spend it. Missing reports are caught quickly (at least in Kansas) and if you don't sent the report as requested the state may "estimate" your sales for you. If you don't make payments on time, you risk an audit of not only your sales tax liabilities but your compensating use tax liabilities. (Comp use is the sales tax on your internet and phone purchases where no sales tax is collected because the company doesn't have a presence in that state. In this case, the seller doesn't collect it from you so you are expected to pay it yourself. There has been a lot of talk, lawsuits, and legislation on this issue but you still pay it.)

So, you need to work out some procedure for saving sales tax you collect back and not spending it. And get the reports and payments in on time.

Dangerous Money

In a previous post, I talked about the reporting forms that are required for business payroll. In this post, I want to focus on the business killer - trust fund mis-management. As you pay employees, you withhold money from their paycheck and then submit it to the IRS and states for them. The deposits should be made electronically and you will need to set up the accounts before you need them. And you have to understand that the deposits may be made on a different schedule than filing the 941 and state payroll reports.

For Example: You agree to pay Sue $500 a week salary. That $500 will be reduced by her Social Security and Medicare contributions of $28.25 (current reduced rate) and her Federal and state withholding. That means you are writing her a check for say $378.97. That $121.03 that you withheld from her check is the most dangerous money, Trust Fund. It's called Trust Fund money since you are only holding it for Sue in trust until you are required to deposit it (based on the schedules the IRS and State gave you.) Of that $121.03, $28.25 is her SS and Medicare and $60.77 for Federal withholding and $32.01 for the state. You will also be expected to match the $38.25 (full rate) for your part of SS and Medicare. And you will be kicking in for Federal and state unemployment; say another $10. So: $378.97 paycheck + $121.03 trust fund money + $38.25 matching SS/Med + $10 for unemployment=$548.25 is what Sue's week really cost you. You write her a check for $378.97 and then what do you do with the remaining $169.28? That is where too many employers get into trouble. That money is allotted to be paid in a few days to months but it's still sitting in the checkbook where it can be spent on other things. Since Sue is your only employee, I would guess you'll be set up for quarterly deposit. At the end of the quarter, you fill out the Federal 941 and your state's forms for withholding and unemployment. Then you discover the IRS wants a check/deposit of say $1527.24 to cover this quarter payroll liabilities. And the state and state unemployment will want their shares too. Which by this time, you don't have.

If you are going to hire employees, you have to find a way to not be in this predicament. Some employers use a separate checking account for payroll and move into it the salary plus employer's obligations before they write the paychecks ($548.25 for this example). Other employers subtract the whole about out of the checkbook at the time. No matter what system you come up with, you have to do it religiously. If you don't, the letters will start.

The IRS catches shorts in payroll deposits and filings a lot quicker than short in income taxes. They have to because these problems can grow huge quickly. Penalties on Trust Fund money (what came out of employee's paychecks) can be up to 100%. Even a few days late will see a penalty. Remember this is the employee's money. You promised Sue $500 a week not $378.97. Withholding, Social Security and Medicare are credited to her accounts whether you pay them or not. The IRS needs to deter/scare employers into keeping payroll obligations current. That is the reason for the high penalties and tough enforcement.

If you find yourself in this situation, don't panic but don't ignore it. Put into place procedures so this won't happen again. File your reports and send in what you can. Call the IRS or your state department of revenue and work with them. Don't make promises you can't keep but get caught up and stay that way.

Payroll Reports

It’s time to take on the employee issue, at least the tax part of having employees. There are a lot of rules and things you should know when you add an employee. Most I’m not qualified to discuss such as labor laws. You’ll have to do your research to make sure that you are following the laws in your state. But I can outline the tax issues. I’m going to keep it simple and focus on payroll withholding and reporting. Issues such as setting up retirement and health insurance plans I leave to the experts.

Back when you applied for your EIN and state business numbers, you were asked to estimate your annual payroll. If you said you were not hiring at that time, you need to get a hold of the IRS and your state (and in a few cases local) tax people to tell them this has changed. They will set you up for a payment (actually a submission) schedule for your deposits and payroll reports. As an employer, you will have payroll reports for the Federal and state, payroll deposits for Federal and state, unemployment reports and payments for your state and an annual unemployment report for the IRS. This is on top of W-2 and W-3s for the year. Now you understand why employers could be tempted to treat employees as contract labor, less paperwork.

Let me skirt around the 800lb gorilla, money, until the next post and concentrate on reporting. Please understand that this is general info, so follow the requirements the IRS and your state has set up for you.

On the Federal level, you will need to file a form 941 on a quarterly basis. This reports (among a few other things) how much you paid in wages for the quarter, how much money should be credited to Social Security, Medicare and for Federal Withholding. It also tracks deposits of that money. You may also have a state report. The actual report and its frequency will depend on the state. In Kansas, there isn’t a report separate from the money until you send them the W-2s at the end of the year. Then once a year, the IRS wants a form 940 which reports and pays the Federal unemployment due. This form also gives you credit for the unemployment you have been paying your state Unemployment organization. Again, each state has their own rules and forms and you will need to do some research. In Kansas, it’s filed and paid on a quarterly basis.

This is where a good payroll bookkeeping system can come in very handy. If you want to run afoul of the IRS and States quickly, don’t follow these schedules. They will let you know within a few months about missing forms. Then the penalties begin. But more about those in the next post.

Business Financial Mistakes

Simple, but very good, article on INC online about the biggest financial mistakes a business can make. I'm very glad to see payroll taxes make the list.

Employee Or Not?

The worse problem with being a tax preparer is that I don’t hear about an issue until the client comes in to get their taxes done. That’s when they tell me about the 401K distribution, starting social security, a new business or hiring an employee. Too often, I’m told that the business paid $XXX in labor costs. No 1099MISC was issued and serious questions if those paid are really employees not contract labor. Then I have to clean up the mess.

A major issue with the IRS is the classification of an employee as an independent contractor. For the business owner, an independent contractor is easier. There is no withholding, only one form to file at the end of the year and the costs are lower. For the employee, being an independent contractor is great on payday but a killer at the end of the year when you have to pay self employment taxes and have no withholding. Big tax bills with no way to pay it off. No wonder the IRS is concerned.

When it comes to the employee vs. independent contractor issue, the IRS looks at the control the employer has over the worker. Someone hires me to do their bookkeeping as an independent contractor. We have an agreement about what work will be done but I do it at my office on my timetable. They have no control over my work procedures as long as I get the work done when they need it. At the other end of the scale, is the receptionist I hire during tax season. She has very little control over the job. I set the times she works and provide her with all the equipment and materials. I specify how I want the work done and supervise her. She is an employee. It can get gray in between the two end points. And let’s not forget the business owner trying to save money and work by treating employees as if they had their own businesses.

Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) can be completed by the worker or business owner to clear up the gray areas. The completed form can be used by the business to document their classification decision. Or it can be submitted to the IRS and based on that information  they will determine if the worker is an independent contractor or employee. The forms covers issues like who decides what work is done, when it’s done and how it’s done. Who provided the tools and materials? How is payment made, expenses reimbursed, what benefits are provided? Who is in control basically? Whoever makes the determination, the proper procedures for that classification (employee or contract labor) will need to be followed.

If the IRS is involved because the SS-8 was submitted to them or they initiated the investigation, there is a possibility that the business will have to go back pay the back taxes for the now employee. That’s why it’s better to get this right from the start.

Keeping Books

Every business needs to set up a bookkeeping system. The actual system is not as important as being contemporary with your records. I use a bunch of programs and systems to track client’s income and expenses. It depends on the client and what shape their records are in when I get them. Some bring me computer files or reports, others use spreadsheets (paper or electronic) and too many bring me a bag of receipts and bank statements for their taxes. I wouldn’t recommend the last options.

To me there are two reasons to keep contemporary records. The first is taxes, of course. This is the info your preparer will need to prepare your business tax return. The best time to make notes and secure receipts is at they time you get the income or spend the money. But more importantly, don’t overlook that you need to know how your business is doing in order to make decisions to stay in business. That’s why you need to keep your financial books up to date. You or I can re-create your books from receipts and bank statements for taxes. But that doesn’t help you in June to know how much income you took in from a special promotion in May. A good set of books should do that.

Besides keeping your financial records up to date, I have a few other suggestions.

• First, it has to be a system that you will do. Bookkeeping doesn’t have to be complex. You don’t need the fanciest, most expensive accounting program on the market. Most small businesses don’t need thousands of report options or any other bells and whistles. But they do need a system they will use.
• Don’t be afraid of breaking down income and expenses into sub-categories. Otherwise, how do you know how much you have spent on radio vs. TV advertising?
• Keep larger purchases separate and well documented. It’s easy to lump a printer or office chair in with the pens and paper under office supplies, but don’t. Create categories for big equipment, small equipment, software, anything else that you expect to last for a while. These need to be depreciated or may qualify for special treatment.
• Keep your receipts even after they are in your system. And don’t rely on credit card statements as a proof of an expense. All you are getting is a vendor or cleaning house. The documentation is the actual receipt.
• This is not a place to skimp on professional help. Even if you are going to keep the books yourself, pay for an hour of a professional’s time. Make sure you understand what you will need to track and how business finance works.
• Keep your personal and business finances separate. I’ve talked about having a separate check book for the business. But what about credit cards and savings accounts. There may be a rare occasion that you have pay for a business expense out of a personal account or personal from a business so learn how to handle them properly.

 A key to keeping your business going is to track its financial health. It actually doesn’t take much time or money if you do it as it happens. And if you get behind, don’t panic; just take the time the catch up.