Taxing Matters

Everything you wanted to know about payroll taxes, and then some.
Magazine Contributor
14 min read

This story appears in the October 1996 issue of . Subscribe »

If you are the sole owner of a corporation and pay yourself a salary, you are in the unique position of being your own boss--and your own employee.

As an employee of your corporation, you must have payroll taxes withheld from your earnings: federal and state income taxes, as well as FICA (Federal Insurance Contributions Act, to be explained in detail below). As the employer of your corporation, you must pay a matching amount of FICA tax and remit this tax, along with the federal income tax withheld, to the IRS. Any state and local income taxes withheld must be paid to the state department of revenue. Employers must also pay federal and state unemployment taxes on behalf of their employees.

If you are a self-employed entrepreneur who files a Schedule C (Profit or Loss from Business) with your federal Form 1040, you'll avoid the hassles of payroll taxes, as long as you hire no employees. Unlike your corporate counterparts, you calculate payroll taxes once a year, on April 15th. You use Schedule C to figure your income taxes, and Schedule SE to determine the self-employed's version of FICA.

But your payroll responsibilities begin the day you hire your first employee. While you continue to file Schedules C and SE, your new employee must have payroll taxes withheld like any corporate employee.

While it could take years--if ever--for the IRS to audit your corporate income tax return or individual return with Schedules C and SE, if you miss even one payroll tax deposit, you could hear from the IRS in a matter of months. The IRS makes no allowances for start-up businesses; a deposit or return late by one day could generate a penalty.

"New businesses get in trouble with payroll taxes faster than with income taxes," says Marion Penrod, owner of Penrod Tax Service in South Bend, Indiana. "If they're smart, they'll get help."

Whether you get help or go it alone, you need to understand the basics of payroll taxes. Here is a checklist of payroll tax requirements for start-up businesses:

1. Federal identification number. Any business with an employee must file Form SS-4 with the IRS to receive an Employer Identification Number (EIN). This number is used to track your business income tax returns and your payroll tax returns. Corporations and partnerships must have an EIN regardless of whether they have employees or not. Sole proprietors only need an EIN if they have a Keogh retirement plan or hire an employee.

2. Federal income tax withholding. To determine how much federal income tax to withhold from an employee's earnings, you must have the employee fill out a Form W-4 (Employee's Withholding Allowance Certificate). Once you know the employee's salary, marital status and number of exemptions being claimed on their Form W-4, you can determine the federal taxes that must be withheld from each paycheck from the IRS Publication 15, Employer's Tax Guide. Also known as Circular E, this publication contains tables that show how to calculate the withholding and when deposits must be made with the IRS. To order a free copy, call (800) TAX-FORM.

3. FICA withholding. When you worked for someone else, you could just complain about FICA. As an employer, you now have to calculate it.

FICA is actually two separate taxes: Social Security and Medicare. The Medicare tax of 1.45 percent must be withheld on an employee's entire salary. Social Security tax of 6.2 percent is withheld on only the first $62,700 of salary (the limit in 1996). Even if you are a long way from meeting the $62,700 limit, the quarterly Form 941 Payroll Tax Return will require you to account for the Social Security and Medicare taxes separately. In addition to withholding these FICA taxes from your employee, employers are required to pay to the IRS a matching amount.

4. FICA and federal deposits. If your combined employer and employee FICA and federal taxes for all employees total less than $500 in a quarter, you can pay the entire amount when you file your quarterly Form 941. If, however, you owe more than $500 in FICA and federal payroll taxes, you qualify as a monthly depositor and must deposit the payroll taxes by the 15th day of the following month.

Monthly deposits must be made with Form 8109, and the taxes must be deposited with a Federal Reserve or authorized commercial bank. Beginning January 1, 1997, the IRS is phasing in mandatory electronic filing of federal payroll taxes. For calendar year 1997, only businesses that deposited more than $50,000 in annual federal payroll taxes in 1995 are required to file electronically. The IRS will notify you when you hit the threshold for mandatory electronic filing, which can be done via your personal computer, over the telephone, or through your bank. In the meantime, for more information on how and when to make payroll tax deposits, ask for IRS Publication 937, Employment Taxes and Information Returns.

5. Federal unemployment tax. You must pay FUTA (Federal Unemployment Tax Act) tax on behalf of your employees if you meet one of two criteria: You paid total wages for one or more employees of $1,500 or more in any quarter of the year, or you had at least one employee who worked at least one day during each of 20 different weeks of the year.

The FUTA rate is 6.2 percent, which is applied to the first $7,000 of wages of all employees. Up to 5.4 percent of any state unemployment tax you pay is subtracted from your federal rate. If you qualify for the full 5.4 percent credit, your FUTA rate could be reduced to 0.8 percent. While you only file one annual FUTA return (Form 940) at the end of the year, you must make FUTA deposits quarterly if your FUTA tax liability is $100 or more. The rules for federal unemployment tax are also explained in Circular E. Contact your state Department of Revenue to find out the requirements for state unemployment tax.

Sales & Marketing

Mail Bonding

As a writer who specializes in marketing topics and a devoted small-business advocate, I sometimes have the urge to stand on a rooftop and yell: "Hey, small-business owners: Learn how to use direct mail! It will change your life!"

The reason for my excitement is that I know from experience that most business owners don't know how to put direct mail to work for their business. Why is direct mail such a great marketing tool? For two simple but extremely powerful reasons: It allows you to target your audience and receive a measurable response. With direct mail, you estimate the cost, response and profit--before you mail. Here's how it works:

1. Find the mailing list of prospective clients for your product or service. Who you mail to is the most important element of direct mail. If you have an established list of customers, mail to them, because they are the best audience for your offer. If you don't, you can locate new business prospects from a mailing-list broker. List brokers can be found in the Yellow Pages; if you hire one, be sure to get a name (not just "Occupant") and a phone number (for follow-up calls) for every entry on the list. Also, be sure to ask when the list was last updated.

2. Formulate a strong offer. Examples of offers you can use are: free information, a free sample, a free gift, a pricing discount, sweepstakes or contests, or a free trial offer.

3. Create a sales letter. Sales letters are the most effective form of direct mail you can use. They are also inexpensive to produce. There are many books available that show how to write sales letters; a good one to look for is The Copywriter's Handbook, by Bob Bly (Henry Holt, $13.95, 800-288-2131).

4. Estimate your profit. Add up all of your costs, including postage, printing, labor and materials. If you've done your research correctly, you can expect approximately a one percent response rate. You could receive more than this--possibly much more--but this estimate will help ensure that you don't lose money. Also, don't forget to factor in the lifelong potential value of a new customer. If you're mailing to your list of current customers, you can expect a much higher return.

Following these tips will help make your mailing a success:

Make your offer very clear and evaluate it from your prospect's point of view. If you were your prospect, would you be interested?

Use simple, sincere language. Concentrate on believability. Explain honestly how your product or service will solve a problem or fulfill a need.

Use these tried and true "power words": you, now, new, free, save and discover.

Include a "hard offer" and a "soft offer." Examples of hard offers are: "Call today for an appointment" or "Bring the enclosed coupon to our store for a special offer." An example of a soft offer is: "Call for more information." Give your prospects more than one way to take advantage of your offer and you'll get more responses.

Use your prospect's name on the outside of the mailing piece, and, if possible, in the salutation. If you can't, identify him or her by profession or interest: "Dear Valued Client," "Dear Pool Owner," or "Dear Patient," etc.

Create a sense of urgency by putting a time limit or expiration date on the offer. This will help encourage the indecisive to take action. What good is an offer that's never-ending?

Use an eye-catching headline. Center your offer across the top of your letter, postcard or flier.

Include a response mechanism, such as a response card, a postage-paid envelope, or a toll-free number.

Tell your prospect exactly how to take advantage of the offer. If you want them to fill out a reply card and mail it back, or call you for an appointment, say so.

Offer a guarantee. People like guarantees because they remove risk. And research has proven that guarantees not only increase sales, but that the benefits of offering a guarantee almost always outweigh the costs of providing them.--Julie Clairmont

Legal Ease

Hire Education

As an employer or prospective employer, you need to stay on top of federal and state employment laws. Penalties for non-compliance can be stiff, with fines of up to $10,000 for federal wage and labor violations. Here are seven basic things you should know before hiring your first employee:

1. Minimum wage and overtime: On July 9, 1996, the Senate approved a 90 cent increase in the Federal minimum wage, from $4.25 an hour to $4.75, and eventually to $5.15, starting July 1, 1997. This will be the first increase in the minimum wage since April 1991. In November, California residents will vote to decide whether to raise their state's minimum wage to $5.75.

You must also pay employees time-and-a-half for every hour over forty hours worked in a week. The only exceptions are employees who fit Department of Labor classifications for managerial or administrative positions.

2. Underage workers: Workers under age 18 are restricted to "non-hazardous" jobs. Employees under age 16 are limited in the number of hours and times of day they can work. Children who work for their parents in sole proprietorships are exempt from some of these rules.

3. Occupational Safety and Health Administration (OSHA): OSHA requirements for providing a safe work environment apply to even small-business owners. For information on how to meet OSHA standards, call their information office at (202) 219-8151.

4. Anti-discrimination laws: It's illegal to discriminate against a potential employee because of race, sex, age, national origin or religious belief. If you have more than 15 employees, you must accommodate disabled workers under the Americans with Disabilities Act. To avoid problems, familiarize yourself with anti-discrimination law requirements before you start interviewing.

5. Immigration documentation: You must ask all employees, even those who are U.S. citizens, to prove their authority to work in the United States. Keep a completed I-9 form on file for all of your employees for a minimum of three years after they're hired, or until one year after employment is terminated. You can request I-9 forms by calling the INS Forms Request line at (800) 870-3676.

6. State laws: Each state has its own employment laws, many of which are more restrictive than federal regulations. Your state Department of Labor can provide details of current regulations. Check your phone book for a list of state government offices.

7. Federal laws: A good source of information on federal labor laws is the Department of Labor's World Wide Web site at The Department of Labor will also answer federal wage and labor questions at (202) 219-4907. --Carolyn Z. Lawrence

Just For You

Ancient Ambience

Success in any business demands that you go beyond fashion, fads and facades to create surroundings that attract people and maximize your personal efficiency. In search of the elusive competitive edge, some entrepreneurs are exploring the Chinese practice of feng shui (pronounced: "fung schway"), the ancient art of environmental design.

While architects, builders and scientists have found a new appreciation of the impact surroundings have on health and well-being, the Chinese have perfected this knowledge over the last 3,000 years. Blending art, science and shamanism, feng shui masters utilize a variety of scientific and mystical techniques to assure health, happiness and good fortune.

East meets West in Bedford, Texas, a suburb of Dallas, where Pamela Slader operates WordPros, a homebased marketing and employee-communication business. As an entrepreneurial coach, I assisted Slader as her company was in transition from a part-time to a full-time enterprise. The process of reorganizing her home office gave me an opportunity to introduce Slader to feng shui.

It may not be surprising that the first rule of feng shui is to eliminate clutter and fix or remove broken equipment. The old computer and broken printer piled in the corner of the office had to go. Slader was beginning to think that feng shui was mostly just common sense, but there is more to it.

Some feng shui practices have a logical or scientific basis, while others are more mysterious. Removing clutter and including plants and flowers are logical. Indeed, recent studies have shown that placing fresh flowers near an entrance or waiting area in your business increases the percentage of favorable first impressions by 30 percent.

Other feng shui "cures," as they are called, seem less scientific. Using mirrors and wind chimes to deflect and diffuse surrounding energy is a practice some may view with skepticism. However, quantum physicists are validating the feng shui claim that there is an invisible world of electromagnetic energy that flows through everything. Like light and heat energy, which we can see or feel, this invisible energy also impacts our health and well-being.

Slader made a number of simple changes, most of which can be incorporated into any business setting:

All-white color schemes reduce human energy. Slader didn't repaint, but added red chairs and black lacquer furniture to balance the decor. According to feng shui, the color red carries a lot of energy and is used to make "corrections." Black enhances communication--ideal for communication businesses.

Introducing water creates a sense of well-being because it carries and collects chi--life-giving energy. As you enter the WordPros offices, you're now greeted by an octagonal aquarium, which separates the office from the entry area. Fountains are another easy way to bring water into a business space.

Living or working in the shadow of a large or dark building can be physically and psychologically oppressive. With a little coaxing, I got Slader to put a shiny brass door knocker on her front door to reflect the energy coming from a high-rise building across the street.

When asked about the ancient practice, Slader describes herself as "ambivalent, but open-minded." While she is understandably reluctant to attribute the success of WordPros to feng shui, she does give it its due. "If nothing else, it makes you more aware of your environment and how you relate to it," Slader says, "and that helps any business."

If you keep doing what you've always done, you'll just keep getting what you've always gotten. Something has to change--maybe it can be your business's space, for starters. To propel your business into the 21st century, take advantage of 3,000-year-old knowledge. With or without the aid of feng shui, you can find ways to make your customers more comfortable and your employees more efficient. And isn't that good business?--Kim H. Krisco

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