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Q: I have decided to hire an employee to help me in my growing business. What kind of forms do I need to fill out for his or her taxes and to register him or her as an employee?
A: The IRS says businesses that hire employees must have each employee complete two important forms: Form I-9 and Form W-4. Form I-9 provides the Immigration and Naturalization Service (INS) with verification that each new employee is legally eligible to work in the United States. Both you and your employee must complete the I-9, available by calling the INS at (800) 755-0777. The W-4 form, Employee's Withholding Allowance Certificate, provides the IRS with the filing status and withholding allowances for each employee. Have your employees fill out and sign a W-4 form on their first day of work.
You use an employee's filing status and withholding allowances to determine how much federal income tax to withhold from his or her wages. The IRS will provide you with a tax table to figure out the withholding amounts you must take out for each employee. To get a copy of the table from the IRS, simply request "Circular E" and "Employer's Supplemental Tax Guide," a supplement to Circular E.
You also have another responsibility: You're required to withhold state and local income taxes from your employees' paychecks, assuming your state and locality have them. Keep in mind that tax rules and requirements differ from state to state. To get forms and more information on these taxes, contact your state and local government tax agencies or departments.
As an employer, you must also withhold Social Security and Medicare taxes, known as FICA (Federal Insurance Contributions Act) taxes. You must withhold a portion of these taxes from your employees' wages and pay a matching amount for each employee. The 15.3 percent tax rate is made up of a Social Security tax of 12.4 percent and a 2.9 percent Medicare tax. You'll pay 7.65 percent of the tax (a 6.2 percent Social Security tax and a 1.45 percent Medicare tax) for each employee.
You need to deposit employment taxes with the federal government on a regular basis. This includes income taxes withheld as well as employer and employee Social Security and Medicare taxes. You can mail or deliver them with a completed deposit coupon, Form 8109 (Federal Tax Deposit Coupon), to an authorized financial institution or a Federal Reserve bank for your area, unless you make deposits electronically. (The federal government is attempting to phase in the electronic deposit of payroll taxes over a period of years.) In addition to federal payroll and FICA taxes, you have to pay federal unemployment taxes.
At the end of each tax year, you must furnish copies of Form W-2, Wage and Tax Statement, to every employee who worked for you at any time during that year. The forms, which indicate how much money each of your employees earned and the amount of federal, state and FICA taxes you withheld, must be distributed to your employees by January 31 of the year following the calendar year covered by the form.
For copies of the forms you need as well as a number of free tax publications that explain your responsibilities as an employer, call the IRS at (800) TAX-FORM.
Q: Will I have to pay higher payroll taxes this year because of an increase in the wage base on which Social Security taxes are due?
A: That depends on your income. The Social Security Administration reports that the wage base on which Social Security taxes are due will increase to $68,400 this year, up from $65,400 in 1997. If you earn more than $65,400 this year, you'll pay more in FICA (Federal Insurance Contributions Act) taxes. According to a calculation done by CCH Inc., a provider of tax and business law information in Riverwoods, Illinois, you may owe as much as $186 more.
While the tax rate portion of FICA remains at 6.2 percent for employees, the amount of wages subject to the tax can and often does increase each year based on the national average wage index. Another portion of the FICA tax goes toward Medicare. The tax rate for the Medicare portion is 1.45 percent and applies to every dollar of an employee's earnings.
If you are self-employed and making more than $65,400, you may owe as much as $372 more in self-employment taxes this year over last year, according to CCH. That's because you pay double the FICA tax rates paid by employees since you must also pay the employer portion of these taxes. Some of this double tax can be recouped, however, through a deduction on your federal income tax.
Q: I'm operating my business as a C corporation, but I've heard that organizing as an S corporation or as a limited liability company (LLC) may be better. What are the advantages and disadvantages of selecting one of these other options?
A: The biggest benefit for small-business owners who select a C corporation as their legal structure is the liability protection it offers. The debt of a C corporation is generally not considered the debt of its owners, so you aren't putting your personal assets at risk. In addition, corporations continue indefinitely, even if one of the shareholders dies, sells the shares or becomes disabled. For the most part, however, the benefits of organizing as a corporation end here for small-business owners.
With a C corporation, you pay what amounts to a double tax on the earnings of the business. Not only are corporations subject to a corporate income tax at both the federal and state levels, but any earnings distributed to owners as shareholders in the form of dividends are taxed at that individual's personal tax rate. This includes profits distributed upon liquidation of a C corporation's assets.
However, switching from a C corporation to another type of entity is not usually recommended; if you try to convert from a regular corporation to an S corporation, for example, it is often treated as a taxable sale. A conversion from a partnership or existing unincorporated business, however, results in no tax consequences.
But you should be mindful of the tax benefits small companies organized as S corporations receive. With an S corporation, the business owner avoids the whammy of double taxation but still enjoys the liability protection of a C corporation. Income and losses pass through to shareholders and are included on the shareholders' individual tax returns. As a result, there is just one level of federal tax to pay.
Some recent tax law changes in the Small Business Job Protection Act of 1996 have made S corporations even more attractive for small-business owners. S corporations used to be limited to 35 shareholders, but the 1996 law boosted that number to 75. As a result, tax experts say, it's possible for S corporations to have more investors and attract more capital.
Another attraction of an S corporation is that in 1998, tax-exempt organizations such as qualified pension plans can own stock in these corporations. In the past, ownership was limited to individuals, estates and certain types of trusts. The change is expected to provide S corporations with greater access to capital because many pension plans are willing to invest in the stocks of closely held small-businesses.
S corporations also have their downsides. For example, you still have to comply with the more costly requirements of C corporations, and that means higher legal and tax service expenses. S corporations, like C corporations, also have to file articles of incorporation, hold directors and shareholders meetings, keep corporate minutes, and allow shareholders to vote on major corporate decisions.
For those just launching a business, LLCs are considered the best legal structure to select, says CPA Ralph Anderson with Florham Park, New Jersey, accounting firm Richard A. Eisner & Co. LLP. LLCs were created to provide business owners with the liability protection corporations enjoy without the double taxation expense. As with S corporations, the earnings and losses of an LLC pass through to the owners and are included on their personal tax returns. Unlike an S corporation, however, there are no limitations on the number of shareholders an LLC can have.
Unlike C corporations, which can last indefinitely, LLCs have a fixed life. Some state statutes indicate that LLCs must dissolve after 30 or 40 years. Technically, the company dissolves when a member dies, quits or retires. Careful drafting of charter documents, however, can allow the business to continue as a new LLC.
If you are seriously considering selecting an LLC as the legal structure for your business, you should know that since their widespread use is relatively recent, state laws vary on their tax treatment. Be sure your accountant knows the various rules and regulations of LLCs in the states where you intend to do business.
CCH Inc., http://www.cch.com
Richard A. Eisner & Co. LLP, 100 Campus Dr., Florham Park, NJ 07923, (973) 593-7013