Fill In The Blanks Planning to hire a new employee? Better sharpen your pencil.

Q: I have decided to hire an employee to help me in mygrowing business. What kind of forms do I need to fill out for hisor her taxes and to register him or her as an employee?

James Edwards
Via e-mail

A: The IRS says businesses that hire employees must haveeach 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 towork in the United States. Both you and your employee must completethe I-9, available by calling the INS at (800) 755-0777. The W-4form, Employee's Withholding Allowance Certificate, providesthe IRS with the filing status and withholding allowances for eachemployee. Have your employees fill out and sign a W-4 form on theirfirst day of work.

You use an employee's filing status and withholdingallowances to determine how much federal income tax to withholdfrom his or her wages. The IRS will provide you with a tax table tofigure out the withholding amounts you must take out for eachemployee. To get a copy of the table from the IRS, simply request"Circular E" and "Employer's Supplemental TaxGuide," a supplement to Circular E.

You also have another responsibility: You're required towithhold state and local income taxes from your employees'paychecks, assuming your state and locality have them. Keep in mindthat tax rules and requirements differ from state to state. To getforms and more information on these taxes, contact your state andlocal government tax agencies or departments.

As an employer, you must also withhold Social Security andMedicare taxes, known as FICA (Federal Insurance Contributions Act)taxes. You must withhold a portion of these taxes from youremployees' wages and pay a matching amount for each employee.The 15.3 percent tax rate is made up of a Social Security tax of12.4 percent and a 2.9 percent Medicare tax. You'll pay 7.65percent of the tax (a 6.2 percent Social Security tax and a 1.45percent Medicare tax) for each employee.

You need to deposit employment taxes with the federal governmenton a regular basis. This includes income taxes withheld as well asemployer and employee Social Security and Medicare taxes. You canmail or deliver them with a completed deposit coupon, Form 8109(Federal Tax Deposit Coupon), to an authorized financialinstitution or a Federal Reserve bank for your area, unless youmake deposits electronically. (The federal government is attemptingto phase in the electronic deposit of payroll taxes over a periodof years.) In addition to federal payroll and FICA taxes, you haveto pay federal unemployment taxes.

At the end of each tax year, you must furnish copies of FormW-2, Wage and Tax Statement, to every employee who worked for youat any time during that year. The forms, which indicate how muchmoney each of your employees earned and the amount of federal,state and FICA taxes you withheld, must be distributed to youremployees by January 31 of the year following the calendar yearcovered by the form.

For copies of the forms you need as well as a number of free taxpublications 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 becauseof an increase in the wage base on which Social Security taxes aredue?

Name withheld
Via e-mail

A: That depends on your income. The Social SecurityAdministration reports that the wage base on which Social Securitytaxes are due will increase to $68,400 this year, up from $65,400in 1997. If you earn more than $65,400 this year, you'll paymore in FICA (Federal Insurance Contributions Act) taxes. Accordingto a calculation done by CCH Inc., a provider of tax and businesslaw information in Riverwoods, Illinois, you may owe as much as$186 more.

While the tax rate portion of FICA remains at 6.2 percent foremployees, the amount of wages subject to the tax can and oftendoes increase each year based on the national average wage index.Another portion of the FICA tax goes toward Medicare. The tax ratefor the Medicare portion is 1.45 percent and applies to everydollar of an employee's earnings.

If you are self-employed and making more than $65,400, you mayowe as much as $372 more in self-employment taxes this year overlast year, according to CCH. That's because you pay double theFICA tax rates paid by employees since you must also pay theemployer portion of these taxes. Some of this double tax can berecouped, however, through a deduction on your federal incometax.

Q: I'm operating my business as a C corporation, butI've heard that organizing as an S corporation or as a limitedliability company (LLC) may be better. What are the advantages anddisadvantages of selecting one of these other options?

Name withheld
Via e-mail

A: The biggest benefit for small-business owners whoselect a C corporation as their legal structure is the liabilityprotection it offers. The debt of a C corporation is generally notconsidered the debt of its owners, so you aren't putting yourpersonal assets at risk. In addition, corporations continueindefinitely, even if one of the shareholders dies, sells theshares or becomes disabled. For the most part, however, thebenefits of organizing as a corporation end here for small-businessowners.

With a C corporation, you pay what amounts to a double tax onthe earnings of the business. Not only are corporations subject toa corporate income tax at both the federal and state levels, butany earnings distributed to owners as shareholders in the form ofdividends are taxed at that individual's personal tax rate.This includes profits distributed upon liquidation of a Ccorporation's assets.

However, switching from a C corporation to another type ofentity is not usually recommended; if you try to convert from aregular corporation to an S corporation, for example, it is oftentreated as a taxable sale. A conversion from a partnership orexisting unincorporated business, however, results in no taxconsequences.

But you should be mindful of the tax benefits small companiesorganized as S corporations receive. With an S corporation, thebusiness owner avoids the whammy of double taxation but stillenjoys the liability protection of a C corporation. Income andlosses pass through to shareholders and are included on theshareholders' individual tax returns. As a result, there isjust one level of federal tax to pay.

Some recent tax law changes in the Small Business Job ProtectionAct of 1996 have made S corporations even more attractive forsmall-business owners. S corporations used to be limited to 35shareholders, but the 1996 law boosted that number to 75. As aresult, tax experts say, it's possible for S corporations tohave 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 ownstock in these corporations. In the past, ownership was limited toindividuals, estates and certain types of trusts. The change isexpected to provide S corporations with greater access to capitalbecause many pension plans are willing to invest in the stocks ofclosely held small-businesses.

S corporations also have their downsides. For example, you stillhave to comply with the more costly requirements of C corporations,and that means higher legal and tax service expenses. Scorporations, like C corporations, also have to file articles ofincorporation, hold directors and shareholders meetings, keepcorporate minutes, and allow shareholders to vote on majorcorporate decisions.

For those just launching a business, LLCs are considered thebest legal structure to select, says CPA Ralph Anderson withFlorham Park, New Jersey, accounting firm Richard A. Eisner &Co. LLP. LLCs were created to provide business owners with theliability protection corporations enjoy without the double taxationexpense. As with S corporations, the earnings and losses of an LLCpass through to the owners and are included on their personal taxreturns. Unlike an S corporation, however, there are no limitationson the number of shareholders an LLC can have.

Unlike C corporations, which can last indefinitely, LLCs have afixed life. Some state statutes indicate that LLCs must dissolveafter 30 or 40 years. Technically, the company dissolves when amember dies, quits or retires. Careful drafting of charterdocuments, however, can allow the business to continue as a newLLC.

If you are seriously considering selecting an LLC as the legalstructure for your business, you should know that since theirwidespread use is relatively recent, state laws vary on their taxtreatment. Be sure your accountant knows the various rules andregulations of LLCs in the states where you intend to dobusiness.

Contact Sources

CCH Inc., http://www.cch.com

Richard A. Eisner & Co. LLP, 100 Campus Dr., FlorhamPark, NJ 07923, (973) 593-7013