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Business taxes and your company:
What you'll have to pay and why

July 29, 1999 -- Are you a potential business owner trying to figure out what kinds of taxes you will have to keep up with if you go into business?

The answer to your question partially depends on how you structure your company. This tax tip explains the four general types of business taxes: income taxes, self-employment taxes, employment taxes and excise taxes.

Income taxes
Income taxes are "pay as you go." This means that waiting until tax returns are due to pay can cause problems. The IRS expects business owners to pay these taxes as they earn income through the year. The problem for many owners is that they often don't have this income withheld from their wages the way employees usually do. If this is the case, or if the amount withheld is insufficient, the business owner has to make estimated tax payments.

What determines whether estimated taxes are due? This depends on the business structure. Sole proprietorships, partnerships, and S corporation shareholders should make estimated tax payments if they expect to owe at least $1,000 when they file their annual returns. They should use Form 1040-ES, Estimated Tax for Individuals, when they calculate and pay these taxes.

Corporations should use Form 1120-W, Estimated Tax for Corporations, to make estimated tax payments if they expect to owe at least $500 when they file their tax returns.

Self-employment taxes
People who work for themselves might avoid some workday hassles, but taxes aren't on the list. They have to pay self-employment taxes for their Social Security and Medicare coverage if they net at least $400 from their self-employment, or if they receive at least $108.28 working for a church. They should use Schedule SE, Form 1040, when they calculate these taxes. They can deduct one-half of this tax as an income adjustment on Form 1040.

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Employment taxes
Many business owners try to use independent contractors so that they can avoid the expense and paperwork associated with having employees. It is important to know the rules for making this designation. If a business owner incorrectly classifies an employee as an independent contractor, he may be held accountable for employment taxes for that worker, plus a penalty.

If a business owner does have employees, he needs to know what the IRS requires in terms of paying employment taxes and filing forms. The three groups of employment taxes are Federal income tax withholding, Social Security and Medicare taxes, and Federal unemployment (FUTA) tax.

Business owners are required to withhold federal income taxes from each employee's wages. Don't be intimidated by the process of figuring how much federal income tax to withhold from each paycheck. Use the filing status and withholding allowances shown on Form W-4, Employee's Withholding Allowance Certificate, to figure out how much income tax to withhold from an employee's wages. For additional assistance, refer to Publication 15. It details exact withholding amounts.

Components of withholding
Keep in mind that the amount of income tax withholding should depend on marital status, withholding allowances and income bracket. Employees can't base their withholding amounts on a fixed dollar amount or percentage; however, the employee can choose to specify a dollar amount to be withheld in addition to the amount that the employer is supposed to withhold.

There are instances where a business owner should send the IRS copies of certain Forms W-4 received. Specifically, a business owner should contact the IRS if an employee claims more than 10 withholding allowances or exemption from withholding when his wages would normally exceed $200 per week. Don't send other forms W-4 unless the IRS requests them.

Also, the IRS permits employees to claim fewer withholding allowances than they are entitled to claim. Workers will often do this to make sure a sufficient tax is withheld or so that they can offset other sources of taxable income that aren't subject to adequate withholding.

Social Security and Medicare taxes pay for benefits that workers and their families receive under the Federal Insurance Contributions Act (FICA). Social Security tax pays for benefits under the old age, survivors and disability insurance part of FICA. Medicare tax pays for benefits under the hospital insurance part. A business owner's responsibility here is twofold: He must withhold part of these taxes from his employee's wages, and the IRS expects him to pay a matching amount.

The employee tax rate for Social Security is 6.2 percent -- this is the amount the business owner must withhold. The employer tax rate for Social Security is also 6.2 percent. For 1999, once an employee's annual wages exceed a wage base limit of $72,600, the IRS no longer charges Social Security taxes on his income, meaning the employer no longer has to withhold or pay these taxes.

The employee tax rate for Medicare is 1.45 percent -- this is the amount the business owner must withhold. The employer tax rate for Medicare tax is also 1.45 percent. There is no wage base limit for Medicare tax.

The federal unemployment tax compensates workers who lose their jobs. Business owners must report and pay FUTA tax separately from Social Security and Medicare taxes and withheld income tax. Business owners are to pay this tax only from their own funds instead of withholding it from their employees' pay.

Forms for employment taxes
Most business owners report federal unemployment tax on Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return. Those who qualify can use the Form 940-EZ instead.

There are three requirements for using Form 940-EZ. A business owner must be paying unemployment taxes to only one state and making that payment by the due date for filing Form 940 or 940-EZ. In addition, all wages that are taxable for FUTA tax purposes must also be taxable for the state's unemployment tax. See Publication 15 for more information regarding this form.

When hiring employees, following certain procedures will simplify a business's tax records tremendously. First, have each new employee fill out Form I-9 and Form W-4.

An employee with a qualifying child may be entitled to receive advance earned income credit (EIC) payments with his or her pay during the year. To get these payments, the employee must provide a completed Form W-5, Earned Income Credit Advance Payment Certificate. Business owners are required to make advance EIC payments to employees who have provided this form. For more information, see Publication 15.

Business owners must verify that new employees are eligible to work in the United States. Both the business owner and the employee must complete the Immigration and Naturalization Service (INS) Form I-9, Employment Eligibility Verification. This form is available for download, at INS offices or by calling the INS at 1-800-755-0777.

Once the calendar year ends, business owners must provide copies of Form W-2, Wage and Tax Statement, to each employee who received wages during the year. Business owners should also send copies to the Social Security Administration. Generally, these should be in the hands of the employees no later than Jan. 31 of the following year.

Excise taxes
There are some special excise taxes business owners should be aware of if their business involves:

  • Selling or using vehicles
  • Betting
  • Producing, selling or importing guns, tobacco or alcohol.

There are five forms that are of particular interest:

  • Form 720 is the Quarterly Federal Excise Tax Return -- Used to report environmental and communications taxes, as well as taxes on heavy trucks, trailers and passenger cars.
  • Form 2290, Heavy Vehicle Use Tax Return -- Used to report taxes on trucks, truck tractors and buses used on public highways.
  • Form 730, Tax on Wagering, -- Used by businesses that accept bets, or run pools or lotteries, to figure taxes due on betting.
  • Form 11-C, Occupational Tax and Registration Return for Wagering --Used by businesses that accept bets, or run pools or lotteries, to register wagering activity.
  • Federal Bureau of Alcohol, Tobacco and Firearms forms -- Used by businesses that produce, sell, or import guns, tobacco or alcohol, as well as businesses that manufacture equipment used in the production of these items. Business owners should use Form 5630.5 (Alcohol, Tobacco) or Form 5630.7 (Firearms -- not yet available online), Special Tax Registration and Return, to register their place of business and pay an annual tax. Also, use ATF Form 5300.26, Federal Firearms and Ammunition Excise Tax Return, to determine any firearms excise tax liability.

Consult Publication 510 for additional information on excise taxes.

-- Posted July 29, 1999

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