Welcome to lesson six.
This lesson is for small business owners who have employees or use independent contractors.
In this lesson we'll discuss your responsibilities as an employer or as one who pays others for services in the course of your trade or business.
Whether you're handling this yourself or paying someone else to do it, you need to know your responsibilities.
At the end of this lesson you'll be able to identify an employee versus an independent contractor.
Discuss your payer responsibilities.
Identify payer-related forms.
Verify employee information with the Social Security Administration.
Explain the purpose of the State New Hire Registry.
Enroll for filing W-2s online.
And enroll in and use the file information return electronically system, it's called FIRE for short.
In lesson one we discussed the process for getting a federal employer identification number or EIN.
In this lesson we'll discuss the distinctions between an employee and an independent contractor and how to report payments made to each.
This lesson also provides video instruction and practical exercises to assist you with learning how to compute employee paychecks.
We'll also review the rules for depositing and reporting payroll taxes.
Most of the information from this lesson is also in publication 15.
You can get it online at irs.gov/smallbiz or by calling 1-800-829-3676.
As an employer you are responsible for certain taxes and for withholding taxes from your employee's paychecks.
Your employees expect you to pay those taxes to the treasury.
These are their paycheck deductions for income taxes and their FICA, that is the social security and Medicare taxes.
In addition you have to pay the employers' matching share of FICA taxes and in most cases you'll have to pay the federal unemployment, or FUTA tax.
However, in most cases you do not have to withhold or pay any taxes on payments to independent contractors.
When you pay someone for performing services for you, how do you know if that individual is an employee or an independent contractor?
To figure out if an worker is an employee or an independent contractor look at the business relationship between you and the worker.
Generally a person who performs services for you is an employee.
The common law standard states that an employer/employee relationship exists when you have the right to direct and control the worker who performs the services.
What?
In other words, a person is your employee when you control what is to be done, and how the work is done.
It's not necessary to actually direct or control the worker.
Your business only has to have the right to direct and control.
So what do we mean by control?
There are three areas to consider.
Behavioral control, financial control, and the relationship of the parties.
Let's look a little closer at each of these areas.
For behavioral control ask yourself, does my business have the right to direct and control how the worker does the work I hired them to do?
As the business owner do you direct when and where to do the work?
What tools or equipment to use, or where to purchase supplies and services?
Do you control hiring?
Do you control what work a specific individual must do, and how about the order to follow when performing tasks?
Do you train the worker?
Generally if you have the right to control what will be done and how it will be done, the workers are employees.
Financial control is another important factor you must consider.
Who directs or controls the business aspects of the work?
Independent contractors are in business for themselves, they usually offer their services to the public and may have a significant financial investment in their business.
They may also have their own tools or equipment.
Independent contractors are more likely to have out of pocket business expenses and can have profits or losses.
Finally, consider your relationship with the worker.
What relationship do you and your worker intend to have?
If you provide employee benefits such as health insurance, a pension plan, or a paid vacation or sick days, this generally indicates an employer/employee relationship.
Also, consider the importance of the worker's services.
If the worker provides services that are a key aspect of your regular business activity, it is more likely that the worker is an employee.
In some cases it may not be easy to decide a worker's status.
Maybe I can get around this by having them sign a contract that says they're an independent contractor.
It's important to remember that just signing a contract does not automatically make the worker an independent contractor.
Deciding a worker's employment status up front is important for you and the worker.
If you misclassify workers as independent contractors and you have no reasonable basis for doing so, you may be liable for their employment taxes.
You may have to pay all the employee's taxes.
So as you can see it is very important to properly classify your workers.
If you're just not sure, the IRS can help.
You can send in Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
The IRS will send you and the worker a determination letter, and as usual you can get this form from the IRS web site.
At C&S construction Bill just hired a carpentry foreman to oversee a group of seven framers and carpenter's helpers to help finish a number of building projects his company has contracted to complete.
It's great to have you on board Jeff.
We've always had a good relationship with your father's company so it's nice to know we can expect quality work with you on the job.
Well thanks, having worked on dad's crew for the past three years I think it's really prepared me to step up as foreman and I want to thank you for giving me the opportunity to prove that.
Well you're welcome Jeff, we're glad to have you.
Before I take you out to meet the crew I just want to cover a few of your daily duties.
As you know we're running on a pretty tight deadline and need to be sure there are no set backs.
So each morning after a quick onsite meeting with all the foremen I'll expect a report on where you are in the project and what materials you need delivered for the next day.
Here's our standard report form and a list of materials available.
You'll need to bring in your own hand tools but you can get the nail gun and other larger equipment out of the equipment shed.
Just make sure you lock it up each night.
Sure.
Oh, speaking of forms, who do I talk to about my paycheck and withholding forms?
I think it's a W-4 right?
You recognize that Jeff is an employee, not an independent contractor.
He is classified as an employee because C&S construction controls when, where and what projects the foreman completes.
Once you have decided the status of a worker, what then?
If the worker is an employee, how much should you withhold?
What forms must you have on file for each employee?
And what are your responsibilities when paying independent contractors?
Now we're going to go into detail about your responsibilities if you have employees.
Each employee must complete a Form W-4, Employees Withholding Allowance Certificate.
Use the employee's gross wages and the information on the form W-4 to figure the amount to withhold.
This information includes the employee's marital status, the number of withholding allowances claimed, the employee's desire to have additional tax withheld, and an employee's claim to exemption from withholding if applicable.
If an employee doesn't give you a signed W-4 withhold tax at the single rate with no withholding allowances.
If an employee claims to be exempt from withholding the exemption only applies to income tax, not to social security or Medicare, the FICA taxes.
Employees claiming exemption from withholding must submit a new W-4 each year by February 15th to re-establish their exempt status.
If you e-file your 941, this form W-4 information should also be filed electronically.
If you e-file your 941 and need to mail the W-4, include a cover letter with your name, address, EIN, and the number of W-4s included.
Always make sure boxes 8 and 9 on the W-4 are completed.
As an employer you are responsible for determining that employees are legally eligible to work in the United States.
To work in the United States the employee must be a US citizen, a national, or legal, permanent resident, or must have been granted authorization to work in the US.
US Citizenship and Immigration Service or USCIS is the new name for the INS.
The USCIS requires that all employers and employees complete Form I-9, Employment Eligibility Verification.
While citizens and nationals of the US are automatically eligible for employment, they too must present proof of employment eligibility in identity and complete an I-9.
As an employer you complete the employer section of the form.
This certifies that you have reviewed original documents establishing the identity and employment eligibility of the employee.
The I-9 lists several documents that the employee can show you to satisfy this requirement.
For example an employee may provide a US passport, certificate of US citizenship, certificate of naturalization or a voter's registration card.
The employee has three business days from the date employment begins to show you the required documentation or a receipt for a replacement document if documents are lost, stolen, or destroyed.
You can fire an employee who doesn't do this however you must apply this rule to all your employees.
Employers are not responsible for the authenticity of documents, however, if a document does not appear to be genuine, do not accept it.
You do not need to file the I-9 with USCIS.
But you must keep the I-9 for three years after the date of hire or one year after employment ends, whichever is later.
In other words if someone has been working for you for five years you still need to have their I-9 on file.
To get more information on your responsibilities in this area, access the USCIS web site.
Social Security offers a free service so employers can check that the names and social security numbers of their employees match those in the social security records.
To verify up to five names and social security numbers, just call Social Security's employer help line at 1-800-772-6270.
A representative will verify the numbers while you wait.
You need your company name and EIN, the employee's social security number, last name, first name, middle initial if applicable, date of birth, and gender.
So be sure to have this information available when you call.
Okay, that's what you'll need when using the telephone system to verify one to five names and social security numbers.
If you have more employees you can verify up to 50 names and social security numbers by sending a paper list with the same information to your local social security office.
Some offices accept faxed listings.
Go to socialsecurity.gov to find the address of your local office.
To check more than 50 names and numbers you can use Social Security's employee verification service by sending requests on magnetic media.
However, you'll need to register with Social Security.
The process is simple.
Go to the Social Security Administration web site for more information.
Social Security will only tell you if the name and social security number match.
Social Security will not tell you the correct social security number.
If the name and number do not match it's up to you to get the correct social security number or name from your employee.
As an employer you must complete a form W-2, Wage and Tax Statement for each of your employees every year.
As we'll discuss later in this lesson, the W-2 shows the amount of compensation paid to employees and the amount of tax withheld for the year.
Social Security also uses this form to update the employee's lifelong earnings history.
They use this earnings history to calculate the employee's benefits.
Because this information is so important, you can be assessed a penalty for W-2 names and numbers that don't match.
The IRS has the responsibility to assess the employer a $50 penalty for each incorrect W-2 filed with social security and another $50 penalty for each incorrect W-2 it gives to an employee.
So as you can see it is important that an employee's name and social security number as shown on form W-4 match your payroll records, the year end form, W-2.
Wait a minute, if an employee gives me the wrong social security number, I could get penalized?
You're probably asking yourself, how can you make sure your new employee gave you the correct information?
Well first keep your payroll records up to date.
When you hire new employees always check the name and social security number.
Ask them to show you their Social Security card if it's available.
It's okay to photocopy the Social Security card, but it isn't required.
Remind employees to report any name change due to marriage, adoption, divorce, et cetera, first to the Social Security Administration and then to you.
Make sure employees know that notifying the employer of a name change is not enough.
They must complete the Form SS5, Application for a Social Security Card to have the change made on their social security record.
Form SS5 and additional information is available on the web at www.socialsecurity.gov.
They can also call 1-800-772-1213 or visit a local social security office.
Do you remember the Form W-4, Employee's Withholding Allowance Certificate?
Yeah, I think that's the form we use to calculate withholding.
Well the W-4 also shows an employee's name and social security number.
If you relied on the information provided by your employee on the W-4 to prepare their W-2 IRS may waive the penalties.
Just remember that the law allows a waiver of penalties where an employer had reasonable cause for including incorrect information on a W-2.
Documenting the steps you take to obtain and correct any social security number and name mismatches may help you avoid costly penalties down the line.
One of those steps is getting the W-4 so it is important to keep it in your files.
IRS issues individual taxpayer identification numbers or ITINs to individuals who are required to have a US taxpayer identification number but who do not have and are not eligible to get a social security number from the Social Security Administration.
ITINs are not valid for employment and should not be used on worker's W-2s.
They do not provide eligibility for social security benefits or the earned income tax credit.
An ITIN is a nine digit number that always begins with the number 9 and has a 7 or 8 in the fourth digit.
You may have employees who are eligible for the earned income tax credit, or EITC.
EITC is a refundable tax credit for people who work but do not earn high incomes.
As an employer you may be required to notify an employee that they may be able to claim a tax refund because of the earned income tax credit.
You must notify employees who have no income tax withheld that they may be eligible for the earned income tax credit.
We encourage you to notify employees when their income is below the maximum income threshold allowed for claiming the EITC that they may be eligible for the credit.
This is because eligible employees may get a refund of EITC that is more than the tax that they owe.
You may use Notice 797, Possible Federal Tax Refund Due to Earned Income Credit to meet the notification requirement.
Go to irs.gov to get a printable copy of notice 797.
Publication 15 lists other ways you can meet the notification requirement.
Some EITC eligible employees may qualify to receive advance payment of the earned income tax credit.
Employees who are EITC eligible and have a qualifying child are entitled to receive EITC payments with their pay during the year.
As the employer you add the correct amount to your employee's paychecks.
In a few minutes I'll explain how employers claim any advance payments of EITC as credits against their payroll taxes.
To get advanced payment of the EITC an employee must give you a completed form, W-5, Earned Income Credit Advance Payment Certificate.
An employee may have a certificate in effect with only one employer at one time.
Married employees with working spouses file separate forms.
Eligible employees must give you a form W-5 every calendar year.
In addition to getting and verifying personnel information for payroll purposes, you must also send information on new employees to your state's new hire registry.
The state matches records from the new hire registry against child support records at the state and national levels to locate parents who owe child support.
Federal law requires that you send basic information to the new employee registry in your state.
Your business name and address, your EIN and the name, address, and social security number of the new hire.
Since most of this information is on a completed W-4 many states accept a copy of the W-4 with employer information added.
Quarterly wage reports and unemployment claims are also required.
To find out the specific requirements in your state go to your state's web site.
At the end of the year you must complete information returns such as W-2s and 1099s.
All employers must issue W-2s to report wages and withholdings to their employees by January 31st.
Send electronic copies of the W-2s to social security by March 31st.
If you still file by paper, tape, or diskette, you'll need to file a whole month earlier, February 28th.
Electronic filing is faster and easier to use.
Social security has two electronic filing methods.
If your employee leaves before the end of the year you can give them their W-2 at any time after they leave as long as it is before January 31st.
If any employee asks for their W-2 you have 30 days after their last pay date or 30 days after they leave, whichever is later.
You can upload a wage report to social security using the internet.
Use the guidelines in social security's magnetic media reporting and electronic filing or MMREF publication.
In many cases commercial software providers supply formatted software.
Companies with fewer than 250 W-2s may use the MMREF format.
Companies filing 250 or more W-2s must use it.
The second option business services online is ideal for business filing 20 or fewer W-2s.
This option also uses the internet but instead of uploading an MMREF report, you create the W-2s right on your computer.
You can print W-2 statements suitable for employee's distribution and your records.
You'll need Adobe Acrobat reader to print the forms, it's available free of charge online.
The online filing of W-2 forms is on the social security web site at www.ssa.gov/employer.
Another nice feature is that the system creates your W-3 transmittal form automatically saving you time and effort.
Of course you'll need to register.
To do that go to the social security employer web site and select business services online.
Then follow the screen prompts to register for a personal identification number or a PIN.
You'll get it immediately.
Within 10 to 14 days you'll get a password in the mail.
When you receive the password change it right away to one you personally select.
Change it at least once a year to keep your PIN active.
A PIN is the electronic signature of an individual, not a company ID.
Each person you authorize to sign W-2 reports needs their own PIN.
The Business Services Online User Handbook has systematic instructions for filing your wage reports electronically plus phone numbers for technical support.
Social security's Business Services User Handbook is available through their web site.
Of course if you choose not to use the electronic system you may still send the W-2s by mail along with your W-3.
Let's review the due dates.
Again the deadline for filing W-2s with social security is February 28th for paper, magnetic tape, and diskette filers.
And March 31st for electronic filers.
But don't forget you must issue W-2s to your employees by January 31st.
Okay.
We're going to look at your responsibilities regarding independent contractors.
You know how you file W-2s with social security for employees?
For independent contractors you file form 1099 miscellaneous with the IRS and give a copy to the independent contractor.
Just as you file W-2s with the social security at the end of the year, you file forms 1099 miscellaneous with the IRS at the end of the year.
The due dates for W-2s and 1099s are the same.
Since electronic filing is the easiest way to file, it's available to everyone.
As with W-2s, if you have 250 or more you must file electronically.
The IRS electronic system for filing 1099s is called filing information returns electronically or FIRE for short.
Let's take a look at the advantages of filing electronically.
Filing electronically allows you to verify if your forms were accepted in a matter of days.
You get more time to file.
Instead of February 28th you have until March 31st.
You don't need a transmittal form and filing electronically allows you up to ten days from transmission to stop processing.
This means you have another chance to make corrections to your final transmission before the due date.
Although the FIRE system is easy to use, you still must use pre-approved software.
You can develop the software by following the specifications in publication 1220.
Or you can go to Publication 1582, Information Returns Vendor's List for a vendor who sells pre-approved software or for a transmission service provider.
The IRS does not endorse or approve products and services offered by these vendors.
The publication is simply for your convenience.
You may also consider checking your local listings for a vendor near you.
To use the FIRE system you must complete Form 4419, Application for Filing Information Returns Magnetically Electronically and mail it to the IRS at least 30 days before the due date for filing 1099s.
Once approved the IRS assigns a transmitter control code to you.
When you receive your transmitter control code you may create a log on name, password, and personal identification number right away.
Several states have entered into an agreement with the IRS to accept FIRE files, that means you may not need to file additionally with your state.
If you're in a participating state and you want to be in the program, you must send the IRS a test file.
See publication 1220 for more information on the FIRE system and to see if your state participates in the combined federal state filing program.
Publication 1220 is available through our web site at irs.gov.
And that's the end of lesson six.
Let's review.
First we talked about the differences between an employee and an independent contractor.
We said it is important to decide if the business has the right to direct and control the manner in which services are performed.
There are three areas to consider, behavioral, financial, and the relationship of the parties.
Then we discussed form W-4 and the employers responsibility regarding withholding.
We talked about verifying work authorization and social security numbers.
Then we briefly discussed the advanced earned income tax credit.
We mentioned the state new hire registry and its purpose.
We went over information returns.
That's W-2s and 1099s.
And finally we looked at filing W-2s with social security and 1099s with IRS.
I hope you found this lesson helpful.
As you are probably aware by now there are many employer responsibilities involved in meeting your tax obligations and there's still more to learn.
Thanks for joining me, enjoy the next lesson.
For resources discussed in each lesson, please visit the Lesson 10 Supplement.
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