November is National Adoption Month in the United States. In light of that, we wanted to focus on some of the most important issues for (potential) new parents. Namely, what kind of adoptions exist, how long it can take to adopt and what an adoption costs. Also, there is a tax credit that some new adoptive families may not know about.
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Ed note: There’s a perception that owning your own business means you get all kinds of tax write-offs. To be sure, there are some tax benefits that are available to you. However, there are also a number of new tax complexities that you must account for. We detail a few of the most important changes here.
1. Your income is taxable even if you reinvest it into your business.
As a business owner, any profit your business makes each year will be taxable to you, regardless of whether you withdraw it or reinvest it into growing the business. Luckily, any deductible business expenses can be used to directly offset that income. This is unlike employees, whose unreimbursed expenses are subject to a threshold based on 2% of their adjusted gross income and are only deductible if they itemize their deductions.
Your net profit from your business will be subject to the self-employment tax. This tax pays for contributions to both social security and Medicare. Currently, you will pay self-employment tax at a 15.3% rate on your net self-employment earnings up to $117,000. Any earnings above that amount would be subject only to a Medicare tax at a 2.9% rate. An additional 0.9% Medicare tax will be imposed on self-employment income in excess of $250,000 for joint returns, $125,000 for married taxpayers filing separate returns, and $200,000 in all other cases. While self-employment tax is imposed in addition to income tax, you can deduct half of your self-employment taxes as an adjustment to income.
Though paying the additional tax may seem burdensome, it actually designed to act the same way as the social security and Medicare taxes that would normally be withheld from the wages of an employed individual. Furthermore, the social security portion of the tax increases the potential social security benefits you may receive at retirement.
If you choose to incorporate your small business you will not be subject to self-employment tax on your earnings. However, you will then be subject to payroll taxes, since shareholders who perform services for their corporations are required to be paid Form W-2 wages subject to social security and Medicare withholding.
3. Your filing requirements will change.
Normally, individuals with taxable income under certain threshold amounts are not required to file a tax a return for the year. In 2014, a single individual generally only has to file if their adjusted gross income exceeds $10,150. However, if you are self-employed you are required to file a tax return if your net income from your business is $400 or more. This is true even if the $400 is your only income.
4. You will be required to make quarterly estimated payments.
Most taxpayers satisfy their tax payment requirements when their employer withholds the various taxes from their paycheck. However, when you’re self-employed, you’re on your own. Self-employed taxpayers satisfy their tax payment requirements by making estimated tax payments quarterly online or via the mail. If you also work as an employee for another business in addition to your self-employment, you may be able to satisfy your required tax payments by increasing the amount of withholding from your wages.
If you don’t make the required payments, you may be subject to an underpayment penalty. The penalty equals the interest rate charged by the IRS on deficiencies multiplied by the amount of underpayment during the underpayment period. Each quarterly payment will have its own underpayment period, which will run from the due date for that payment until the earlier of (1) the tax return due date for that year, or (2) the date on which the underpayment is actually paid. The penalty can be avoided if you meet certain specified exceptions or waivers.
5. You’ll be subject to more scrutiny.
Unfortunately, being self-employed will be in one of the IRS’ favorite audit target groups. Though being audited doesn’t mean you’re in trouble unless you’ve actually done something wrong, it is best for you to always be prepared for the possibility. In particular, you should carefully record your income and expenses in order to claim the full amount of the deductions to which you are entitled. Certain types of expenses, such as automobile, travel, entertainment, meals and office-at-home expenses, require extra attention because they are subject to special recordkeeping requirements or limitations on deductibility.
Ed note: FICA, FUTA, FIT. No, that isn’t the start of some wacky Dr. Seuss book. It’s just a few of the alphabet soup of taxes that you will need to know once you bring on employees. Lucky for you, our Tax Institute small business expert Mike Slack is here to help out.
Generally, employers are required to withhold and deposit federal income tax (FIT), state income tax, social security and Medicare taxes, and federal unemployment tax. Depending on where the employee is working, they may also be required to withhold and deposit local income taxes.
Even when a sole-proprietor hires an employee, the owner’s earnings from the business remain subject to self-employment tax, and they cannot be treated as an employee as well. The exception to this rule is in the case of corporations, where the business owners are considered to be employees of the corporation as well.
Federal and State Income Tax
When hiring a new employee, one of the first documents that should be received is a Form W-4. This form helps determine the amount of federal and state income taxes that should be withheld from the employee’s wages. Failure to receive a Form W-4 from the employee means that the income taxes from their wages must generally be withheld at the maximum rate provided for their amount of wages.
- How It Is Reported: Most employers are required to file IRS Form 941 quarterly to report income tax withheld from the employee’s wages, while agricultural employers file IRS Form 943 annually. Reporting for state income tax withholdings is varied.
- Year-Reporting: In addition to Form 941 or 943, an employer is required to file IRS Form W-3, with the employees’ Form W-2s attached, annually with the Social Security Administration.
Social Security and Medicare Taxes
Employers generally must withhold part of social security and Medicare taxes (referred to as “FICA” taxes since they were created based on the Federal Insurance Contributions Act) from their employees’ wages and pay a matching amount themselves.
Currently, the withholding rate is generally 6.2% for social security and 1.45% for Medicare. The employer is responsible for paying an equal amount for each employee. However, once the employee’s wages for that year exceed a certain amount ($117,000 in 2014) their wages are no longer subject to the social security portion of the tax.
Since 2013, employers are also responsible for withholding the 0.9% Additional Medicare Tax on wages and compensation that exceeds a threshold amount based on the employee’s filing status. However, employers are not required to pay matching amounts for the Additional Medicare Tax.
- How It Is Reported: Most employers are required to file IRS Form 941 quarterly to report FICA withheld from the employee’s wages, while agricultural employers file IRS Form 943 by February 28 annually.
Federal unemployment tax (FUTA), together with state unemployment systems, provides for unemployment compensation payments to workers who have lost their jobs. Most employers pay a federal and state unemployment tax. Currently, FUTA is only paid on the first $7,000 in wages, while for states this wage base will vary. Only the employer pays FUTA tax, meaning nothing is withheld from the employee’s income to pay the tax.
It is important to note that FUTA rules differ in the case of business employers, farm employers, and household employers.
- How It Is Reported: The employer should file IRS Form 940 annually to report the amount of FUTA tax on wages paid to employees. Different forms will apply for each state.
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