Tax Tips Blog

Melissa writes:
Hope you can help me with a couple of questions:
I am starting a small dog walking business and I am going to pay my children that are ages between 11-14 yrs to make flyers and put them out ,do some light office work and perhaps help with the walking.Since I am just starting out do I need to show a profit to do this?
Chances are I might be able to make what I have already put into my business by the end of the year but its’s questionable.
I am a soleproprietor and do not yet have a EIN # I am assuming I probably need one if I am going to pay my children,right?
How do I figure how much I am suppose to take out for my taxes?
State
FICA
Fed
Is there a certain percentage?
Do I pay that at the end of the year when I file my earnings with my husbands earnings and they just take it out or do I pay quarterly?
Thanks I have gone on the IRS site numerous times I just get more confused.
Melissa

My reply:
Congratulations on starting your business!

While reading my reply, please remember that you didn’t say what state you’re in and you’ll probably be subject to state taxes so please visit your state’s department of revenue to find out more about that.

It is very common that when businesses first start out they do not make a profit. The IRS doesn’t expect to see a profit in the first year of business; however they do expect you to run your business in such a way that it is reasonable to believe that you will make a profit. If you do not run your business professionally or you do not generate a profit after a certain number of years, the IRS will assume that this venture is a hobby and not a business.

Yes, if you hire your children (or anyone for that matter) you will need to obtain an Employer Identification Number (EIN), which you can get online at the IRS website. Again, you may also need a state ID number, please check with your state department of revenue.

As for how much to withhold and when to deposit the withholdings, your state department of revenue will help you with determining the amount of state tax to withhold, if any. Your state department of labor will help you determine the amount of unemployment compensation to withhold, if any. IRS Publication 15, Circular E is the most helpful for determining your basic withholding and depositing responsibilities. The IRS also publishes two supplemental guides, Publication 15-A and Publication 15-B (all publications can be found at the IRS website, they won’t let me link directly to the publications sorry), which explains other payroll items and withholding that you may run into at some point in your business. You may want help with your payroll. If so, many have found my fees very reasonable and I do help employers in various states.

Since you stated you are a sole proprietorship and your children are under age 18, you will not have to pay Social Security or Medicare tax on their wages and, usually, no state unemployment or disability taxes, but you should confirm that with your state. And assuming this is your children’s only source of income, the wages you are paying them are considered “earned income,” which means that the first $5,450 received by each child in 2008 is not subject to Federal taxes. Because of all of this, payroll is usually pretty easy for sole proprietors with young children, but you still must be professional and treat them as employees with a full job description, time card, etc.

Best wishes,
Gina

I am a strong advocate of having a professional handle your payroll as many small businesses end up paying unnecessary interest and penalties due to late or inaccurate payroll forms and tax payments. Short of that, please use this as a general guide prior to performing your year-end payroll duties:

1. Verify the accuracy of your employee’s address and social security number
2. Verify the accuracy of your terminated employee’s address and social security number
3. Verify the accuracy of your company contributions to employee provided retirement plans
4. Determine the amounts of non-cash fringe benefits or awards that need to be included on your employee’s W-2s. This will include items such as: group term life insurance, health insurance benefits for 2% shareholders of an S-corporation and personal use of a company car
5. Compare the amounts submitted each quarter on Form 941 and your State Forms to your year-to-date records
6. Don’t forget to file any annual forms, which include Form 940 (Federal Unemployment), Form W-3 (W-2 transmittal), Form W-2s (Employee Wage Statements), Form 1096 (1099 transmittal) and Form 1099s (Independent Contractor statements).
7. Deliver a W-2 to each of your employee’s by January 31, 2007.
8. Deliver a 1099 to each of your Independent Contractors by January 31, 2007.

Many people have had headaches, some even migraines, but only a small business understands how bad a payroll headache can be. QuickBooks and other software have provided the illusion to a lot of small businesses that even if they have never prepared payroll they can handle their own payroll. I have found that is rarely the case. Software programs are fancy sophisticated calculators. If the software is not properly updated it will not calculate the proper amount of withholding. If the person using the software does not use it properly, it will not work properly. Even if you manage to correctly calculate the taxes to be withheld, your payroll responsibilities do not end there. Your responsibility as an employer to withhold payroll taxes from your employees is a fiduciary responsibility. As soon as you issue a check to an employee, you become a trustee for the U.S. Government and the amount of taxes withheld should not be used to pay other expenses. One of the most confusing areas for small businesses in regards to employment taxes seems to be the timing of the tax payments to the governemtn. If you are busy trying to run and grow your small business, it’s easy to forget to make a payment, complete the payment coupon incorrectly, or pay the wrong amount. In general, new employers are required to pay federal withholding taxes on a monthly basis. As your business grows, the frequency increases to semi-weekly. For the largest businesses, taxes are due within twenty-four hours of each payroll. According to the IRS Chief Financial Officer’s Office of Unpaid Assessment Analysis about 128,000 individuals have outstanding trust fund recovery penalties because they didn’t pay their pay payroll taxes. Including accumulated interest, these penalties average $93,750 per person and total about $12 billion. It usually only takes one payroll notice before employers quit doing payroll themselves and hire a professional. Had they hired the professional first they may have saved themselves a payroll headache.

Your business is expanding and it’s time to hire someone to help you out. Will they be an employee or an independent contractor? When answering that question, the important point is whether or not they are working independently. There are 20 common law tests that determine whether or not a worker is an employee, but I’ve found that most employers can figure it out by answering these five questions:

1.Will you be providing a place for the person to work (office, desk, etc.)?

2.Are you planning on providing the person with tools to do their job (paper, pencils, computer, calculator, hammers, etc.)?

3.Will you be telling the person how to do their job or providing a training program for them?

4.Will you be taking responsibility for their work?

5.Do you want to be able to fire this person whenever you see fit?

If you answered yes to all of the above questions, then you are about to hire an employee. If you answered no to any of the above questions, then they may be an independent contractor. To be sure you can take a look at Form SS-8, which is what the IRS uses to classify workers, or ask your tax consultant. Just remember, the distinction between employee and independent contractor is not a matter of choice, it’s a matter of law.

Even if an alien decides not to become a U.S. Citizen they are still required to abide by U.S. laws, which includes filing a U.S. Tax return (assuming they earn enough to be required to file).

In order to file a U.S. Tax return you must have either a social security number or an Individual Taxpayer Identification Number (ITIN). ITINs are available for individuals who are ineligible for a social security number and can be obtained by completing and filing form W-7.

The ITIN does not automatically make an individual eligible for employment or legalize an individual’s immigrant status. It does not make a worker eligible for social security benefits, Medicare benefits or the earned income credit.

The ITIN number enables employers to report wages paid to employees (including domestic workers such as nannies and housekeepers as well as individuals you employ in your business) without fear that the tax returns will be rejected due to missing or inaccurate social security numbers.

It also allows individuals who are ineligible for a social security number to file a US Income Tax return.

Failure to file income tax returns or an improperly prepared tax return can cause problems when the permanent resident files for US citizenship or when a US citizen or permanent resident tries to help family members immigrate.

If you are self-employed and considering hiring some part-time help you should consider hiring either your children or your retired parents. Depending on their abilities and skills your family members can clean your office, file papers, answer phones, design or update your business website, mow the lawn outside your office or just about anything that relates to your business.

No matter who you hire, you need to do it properly in order to get the deductions you deserve. First, make sure that you pay them reasonable compensation for the work you are having them do. The courts already have ruled that you can deduct taxes for any “reasonable wages” that you pay your children ages 7 or older to perform duties related to your work. If you previously had someone else doing this same work pay your family members what you were paying them. If this is a new position then a place like Salary.com may be useful in determining what the current pay level is for these types of services. Document the job description and how the salary was determined.

NOTE: Child labor laws vary from state to state, so before you hire a child review your state’s child labor laws. The federal labor law applies in all states; if the state and federal law differs, the stricter one must be followed. You can see a summary of the Texas Child Labor Law here: The Texas Child Labor Law.

Have all your employees, including your children and parents, complete forms W-4 and I-9. Form W-4 will tell you how much you have to withhold from their paycheck. Form I-9 provides proof of their eligibility to work in the United States. Both of these form can be downloaded from the IRS website.

All your employees should be either using a time clock, punching in and out or writing their time down on a time sheet. Pay all your employees with a business check. Your children can always endorse the check over to you for cash to replace their allowance or accumulate the money for college tuition.

At the end of the work year, file a form W-2 with the IRS for each employee.

Okay, so where are the tax benefits?

If your business is unincorporated (a sole proprietorship or a LLC taxed as a sole proprietorship) and your children are under age 18, you will not have to pay Social Security or Medicare tax and, normally, no state unemployment or disability taxes, either. Assuming this is your children’s only source of income, the wages you are paying them are considered “earned income,” which means that the first $5,150 received by each child in 2006 is tax-free.

So, let’s say I have three children, ages 12, 14 and 16. I hire each one to work for me in my unincorporated business and pay each one $9,150 in 2006. Because they are all under 18, I pay no Social Security, Medicare or state unemployment/disability taxes. Because of the standard deduction, in 2006, the first $5,150 earned by each child is not taxed, but could be saved to help pay for their college education (or buy their first car). The next $4,000 could be sheltered by setting up IRAs for each child. The net result is that I have paid my children a total of $38,600 ($9,150 x 3) that I can deduct from my business income and is tax-free to my kids. If I am in the top marginal tax bracket of 35%, I’ve just saved $13,510 each year in federal taxes alone.

Okay, but are there tax benefits to hiring my parents?

Certainly. If you employ a parent, his or her wages are subject to income tax withholding, Social Security and Medicare taxes, but not Federal or State unemployment taxes. The wages you pay your parents are still deductible to you; therefore you will save on your federal taxes the same way you did in the above example with your children.

NOTE: If your parents were born January 2, 1941, through January 1, 1942, their full retirement age for retirement insurance benefits is 65 years and 8 months. If they work and are full retirement age or older, they may keep all of their Social Security benefits, no matter how much they earn. If they are younger than full retirement age, there is a limit to how much they can earn and still receive full Social Security benefits. If they are younger than full retirement age during all of 2006, they will deduct $1 from their benefits for each $2 they earned above $12,480. If your parents attain full retirement age during 2006, they will deduct $1 from their benefits for each $3 they earn above $33,240 until the month they attain full retirement age.

Hiring your children or parents doesn’t increase your chances of being audited, and it has the potential to increase family wealth substantially.