Tax Tips Blog

Kristy writes: Ms. Gina

Mike asks: My name is Michael and am in need of some help. The company i work for just proposed switching me from a W2 to a 1099. I currently earn 24k a year gross salary but they want to cut my pay to what i make net and have me as 1099. They tell me it would be the same money im making now, i asked them what happens when i have to pay out taxes at the end of the year and their answer is i can claim all my food and gas expenses to counter me having to pay out taxes in addition to an office in my parents home. Please advise if this is possible or even a good idea, i really would appreciate your help.

My reply:Hello Mike!

Your employer does not get to decide if they can pay you as a W-2 employee or a 1099 contractor. The law determines your classification. I wrote an article about this, which you can find here: http://glgcpa.com/blog/2006/08/06/employee-or-independent-contractor/

If you want the IRS to inform your employer as to whether or not they should be issuing you a W-2 or 1099 then complete Form SS-8 (PDF), Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

You didn’t tell me what kind of work you do or why all your food or gas would be considered a legitimate business expense, but food is rarely 100% deductible. Valid, substantiated meals are usually deductible at 50% of the amount spent. Gas is deductible based on the percentage of business use of your vehicle, assuming the business use has been properly documented. For gas to be 100% deductible you would not be able to drive your vehicle for any personal reasons (like going to the grocery store), nor would you be able to drive to or from work.

In addition contractors need to pay self-employment taxes, this includes the employee part (which you’re having withheld now) and the employer part (which your employer is paying now). Thus, it appears that your company is trying to pull a fast one on you.

Best wishes,
Gina

NOTE: I have received several requests as to why I have not been posting.  There are many reasons, but mostly because most of the questions I am receiving I have previously answered.  If you search my site you may be able to find an answer to your question.  Having said that I will try to post some of the past questions I have received and perhaps some reminders of what to watch for this tax season.

Without further ado…

Joyce Asks: I am wondering if it is not possible to treat the children as independant contractors  which would mean that you do not have to contend with unemployment compensation (are you really going to fire your own child?).  You could then set up a very simple contract for services between you (the sole proprietor) and your independant contractors.  The bookeeping would be very simple.  You could do a payment per task completed type of contract.

Also, I am wondering if the children can open a Roth IRA which could give them quite a jumpstart towards a wealthy retirement? They most likely wouldn’t need the tax deduction if they made less than the threshold traxable amount.

My reply: I have discussed much of this before in these three articles:  Benefits of hiring your children and parents, Hiring Children, and Employee or Independent Contractor.

First, I would think it would be very hard to hire most children (depends on their age, maturity level and other source of income) as an independent contractor and be able to support that decision.  As I stated in my previous article, you don’t get to just choose if your workers are employees or independent contractors it is a matter of law.  The first thing that the IRS looks at is are you providing them a place to work?  If your child has their own place to work that surely is impressive.  Second the IRS wants to know if you are providing them the tools to do their job.  If your children have their own money from a source other than you and they used that money to purchase whatever tools they will need to do their job (dust rags, window cleaner, whatever), then I guess that works.  The third thing the IRS wants to know is if you need to tell them how to do their job and/or provide them any training?  If you need to do this, then they’re your employee.  There are many other questions as well, including, do you want to retain the ability to fire this person?  If so, they’re an employee.  So, as you can see it’s hard for a child, especially a young child, to be properly classified as an independent contractor.

Second, and again, as I have explained in one of those prior articles, if you are self-employed (sole proprietor or LLC taxed as a sole proprietor) you will not have to withhold Social Security or Medicare taxes nor will you have to pay unemployment taxes as long as your child is working for you and they are under the age of 18 and you will not have to withhold Federal or State taxes if they earn less than the minimum required to do so.

Third, and again, as I stated in one of those prior articles, yes you are allowed to open IRAs for your children, which can further reduce taxes and help save for their college education and/or retirement.

Rick writes: Hello Gina,

Found your website doing a google search. I’m looking for a good list of deductible items for an independent contractor. I am a pharmacist with a regular job, but also do some relief work.
I only do extra work about 8 times per year, but I don’t have a good handle on what I can deduct. Would your book, WORTH MORE THAN RUBIES be of any help with that?

Thanks for any help,
Rick

My reply:

Rick,

Thanks so much for visiting my website and writing me.

First, I did not write the book, “Worth More Than Rubies”. Second, I don’t think that is the book you are looking for in this situation. That book is more for “stay-at-home” parents who are afraid to work from home. It gives them encouragement to go ahead and try.

As for what you can deduct - there is no real list anywhere because what is deductible depends on your specific business needs. What I usually tell my clients is when they incur an expense they need to ask themselves these two questions:

• What was the business purpose of this expense?
• Would someone else who is in the same line of business also incur this expense?

If there is a valid business purposes and someone else in your line of business would also incur the expense then it’s deductible.

Having said that there are exclusions (these are not exceptions, but certain items or part of the items expense is “excluded” or not deductible no matter what your business). The exclusions relate to meals & entertainment, travel and what I like to call “walk away” devices (cell phones, PDAs, laptops, etc.).

Please let me know if you need help with something more specific.

Best wishes,
Gina

Seth writes: I work several times a year as an independent contractor for a company. I travel to various cities and deliver lectures. I receive a set fee for each lecture. In the past, I always submitted my receipts for my travel expenses and was reimbursed by the company. At year end, the only income ever reported to me on my 1099-Misc from this company was from the lecture fees. The money received for my reimbursement expenses was not reported. I was just been notified that this year the income I receive from reimbursed expenses will be reported on my 1099-Misc. Does this change in reporting mean that I will have to pay income taxes on this company’s reimbursement of meals since 50% of meals is not deductible? Thanks in advance for any help. Seth

My reply:Hello Seth and thanks for visiting.

Since you are an independent contractor being reimbursed by your client (the company), and if you adequately document those expenses to your client (the company), then you are not subject to the 50% limitation.

In this situation the 50% limit applies to your client (the company). You can read more about this in IRS Pub. 463, Travel, Entertainment, Gift and Car Expenses, www.irs.gov/pub/irs-pdf/p463.pdf.

Best wishes, Gina

Question from Ted:Sweet site! I’m doing my own taxes with Tax Cut and I have a question. I have a regular job, but I worked part-time, as a fitness instructor for a local gym. They sent me a 1099 with the amount they paid me reported as “non-employee compensation”. I’m not self-employed, do I just put this amount on Line 21, Other Income? Thanks, Ted

My response: Hello Ted. I’m glad you found my site too.

Although you might not think of yourself as self-employed, it sure sounds like it to me. You may want to read my article, “Employee or Independent Contractor” and the IRS’s frequently asked questions regarding non-employee compensation.

But don’t let being self-employed get you down, having your own business has benefits. If you have the time and are willing to do this work on a more regular basis, make some business cards and drop them off at other fitness centers. Hire a qualified tax professional, who works with small businesses and is available to help you year round.

These tax professionals can help you make sure you are appropriately documenting and maintaining your records in order to take advantage of all available deductions. He/she will help you determine when it’s time to incorporate, start retirement plans, hiring employees, etc.

Until then, you should report this income on Schedule C (or Schedule C-EZ) as well as any expenses you may have incurred and can substantiate. The most common expense I see for fitness instructors is the cost of their certification.

Best wishes, Gina

Oscar writes: My wife owns a small home-daycare, never more than 15 children. She operates out of our house. She has one full-time (employee) for whom she pays all taxes and medicare and two other part-time contract employees. Her business is legally registered as an LLC partnership. One of the part-time contract employees is demanding that my wife pay SS and Medicare because her tax preparer told her my wife was obligated to do so. Is my wife liable to pay SS tax and Medicare tax for part-time contract employees who received a 1099 from her business? How does one address this amicably without any repercussions to either party? Thanks!

My response: Hello Oscar and Happy New Year! Thanks so much for visiting my site and sending me an email! To answer your question, I have my doubts that the two part-time “contractor” employees are actually 1099 independent contractors and obviously so does that employee and his/her tax preparer. If your wife’s part-time contract employees are actually employees, then yes your wife’s LLC should be paying Social Security and Medicare and possibly withholding Federal Income Tax as well. You may want to read the article I wrote on employees and independent contractors. As for addressing the issues with your help, the best thing to do is to be honest with them. Why did you think they were independent contractors? If your accountant or tax advisor suggested paying these people as independent contractors, I’d start looking for a new advisor. Let your wife’s employees know why you felt they were independent contractors and what you intend on doing about it now. 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.

You may not realize it, but if you hire someone to babysit your kids and do light housework a few days a week in your home and you provide the supplies and equipment she needs to do the work, she’s your employee. This is true even if she’s only 12 years old. I wrote an article about businesses hiring help and classifying them as either employees or independent contractors , and the same rules apply to individuals who hire household help. If any of the workers you hire are household employees, then you, as their employer are required to pay and report payroll taxes.

Your requirements:

1. You and your employee must complete Form I-9, Employment Eligibility Verification. Once completed keep it in a safe place just in case you are asked to present it.
2. You will need to get an employer identification number (EIN).
3. You must withhold Social Security (6.2% of their wages) and Medicare (1.45% of their wages) taxes from your employees wages. As their employer you are required to match the amount you withheld (7.65% of their wages) and submit all these taxes to the IRS. There are exceptions to this requirement, the most common one being if the employee is under age 18 and a student. You may also want to read my article about the benefits of hiring your parents or children.
4. You do not have to withhold Federal Income Taxes, but you can if your employee wants you to. Just remember to remit everything that you withhold and owe to the IRS.
5. As their employer you are also required to pay Federal Unemployment taxes (6.2% or 0.8% with a credit of 5.4% if you pay all your state unemployment by April 15, 2007) on the first $7,000 of their wages. This is NOT a withholding, but rather an amount you must pay. Again, there are exceptions which may allow you to avoid paying these taxes.
6. You may also be responsible for withholding states taxes.
7. If applicable, you can make advance payments of the earned income credit.
8. You must provide your employee with their W-2 by January 31, 2007.
9. You must file Copy A of Form W-2 with the Social Security Administration by Feb. 28, 2007.
10. You must complete and attach Schedule H to your Form 1040 and include the full payment due by April 15, 2007.

Or you could just have your accountant take care of this for you. And remember, payments for household help may qualify for the child and dependent care credit.