Business Tax Basics: What You Need to Know

Federal Employment Tax Rules

Most companies rely on employees to fulfill essential job duties that impact the success of the business. At the federal level, there are many regulations regarding the taxes that an employer must pay as well as how they must be paid.

Almost all businesses must have an Employer Identification Number (EIN), which is the same as the taxpayer identification number. Only sole proprietors are exempt, and then only if they do not file pension or excise tax returns.

Social Security taxes cover benefits provided to employees through the U.S. Social Security system, and these include Medicare, disability, retirement, and survivors and family benefits. Medicare taxes affect covered wages, but there is a wage base limit on the Social Security tax. In addition to withholding these taxes from employee earnings, the employer must also match the amount based on the tax rate.

Unemployment tax is paid by the employer, and it provides compensation to an employee who loses a job. The employee does not pay any of this tax, which is required on both the federal and state level. Employers may qualify for a federal tax credit based on the state unemployment tax.

Some experts recommend hiring a professional payroll service to take care of the required taxes and reports. The service would also take care of distributing employee wages.

Expenses That May Be Tax Deductions

Deductions reduce the amount of business income that is taxable. The IRS allows businesses to claim many expenses that are important to the running of the company. A business must be able to show that the expenses are appropriate, which includes determining if they are both necessary and reasonable.

A one-time purchase that continues to produce profits for its lifetime is called a capital expense, and it is generally deducted over a period of three, five or seven years, which is the typical life of the product. However, the entire amount may be deducted in the year of purchase through a Section 179 deduction.

Current expenses include costs and purchases that are necessary for the ongoing operation of the business. Rent and utilities, advertising and office supplies are some examples of current expenses that can be deducted from the company’s annual income total. If a person runs a company from a home office, the costs associated with this space as a percentage of the household may be deductible if it is used exclusively for the business.

IRS Audit Issues

Keeping records of assets, liabilities, income and expenses may not be enough to protect a business in the case of an audit. All business income must be reported, including items that may be considered income. Leaving anything out could result in a criminal conviction and jail time. The IRS evaluates both business and personal factors when conducting the audit.

A cash-driven business or one that lists many miscellaneous costs can alert the IRS that there may be a need for an audit. Likewise, when people claim limited business income but live as if they have a handsome salary, the IRS may decide that there may be dishonesty and determine that an audit is necessary. With precise documentation, a company can substantiate the cash flow and prove that there is no fraud.

Employers may hire independent contractors or employees, depending on their business needs, but misclassification can cause serious legal problems in an audit. The employment taxes that are necessary for employees are not required if the company hires independent contractors instead. The company cannot exercise control over how contractors perform the work required, and this is one factor that the IRS will look at in an audit.

The IRS may determine that areas where business and personal expenses seem to overlap may warrant closer scrutiny. For example, if the company car is also a personal vehicle, the IRS will want to know which miles and fuel costs were used for business. A company must be able to justify business dinners or hotel expenses so they do not appear to be personal entertainment.

The best way to avoid trouble in an audit is to learn the basics of the tax laws that apply to the company. Also, it is essential to document all aspects of the business’s assets, income, expenses and liabilities and seek professional assistance when there are areas that are beyond the scope of those who are running the company.