One of the most laborious tasks for small businesses is managing payroll. But it’s critical that you not only withhold the right amount of taxes from employees’ paychecks but also that you pay them over to the federal government on time.

If you willfully fail to do so, you could personally be hit with the Trust Fund Recovery Penalty, also known as the 100% penalty. The penalty applies to the Social Security and income taxes required to be withheld by a business from its employees’ wages. Since the taxes are considered property of the government, the employer holds them in “trust” on the government’s behalf until they’re paid over.

The reason the penalty is sometimes called the “100% penalty” is because the person liable for the taxes (called the “responsible person”) can be personally penalized 100% of the taxes due. Accordingly, the amounts the IRS seeks when the penalty is applied are usually substantial, and the IRS is aggressive in enforcing it.

Responsible persons

The penalty can be imposed on any person “responsible” for the collection and payment of the taxes. This has been broadly defined to include a corporation’s officers, directors, and shareholders under a duty to collect and pay the tax, as well as a partnership’s partners or any employee of the business under such a duty. Even voluntary board members of tax-exempt organizations, who are generally exempt from responsibility, can be subject to this penalty under certain circumstances. Responsibility has even been extended in some cases to professional advisors.

According to the IRS, being a responsible person is a matter of status, duty and authority. Anyone with the power to see that the taxes are paid may be responsible. There is often more than one responsible person in a business, but each is at risk for the entire penalty. Although taxpayers held liable may sue other responsible persons for their contributions, this is an action they must take entirely on their own after they pay the penalty. It isn’t part of the IRS collection process.

The net can be broadly cast. You may not be directly involved with the withholding process in your business. But let’s say you learn of a failure to pay over withheld taxes and you have the power to have them paid. Instead, you make payments to creditors and others. You have now become a responsible person.

How does the IRS define “willfulness”?

For actions to be willful, they don’t have to include an overt intent to evade taxes. Simply bowing to business pressures and paying bills or obtaining supplies instead of paying over withheld taxes due to the government is willful behavior for these purposes. And just because you delegate responsibilities to someone else doesn’t necessarily mean you’re off the hook.

In addition, the corporate veil won’t shield corporate owners from the 100% penalty. The liability protections that owners of corporations — and limited liability companies — typically have don’t apply to payroll tax debts.

If the IRS assesses the penalty, it can file a lien or take levy or seizure action against the personal assets of a responsible person.

Payroll Services to Avoid the Penalties

You should never allow any failure to withhold taxes from employees, and no “borrowing” from withheld amounts should ever be allowed in your business — regardless of the circumstances. All funds withheld must be paid over on time.

If you aren’t already using a payroll service, consider hiring one. This can relieve you of the burden of withholding and paying the proper amounts, as well as handling the recordkeeping. Contact us for more information.

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© 2019, Provided by Thomson Rueters Checkpoint

Do you owe self-employment (SE) tax on non-wage income that you collect only occasionally or in a one-off circumstance? Some sources of income may not be subject to the dreaded SE tax. Here’s what you should know if you earn income from “irregular” sources.

Reality Check: Random Income Isn’t Tax-Free

Irregular income might be free from self-employment (SE) tax, because it’s not from a trade or business. But it’s not federal-income-tax-free. Under the tax law, it’s treated as miscellaneous income, which is fully taxable. State income tax may also be due.

What Is Self Eemloyment Tax?

SE tax is the way the U.S.Treasury Department collects Social Security and Medicare taxes on non-wage income from business-related activities. For 2019, the SE tax rate is 15.3% on the first $132,900 of net SE income. The rate has two components: 12.4% for the Social Security tax, and 2.9% for the Medicare tax.

Above the $132,900 threshold, the Social Security tax component goes away, but the 2.9% Medicare tax continues before rising to 3.8% at higher income levels. There’s no limit on the Medicare tax component. 

Individuals who are regularly self-employed must include SE tax with their quarterly estimated federal income tax payments to avoid an interest charge penalty.

Important: The Social Security Administration recently announced that in 2020 the 15.3% maximum SE rate will apply to the first $137,700 of net SE income. That ceiling is up by 3.6% compared to 2019. Meanwhile, Social Security benefit payments will go up by only 1.6% next year.  

Will You Owe It on Random Income?

SE tax applies only to individuals who engage in a trade or business. So, if you’re not regularly self-employed and you earn income from some random work, occurrence or one-off circumstance, you don’t owe SE tax — even if the income would be subject to SE tax if you were regularly self-employed in that activity.

You don’t owe SE tax unless the net income in question is from a trade or business. In the landmark Groetzinger case, the U.S. Supreme Court ruled that an activity must be conducted with “continuity and regularity” and with a “profit motive” to incur SE tax. Therefore, income earned from an isolated or sporadic activity isn’t generally subject to SE tax because the random activity doesn’t rise to the level of a trade or business.

The U.S. Tax Court reaffirmed this treatment in its 2016 Ryther decision. Here, the former owner of a steel company had income from sales of scrap metal that he had stockpiled over the years before his steel company was dissolved. The court opined that the income was excluded from net SE income. The scrap metal was neither inventory nor primarily held for sale to customers in the ordinary course of a trade or business. The taxpayer’s sales occurred only once or twice per month and only once per day. Therefore, the sales were too sporadic to constitute a trade or business, and the income wasn’t subject to SE tax. 

Hypothetical Examples

Here are five examples to show how the trade or business standard might be applied.

1. Jim the self-employed construction supervisor. Jim regularly works for a few construction companies. He agrees to supervise the construction of a neighbor’s new home in his “spare time” and collects $30,000 for his efforts.

This is the first time Jim has done this kind of sideline work. The IRS might argue that it’s so closely related to his regular self-employed work that he owes SE tax on the $30,000. However, Jim could reasonably take the position that he does not owe SE tax on income from a one-off activity. This is a situation that would require input from a tax professional.  

2. Tim the construction company employee. Tim is employed full-time by a construction company as a construction supervisor. Similar to the previous scenario, he agrees to supervise the construction of a neighbor’s new home in his “spare time” and collects $30,000 for his efforts.

This is the first time Tim has done this kind of sideline work. The IRS might argue that he owes SE tax on the $30,000 because the sideline work is so closely related to his regular job. In other words, the IRS might claim that Tim is in the business of being a construction supervisor — as an employee or otherwise.

But Tim has never before done such work on a self-employed basis. So, he could reasonably take the position that he does not owe SE tax on income from a one-off activity. This is another situation that would require input from a tax pro.    

3. Abby the former active realtor. For years, Abby was an active realtor, but she took time off to be a stay-at-home mom. She has maintained her realtor license “just in case.” In 2019, she earns a $30,000 fee for referring an acquaintance to another realtor who sells the acquaintance’s home for a significant commission.

It’s clear that Abby isn’t currently in the realtor business. So, it’s highly unlikely that the IRS could successfully argue that she owes SE tax on the $30,000 referral fee.   

4. Gabby the former part-time realtor. A few years ago, Gabby dabbled as a part-time realtor, but she lost interest. Even so, she maintained her realtor license “just in case.” In 2019, she earns a $30,000 fee for referring an acquaintance to another realtor who sells the acquaintance’s home for a significant commission.

It’s clear that Gabby isn’t currently in the realtor business. So, it’s highly unlikely that the IRS could successfully argue that she owes SE tax on the $30,000 referral fee.

Even if Gabby gets lucky several years in row, earning a referral fee now and again, it seems reasonable to take the position that she doesn’t owe SE tax on random referral fees that she collects just by answering the phone and making an occasional call to another realtor. This sporadic activity doesn’t constitute a trade or business, because Gabby doesn’t do it with continuity and regularity. But it’s another situation that should be discussed with a tax pro.     

Important: If you take the position that irregular income is SE-tax-exempt because it’s not from a trade or business, you relinquish the right to claim deductions for any related expenses. For example, neither Abby nor Gabby would be able to write off their annual realtor license fees or the costs of continuing education classes to keep their licenses in force.

5. Jake the teenage entrepreneur. This summer, 16-year-old Jake mowed lawns, painted fences and took care of pools for some neighbors. He earned $3,000 from these activities. He doesn’t owe SE tax on this income. Why? As a full-time high school student, Jake’s not in the yard care and outdoor home maintenance business, even if he does such work several summers in a row.    

Bottom Line

Random income is often SE-tax-exempt — and there are categories of non-random income that are also SE-tax-exempt, such as billboard rental income where your only real “work” is cashing checks. If you have questions or want more information on this issue, check with your tax advisor.

Commissioner v. Robert P. Groetzinger, 480 U.S. 23 (1987)

Thomas L. Ryther v. Commissioner, TC Memo 2016-56 (March 28, 2016)

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© 2019, Provided by Thomson Rueters Checkpoint

It’s hard to believe 2019 is almost over! It’s been a busy year in many sectors, often forcing small business owners to put tax planning on the back burner while they’ve tended to daily business operations.

But procrastinate no longer. Consider the following moves to lower your 2019 business tax bill before ringing in the New Year.

Time Income and Deductions from Pass-Through Entities

Most small businesses are set up as sole proprietorships or “pass-through” entities, such as partnerships, S corporations and limited liability companies (LLCs) that are treated as partnerships for tax purposes. Income and deductions from pass-through entities are allocated to the owners based on their ownership percentage in their businesses. Your pro rata share of a pass-through entity’s net income is taxed at your personal rates.

Under the Tax Cuts and Jobs Act (TCJA), individual federal income tax rate brackets will basically be the same for 2019 and 2020, with modest adjustments for inflation. (See “2019 and 2020 Individual Tax Brackets” below.)

So, the traditional strategy of deferring income from these entities into next year while accelerating deductible expenditures into this year makes sense if you expect to be in the same or a lower tax bracket next year. Deferring income and accelerating deductions will, at a minimum, postpone part of your tax bill from 2019 until 2020.

However, if you expect to be in a higher tax bracket in 2020, take the opposite approach. Accelerate income into this year (if possible) and postpone deductible expenditures until 2020. That way, more income will be taxed at this year’s lower rate instead of next year’s higher rate.

Maximize the Deduction for Income from a Pass-Through Entity

Under current tax law, owners of pass-through entities (including sole proprietorships) may be eligible for a deduction based on qualified business income (QBI) for tax years beginning in 2018 through 2025. The deduction can be up to 20% of a pass-through entity owner’s QBI, subject to restrictions that can apply at higher income levels and another restriction based on the owner’s taxable income.

The QBI deduction is available only to noncorporate taxpayers, meaning individuals, trusts and estates. It also can be claimed for up to 20% of income from qualified real estate investment trust (REIT) dividends and 20% of qualified income from publicly traded partnerships (PTPs).

Because of various limitations on the QBI deduction, tax planning can help increase your allowable QBI deduction. For example, before year end, you might be able to increase W-2 wages or purchase additional business assets to help boost your QBI deduction.

Also, be aware that moves designed to reduce this year’s taxable income (such as postponing revenue or accelerating expenses) can inadvertently reduce your QBI deduction. Work with your tax pro to anticipate any adverse side effects of other tax planning strategies and optimize your results on this year’s return.

Claim 100% Bonus Depreciation for Asset Additions

Under current law, 100% first-year bonus depreciation is available for qualified new and used property that’s acquired and placed in service in calendar year 2019. That means your business might be able to write off the entire cost of some (or all) of your 2019 asset additions on this year’s return.

Bonus depreciation isn’t subject to any spending limits or income-based phaseout thresholds. But the program will be gradually phased out, starting in 2023, unless Congress extends it.

Consider buying some extra equipment, furniture, computers or other fixed assets before year end. Your tax advisor can explain what types of assets qualify for this break.

One type of asset that could deliver a big write-off on your 2019 tax return is a “heavy” vehicle. Heavy SUVs, pickups and vans that are used over 50% for business are treated for tax purposes as transportation equipment. So, they qualify for 100% bonus depreciation.

Specifically, bonus depreciation is available when the SUV, pickup or van has a manufacturer’s gross vehicle weight rating (GVWR) above 6,000 pounds. You can verify a vehicle’s GVWR by looking at the manufacturer’s label, which is usually found on the inside edge of the driver’s side door (where the door hinges meet the frame).

Cash in on More Generous Section 179 Deduction Rules

For qualifying property placed in service in tax years beginning in 2019, the TCJA increased the maximum Sec. 179 expensing amount to $1 million, adjusted annually for inflation. For 2019, the inflation-adjusted amount is $1.02 million. (Under prior law, the limit was $510,000 for tax years beginning in 2017.)

The TCJA provides other beneficial changes to the Sec. 179 expensing rules, including:

Property used for lodging. The TCJA repealed the prior-law provision that excluded from Sec. 179 expensing personal property used to furnish lodging. So now eligible property qualifies for a tax break. This change goes into effect for property placed in service in tax years beginning in 2018 and beyond. Examples of such property include:

• Furniture,
• Kitchen appliances,
• Lawnmowers, and
• Other equipment used in the living quarters of a lodging facility or in connection with a lodging facility, such as a hotel, motel, apartment house, rental condo or rental single-family home.

Qualifying real property. Sec. 179 expensing can be claimed for qualifying real property expenditures, up to the maximum annual allowance. There’s no separate limit for qualifying real property expenditures, so Sec. 179 deductions claimed for real property reduce the maximum annual allowance dollar for dollar.

Qualifying real property refers to any improvement to an interior portion of a nonresidential building that’s placed in service after the date the building is first placed in service. However, costs attributable to the enlargement of a building, any elevator or escalator, or the building’s internal structural framework don’t qualify.

For tax years beginning in 2018 and beyond, the TCJA expanded the definition of real property eligible for Sec. 179 expensing to include qualified expenditures for roofs, HVAC equipment, fire protection and alarm systems, and security systems for nonresidential real property. These items must be placed in service in tax years beginning after 2017, and after the nonresidential building has been placed in service.

Important note: Various limitations apply to Sec. 179 expensing deductions, especially if you conduct your business as a pass-through entity.

Sell Qualified Small Business Stock

A 100% federal gain exclusion break is potentially available when you sell qualified small business corporation (QSBC) stock that was acquired after September 27, 2010. That equates to a 0% federal income tax rate if the shares are sold for a gain.

However, you must hold the shares for more than five years to benefit from this break. Be aware that it’s not available to QSBC stock that’s owned by a C corporation. Plus, many companies won’t meet the definition of a QSBC in the first place. Your tax professional can help explain the details.

Meet with Your Tax Pro Before Year End

A positive side effect of congressional gridlock is that the tax law hasn’t changed much over the last year. Most TCJA provisions that affect small businesses went into effect in 2018, and the year-end tax planning strategies that worked for 2018 are generally valid for the current tax year.

However, your specific business situation might have changed. Don’t assume that last year’s strategies will minimize your 2019 tax bill. Work with your tax pro to identify the optimal year-end tax planning moves based on your current circumstances.

2019 and 2020 Individual Tax Brackets

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© 2019, Provided by Thomson Rueters Checkpoint