I just started my own business the other month. Obviously I'm going to have a bit to write off on taxes next year, and starting it so late in the year I'm making very little profit from it. I currently have zero employees, including myself. Next year however I'd like to start paying myself as well as hire a few people on a contractor basis. I would like to pay them by check in the agreed amount and have them take care of their own taxes. If I have the employees take out their own taxes, do I still need to report how much I paid to who? If so what papers do I need to fill out?
If you are going to be paying independent contractors for your business then you should apply for an Employer Identification Number from the IRS - https://www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-n...
You are required to issue a Form 1099-MISC to each independent contractor you pay if the payment is $600 or more - https://www.irs.gov/forms-pubs/about-form-1099-misc
For information on self-employment, go to this IRS website - https://www.irs.gov/businesses/small-businesses-self-employed/self-employed-individuals-tax-center
Some general info on self employment...........
You will need to keep good records. You may get a 1099Misc at the end of the year if someone pays you more than $600 but you need to report all your income no matter how small. You might want to use Quicken or QuickBooks to keep track of your income and expenses.
There is also QuickBooks Self Employment bundle you can check out which includes one Turbo Tax Online Self Employed return....
When you are self employed you are in business for yourself and the person or company that pays you is your customer or client.
To report your self employment income you will fill out schedule C in your personal 1040 tax return and pay SE self employment Tax. You will need to use the Online Self Employed version or any Desktop program but the Desktop Home & Business version will have the most help.
Self Employment tax (Scheduled SE) is automatically generated if a person has $400 or more of net profit from self-employment. You pay 15.3% SE tax on 92.35% of your Net Profit greater than $400. The 15.3% self employed SE Tax is to pay both the employer part and employee part of Social Security and Medicare. So you get social security credit for it when you retire. You do get to take off the 50% ER portion of the SE tax as an adjustment on Schedule 1 line 27. The SE tax is already included in your tax due or reduced your refund. It is on the Schedule 4 line 57. The SE tax is in addition to your regular income tax on the net profit.
Here is some IRS reading material……
IRS information on Self Employment
Pulication 334, Tax Guide for Small Business
Publication 535 Business Expenses
If you are self employed/sole proprietor etc. you cannot deduct your own salary or any personal withdrawals you make from your business. As a sole proprietor, you are not an employee of the business. The business is a disregarded entity and the Net Profit or Loss is your personal income or expense.
I just started my own business the other month
All of the responses in this thread are based on an unfounded assumption that your business is a sole proprietorship or single member LLC, which gets reported on SCH C as a physical part of your personal 1040 tax return. (single or joint doesn't matter.) Just so you know, when you have a sole proprietorship or single member LLC, under no circumstances and with no exceptions can *you* the owner be an employee of that business. You will never issue yourself a W-2, 1099-MISC or any other kind of tax reporting document. Not ever.
I would suggest you read the below to understand the different business types and *MAKE* *ABSOLUTELY* *CERTAIN* you are following all the laws, rules and regulations for whatever business type you have. Failure to do so can (and most likely will) result in high fines and penalties that can (and most likely will) bankrupt your business before you even get it off the ground.
So what type of business do you have?
Sole Proprietorship – This is a business with one owner, and only own owner. There are no other investors or share holders. This type of business is considered a “disregarded entity” by the IRS. All income and expenses for the business are reported on SCH C as a physical part of the owner’s personal tax return. Again, a sole proprietorship has only own owner. Depending on what state the business is in, registration is not required at the state level. But it may be required at the county, town, or other level of government below the state. For example, your county may require you to register and obtain a county issued Occupational License, which authorizes you to conduct business only within the jurisdiction of the authority that issued the Occupational License. This is most often required when the county, city or other authority below the state taxes personal income or imposes a tangible property tax on business assets utilized to produce business income.
Single Member LLC - This is a business with one owner, and only own owner. There are no other investors or share holders. This type of business is considered a “disregarded entity” by the IRS. All income and expenses for the business are reported on SCH C as a physical part of the owner’s personal tax return. Again, a single member LLC has only own owner. This type of business is required to be registered at the state level, weather that state taxes personal income or not. Additionally, this type of business may also be required to obtain an Occupational License for the county(s), city(s) or other more localized jurisdictions within that state, in which the business will be operating in.
Multi-Member LLC – This is a business with more than one owner. It’s also the exact same as a Partnership (for tax purposes) This type of business also has to register at the state level, and may also be required to obtain an Occupational License from more localized jurisdictions within the state, in which that business will operate. This type of business will file its own physically separate tax return with the IRS (and state if applicable) referred to as a Partnership Return, on IRS Form 1065. When completing the 1065 (using TurboTax) the business will issue each individual owner a K-1 reporting the income (or loss) of each owner. Each owner will use this K-1 to complete their personal return. So an owner can’t even start their personal return, until after the 1065 Partnership Return has been complete, filed, and all K-1’s issued to all owners.
In the community property states of Louisiana, Arizona, California, Texas, Washington, Idaho, Nevada, New Mexico, and Wisconsin if you have a multi-member LLC where there are only two owners, those two owners are legally married to each other, and those two owners will be filing a joint 1040 tax return, they have the option of splitting all business income and expenses down the middle and each partner reporting their share of the business income/expenses on a separate SCH C for each tax filer on the joint return. That means your joint 1040 return will have two SCH C’s included with it – one for each owner. But this can present its own problems in the event of divorce, separation. The issues can become even more compounded upon the death of one of the owners. If that deceased owner’s will does not pass all assets to the surviving partner, then that surviving partner can find themselves in a tax hell, not to mention the problems that can arise with the “new” owner or owners.
LLC “Like an S-Corp” – For tax purposes only (and I reiterate: FOR TAX PURPOSES ONLY!!!!!) one can elect to have the IRS treat their single member LLC or multi-member LLC “like an S-Corp” ****FOR TAX PURPOSES ONLY!!!!!**** This means your business is treated like and considered to be a physically separate taxable entity. This is accomplished by filing IRS Form 2553 – Election by Small Business Corporation. This allows you to act as if your single member LLC or multi-member LLC is an S-Corp. But understand that if you want the IRS to treat your LLC like an S-Corp, then the business “must” act like an S-Corp, and follow all the laws, rules and regulations required of an S-Corp by whichever state your LLC is registered in. All business income and expenses is reported on IRS Form 1120-S – Income Tax Return For An S-Corporation. The S-Corp will then issue each owner, investor and/or shareholder a K-1 which they will need before they can even start their personal tax return. Unlike a single member LLC which is considered a disregarded entity for tax purposes, an LLC that has filed form 2553 “is” considered and treated like a separately taxable entity.
LLC “Like a C-Corp” – For tax purposes only (and I reintereate: FOR TAX PURPOSES ONLY!!!!!) one can elect to the the IRS treat their single member LLC or multi-member LLC “like a C-Corp” ****FOR TAX PURPOSES ONLY!!!!!**** This means your business is treated like and considered to be a physically separate taxable entity. This is accomplished by filing IRS Form 8832 – Entity Classification Election. This allows you to act as if your single member LLC or multi-member LLC is a Corp. But understand that if you want the IRS to treat your LLC like a C-Corp, then the business “must” act like a C-Corp and follow all the laws, reules and reguations required of a C-Corp by whichever state your LLC is registered in. All business income and expenses is reported on IRS Form 1120 – IU.S. Corporation Income Tax Return.
S-Corp – This type of business is registered at the state level and must conform to the laws, rules, regulations and ordinances of that state which apply to an S-Corp. All business income and expenses is reported on IRS Form 1120-S – Income Tax Return For An S-Corp. The S-Corp will then issue each owner, investor and/or shareholder a K-1 which they will need before they can even start their personal tax return. Unlike an LLC which is considered a disregarded entity for tax purposes, an S-Corp “is” a separately taxable entity, and therefore files its own physically separate tax return and issues K-1’s to all owners, officers, investors and shareholders.
C-Corp - This type of business is registered at the state level and must conform to the laws, rules, regulations and ordinances of that state which apply to a C-Corp. All business income and expenses is reported on IRS Form 1120 – Income Tax Return For A C-Corp. A C-Corp “is” a separately taxable entity, and therefore files its own physically separate tax return.
Additional Information For Rental Property Owners
Occasionally a rental property owner will be “convinced” they need to put their rental property into an LLC (be it single owner or multi-owner LLC) as a means of protecting themselves and their personal assets from legal litigation should they ever be sued by a tenant. The property owner is told the LLC gives them and their personal assets a “veil of protection” from any legal litigation that may arise as the result of legal actions perpetrated by a rental tenant. Nothing could be farther from the truth. If you check court records (even in your local area) you’ll probably find numerous cases where a tenant sued their landlord and the LLC provided practically no protection of the property owner’s assets. That “veil of protection” supposedly offered by an LLC is so thin, even a new first time lawyer has no problem piercing that veil and attacking the personal assets of the property owner on behalf of the tenant. There are other problems and issues with this too.
In order to legally transfer ownership of rental property to an LLC, the owner must have the permission of the mortgage holder. No lender in their right mind will give this permission either. Even if you think you can refinance the property or “sell” it to your LLC, unless your LLC has the cash on hand to pay for it in full, your LLC will never qualify for the mortgage loan. The lender doesn’t want to risk your LLC going under (by filing bankruptcy for example), and they lose money because of it. So I’m confident in telling you, that’s not going to happen.
When you create an LLC for your rental property, it’s generally understood that business income gets reported on SCH C as a part of your personal tax return. However, a SCH C business produces “earned” income, and a rental property produces “passive” income. What’s the difference?
Earned income is income which you have to do out and “do something” in order to earn it. This income is subject to regular income tax, and also an additional 15.3% self-employment tax. The SE tax is basically the employer side of your social security and Medicare. But rental income is not “earned” income, and therefore is not reported on SCH C. So if you create an LLC for your rental property, then absolutely nothing concerning that rental property will be reported on SCH C. Not one penny of rental income and not one penny of rental expenses.
Rental income is “passive”. That’s because all you do with rental property on a recurring basis is just “sit there” and collect the rent every month. You are not “doing anything” to “earn” it on a recurring basis. That’s why rental income is reported on SCH E. Rental income is subject to regular tax, but is NOT subject to the additional self-employment tax. This means that rental income DOES NOT COUNT for your social security account or Medicare contributions.
SO if you create an LLC for your rental property, there are two things that will NOT happen.
- You will not be able to “legally” transfer ownership of the property from you, to the LLC unless you have a really dumb lender.
- You will not report one penny of rental income or one penny of rental expense on SCH C.
So in the end, you will be filing a zero income/expense SCH C with your personal tax return.
Now let’s say you decide to file the 8832 to treat your LLC like an S-Corp, and then you transfer ownership of the property to your LLC. You can and will report your rental income on SCH E as a part of the 1120-S Corporate Return, and you will also report the K-1 on SCH E as a part of your personal tax return. But keep in mind that this is for ***TAX PURPOSES ONLY!!!****. So if a tenant sues you, I seriously doubt the courts will recognize your S-Corp, and I seriously doubt the court will recognize the S-Corp as a physically separate owner of the property. Remember, that 8832 Entity Classification Election is for “TAX PURPOSES ONY”. It has no weight at all for any and all other legal purposes – such as you being sued by a tenant.
SO if you want to do this (and it still makes no financial sense) then form an actual S-Corp and transfer ownership of the property to the S-Corp. More than likely the lender won’t allow the transfer. But you can sell the property to the S-Corp if the S-Corp can qualify for a mortgage loan. Overall though, it’s still financially dumb to do this. Here’s why I say that.
When you move out of your primary residence and convert it to residential rental real estate, you have to convert your homeowner’s insurance policy to a rental dwelling policy. Or if you buy the real estate as rental property outright, then you have to obtain a rental dwelling policy at that time. A rental dwelling policy will, at a minimum, include $300,000 of liability coverage. For most that will suffice. But if the property is in certain areas of the country you may want more liability coverage. I have three rentals myself and have a total of $1,000,000 of liability on each. It cost me less than an additional $100 a year on the insurance for each property. So for me, it’s worth it. It’s also significantly cheaper not only in money, but in time spent dealing with corporate taxes and all that other additional paperwork crap.
One mistake I see quite often is that when an owner converts their primary residence or 2nd home to rental property, and they fail to update their insurance policy. This can bite when you have a claim. If the property is insured as your primary residence, but you are using it as rental property (which is other than it’s insured use) don’t be surprised when the insurance company denies your claim, and you can’t find any lawyers that will take your case. If it’s a case of you being sued by a tenant, then to be honest and put it bluntly, you’re screwed.
Next year however I'd like to start paying myself as well as hire a few people on a contractor basis.
what form is the business? if a sole proprietorship, or single member LLC not electing to be tax as a Corporation, you don't take a salary. you'll file schedule C. all the income and expenses of the business are reported there so any money you take out (salary) is not taxed again . you should probably have a business checking account and if needed credit card account. separate accounts makes it easier to separate personal from business expenses. it's also better should you ever be audited. make sure to keep support for expenditures for 6 years.
you talk about independent contractors exceptions to issuing 1099-misc if amount paid $600 or more
Exceptions. Some payments do not have to be reported on
Form 1099-MISC, although they may be taxable to the
recipient. Payments for which a Form 1099-MISC is not
required include all of the following.
• Generally, payments to a corporation (including a limited
liability company (LLC) that is treated as a C or S
corporation). However, see Reportable payments to
• Payments for merchandise, telegrams, telephone, freight,
storage, and similar items.
• Payments of rent to real estate agents or property
managers. However, the real estate agent or property
manager must use Form 1099-MISC to report the rent paid
over to the property owner.
make sure to get a tax ID number from them before they start to work. afterwards they may refuse and that could subject you to penalties when filing 1099's without id #'s use form w-9
see this link for help in determining IC vs employee
should you misclassify an employee as an independent contractor, if audited or the "employee" complains to the IRS that taxes should have been withheld, besides having to pay the payroll taxes you should have withheld, there are 100% penalty for failure to withhold and pay in certain taxes. The IRS doesn't go after the "employee" for the taxes not withheld and whether you can is a question. It is common when the IRS conducts an audit to ask for employee and independent contractor records.
besides taxes most states require that employees be covered bu workmen's compensation insurance and there can be substantial penalties for failure to cover them
as a corporation you are an employee. Failure to take a salary, especially if profitable, can result in the IRS imputing one and then hitting you for taxes, penalties and interest. again 100% penalties may apply to the failure to remit certain of these taxes.
this does mean you don't need to take a salary when unprofitable, there really are no hard and fast rules, but the longer you go without one, the greater the risks the iRS might inquire.
there are other things like good record keeping, I suggest you consult with a tax pro for the first year.
Since I just started records isnt an issue as of yet, but I'm going slow until I can be satisfied with calling my setup finished. I'll check out quickbooks. I started with my own spreed sheet on Excel for the incomes. I dont need to worry about reporting self income yet since this year I'm not paying myself, but I hope to next year. What little money the company makes is staying in the company for now...
I already know I wont be able to deduct my own salary from the business taxes, which is one reason I chose to not pay myself this year. I really didnt think I could deduct any salary from the business, but since you mentioned it can I deduct the pay I give the contractors?
I started the business as a corporation.
What kind of corporation? C-Corp? S-Corp? The legal requirements are vastly different between the two. This is important since NY is one of those states with some really strict laws for corporations. If things are done wrong, the fines and penalties are high not just at the federal level, but at the NY state level too.
I've seen many a business go bankrupt before it even gets off the ground because the owner(s) did not adequately educate themselves on the legal requirements in advance. The 20/20 hind sight made them realize that the cost of professional help for at least their first year was a pittance, in comparison to all the fines, penalties, back taxes and late fees they were assessed that bankrupted the company.