The Crafts Report : Payroll Tax Withholding

ayroll tax withholdings … three words that strike fear in the hearts of most small-business owners. And craft artisans and retailers are no exception. What comes to mind are complicated calculation tables, myriad forms, frequent deposits and reporting to the IRS, exemptions that vary widely from employee to employee and laws and tax codes that differ between the Federal government, states and even local municipalities.

Questions craft artisans ask about payroll withholding taxes

• Is there a minimum annual income level per employee below which I do not have to withhold?

This is a common misconception in craft businesses, but the answer is, “no.” You must withhold for Federal Social Security and Medicare (FICA) taxes regardless of the amount paid per year for each employee. You also must pay the company’s part of FICA taxes, as well as Unemployment Taxes and Disability Insurance Taxes if applicable. As for Federal and State Income Tax withholdings, you must withhold according to the W-4 form unless the employee claims a valid No-Tax Liability exemption.

• Is there a minimum annual payment level per sub-contractor below which I do not have to report to the IRS?

The answer to this question is, “yes,” and the amount is $600. In fact, many craft artisans confuse this threshold with FICA withholdings and mistakenly fail to withhold for employees who earn less than $600 in a year. For all subcontractors who you pay $600 or more, you are required to file a 1099.

• Is it okay to pay my employees in cash?

Yes, but it’s not recommended. Paying by check insures that you have good records of payroll-related withholdings in case you are audited or even questioned by the IRS. And you can’t use payment by cash to avoid withholdings, regardless of the amount earned by the employee.

• I do a lot of shows and subcontract with people to help work the booth and with the logistics. Are they considered employees for whom I have to withhold?

The answer to this question is, “probably not.” As long as they are true subcontractors, you are not required to withhold, no matter how much you pay them.

• If my craft business is set up as a sole proprietorship and I’m paying quarterly estimated taxes and annual Self-Employment tax, is there a certain income level at which I should start withholdings even if I am the only employee?

As long as you are legally structured as a sole proprietorship, you may handle income and FICA-related taxes without the hassle of withholdings. However, your CPA can advise you on the income level at which it might become financially advantageous to you to convert your business to a corporation and begin withholdings on yourself.

• How do I avoid paying the Self-Employment Tax if I am set up as a sole proprietorship?

Unfortunately, as long as you are set up as a sole proprietor, you will be required to pay the Self-Employment Tax. But if you convert to a corporation, you still will pay a similar amount with the 7.65 percent that would be withheld from your check plus the 7.65 percent you would have to pay as the employer.

• Where do I get all the forms I need?

Most payroll software packages also include all the applicable forms with customization depending on the state in which you operate. You also can obtain the forms you need by contacting the IRS by phone (1-800-TAX-FORM) or on the Internet at www.irs.gov.

• Should I use an outside service for my payroll?

Many small-business owners use outside vendors for all payroll needs. These vendors can issue all payroll checks, calculate withholdings, provide all financial reporting to the IRS and generally keep you out of trouble. Automated Data Processing (ADP, www.adp.com) is considered by most to be the industry leader, but there are many others. And most will take an account with as few as one employee. Some accounting firms also provide payroll services.

And if that isn’t enough of a burden for the small-business owner, stiff monetary penalties are charged for even innocent mistakes.
If you employ any other people in your craft business, or if you’re incorporated with you as the only employee, you must comply with payroll tax withholding laws and regulations.

Even if you are a one-person shop set up as a sole proprietor, you are subject to payment of estimated income taxes and self-employment taxes. So, even the smallest craft business must deal with payroll tax withholding laws.

DO NOT TRY THIS AT HOME!

Payroll withholding taxes are kind of like those car commercials you see with a professional driver navigating a tricky closed course. You should seek a trained professional (CPA or accountant) to assist you in the interpretation of and compliance with complex withholding laws.

Your CPA deals with these regulations every day, and should keep you out of trouble and help you avoid costly penalties associated with non-compliance.

There are many very affordable payroll software programs that take the guesswork out of much of the computation and filings necessary to remain in compliance. Even if you have only one or two other employees, you might find it well worth the investment (some are under $1,000) to install a good, basic payroll program.

WHAT COMPENSATION IS TAXABLE?

According to the IRS, taxable compensation includes any payment to an employee for services rendered. These payments can take the form of salary, commissions, bonuses, fees, etc. The withholding laws are applicable for all employees, even part-time and minors, except for a few instances involving compensation to family members.

What forms of compensation are not taxable and, therefore, not subject to withholdings? The most common include:

The taxes employers are required to withhold vary from state to state and sometimes from city to city within a state. Your CPA or the IRS can tell you which taxes and corresponding withholdings are applicable to your jurisdiction.

Federal income taxes apply to all craft business owners in the United States. The IRS provides a tax table that is also available in most payroll software packages. (This table can be obtained by calling 1-800-TAX-FORM and asking for Publication 15, Circular E, “Employer’s Tax Guide,” or by going online to the IRS Web site at www.irs.gov.)

Federal taxes to be withheld are computed based on gross wages reduced by the number of exemptions ($3,000 per exemption in 2002) claimed by the employee on his W-4 form.

Exemptions can be taken for the employee, a spouse, children and other dependents and for itemized deductions. The employer must minimally withhold the amount indicated by the tax table, even if the employee requests a lower withholding level. However, more can be withheld at the request of the employee.

State income taxes must also be withheld in most states. Tax tables are provided by the state with the computation process working similarly to the process to calculate Federal withholdings. The states that do not have an income tax (and no state tax withholdings) are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Washington and Wyoming. Some cities also require local income taxes to be paid.

Other Withholding Taxes

Here are the other major withholding taxes:

Federal Insurance Contributions Act (FICA) Taxes — There are two taxes included in FICA, Social Security and Medicare. The Social Security tax rate is 6.2 percent, and the Medicare rate is 1.45 percent — both payable on gross income (no withholding exemptions allowed). So, the total rate is 7.65 percent to be withheld from each employee.

Payroll taxes mean considerable paperwork and attention to detail

Part I of this two-part guide explains where to get help organizing and maintaining your records and the types of taxable compensation and withholding taxes. In March, Part II will discuss payroll forms and payment schedules as well as how to determine if your crafts helper is an employee or an independent contractor.

The employer also is required to match the taxes paid to the Federal government at the same rate on gross income.
There is a cap on wages subject to the Social Security tax ($84,900 in 2002 compared to $80,400 in 2001) with no such cap associated with the Medicare tax.

Federal Unemployment Tax — The FUTA tax is levied on employers (and paid by the employer) based on the wages paid to employees.

FUTA taxes must be paid by a craft business if: 1) you have paid aggregate wages to all employees of at least $1,500 in a calendar quarter; or 2) you have at least one employee for at least 20 different weeks (not necessarily consecutive) during a calendar year.

The FUTA tax rate is 6.2 percent on the first $7,000 of wages paid to each employee. A credit can be taken against the FUTA tax of 5.4 percent, reducing the effective FUTA rate to 0.8 percent, if state unemployment taxes have been paid on time. This credit applies even if the state unemployment tax rate is lower than 5.4 percent.

State Unemployment Tax — As with the FUTA tax, this tax is levied on and paid by the employer. Rates vary from state to state, and generally are based on the employer’s record of causing involuntary unemployment. So, the fewer layoffs and firings you have resulting in unemployment claims, the lower your rate will be. For this reason, it is advisable to monitor unemployment claims against your company for any that you might want to dispute.

State Disability Insurance Tax — In California, Hawaii, New Jersey, New York, Puerto Rico and Rhode Island, employers are required to pay a State Disability Insurance Tax on behalf of their employees.

-J. Tol Broome Jr. has worked for over 18 years in commercial lending. He has written on business topics in Nation’s Business, The Writer, Bank Management and various trade publications.

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