The Tax Cuts and Jobs Act, otherwise known as the tax reform bill includes some provisions which should prove beneficial to pass-through business owners. For those unfamiliar with the concept of pass-through businesses, they are the most common form of business ownership in the United States, particularly when it comes to small businesses. Pass-through entities include limited liability companies, partnerships, S corporations and sole proprietorships. The good news for small business owners with pass-through structured businesses is that beginning in 2019 (for tax year 2018) and running up through 2026, unless extended, they will be allowed to deduct 20% of all “qualified business income” But, the question then becomes, what exactly is qualified business income?
Qualified business income is defined as “the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer.” Less than helpful on its face, the definition turns on the meaning of a number if items, including what items are qualified. Well, put as simply as possible, qualified business income includes all business income except for a number of items, like reasonable S corporation shareholder compensation or guaranteed payments to stakeholders in an LLC, for example. But, overall, the new deduction has the potential to reduce small business taxes for pass-through entities by 20%.
Of course, this is the Internal Revenue Code, so there are a number of caveats, carveouts and specifics to ensure that abuse is curtailed and at least some semblance of fairness is written into the provision, or at least appears to be.
For example, there are phased-in caps on total income that qualify a business for the deduction and the deduction is simply unavailable for certain service trades and businesses unless they fall under certain income thresholds. Professionals in fields like law, accounting, and financial advising are not permitted to claim the deduction unless they fall under certain income benchmarks ($157,500 for single filers and $315,000 for joint filers), showing an obvious policy preference for favoring the manufacturing sector (one of those places we really only see a façade of fairness in the code).
The deduction is also limited to 50% of the W-2 wages paid by the business. So, with those caveats, it’s clear that the exact amount of the deduction is going to depend on the specific facts and circumstances of each business. For a great illustration of how the deduction for qualified business income would apply in various scenarios, I’d recommend reading Mike Piper’s detailed post on the qualified business income deduction over at Obvious Investor. Mike does a great job of using real life examples to show how the various nuances of the deduction may come into play for certain small businesses.
Regardless of the specifics, one thing is clear—the majority of small businesses operating as something other than a C corporation are going to see a benefit from this provision of the new tax law.
In the words of Benjamin Franklin, "an ounce of prevention is worth a pound of cure." Few places is that more evident than in the field of law, where taking proper measures to protect one's interests preeminently can ward off potentially messy situations down the road. Specifically, businesses that spend the time and resources to properly protect their interests before problems arise can limit their exposure to liabilities and lawsuits in the future. For that reason, it's important for every business owner to assess his or her exposure to legal risk from time to time and address any glaring holes in the business' risk mitigation practices.
When performing a legal audit of your business, ask yourself the following questions:
► Are you up to date on required filings, like your annual report, trademark and assumed business name renewals, business licenses and other registrations?
► Have you reviewed your operating agreement (if an LLC) or shareholder agreement and bylaws (if a corporation) within the last year to ensure they accurately reflect your business structure and operations?
► If you have employees have you assessed their status as exempt or non-exempt employees and determined your obligations to pay overtime?
► Have you appropriately classified your workers as employees or independent contractors?
► Do you have a written employment contract with each employer and a written consulting agreement with each independent contractor, and are they properly classified as employees or independents contractors?
► Have all employees signed non-disclosure or confidentiality agreements to protect your business’ sensitive information like client lists, business practices, marketing strategies, etc.?
► Do all directors/shareholders/partners regularly hold formal annual meetings?
► Are all business decisions recorded in writing?
► Have all transactions involving the business been properly documented?
► Is your business having difficulty collecting payment from your customers?
► Does to business have written contracts with all vendors and customers?
► Have you secured your trademarks?
► Have you reviewed your insurance in the past year with your agent to ensure sufficient coverage types and amounts?
If, after thinking about those questions you feel there are potential areas that may need to be addressed, drop us a line. Let's make sure we tackle things before they turn into expensive issues. You've worked hard to build your business, let us help protect it.
Hiring your first employee is an exiting time for any growing small business. But, it's not as simple as just writing a paycheck to your new worker. Failure to comply with the law can have some serious consequences when it comes to labor and employment, so knowing what you're getting yourself into upfront is essential. Here are 8 standard steps that you’ll want to take before hiring your first employee in Illinois.
Step 1. Obtain an Employer Identification Number (EIN)
Before hiring your first employee, you need to get an employment identification number (EIN) from the U.S. Internal Revenue Service. The EIN is often referred to as an Employer Tax ID or as Form SS-4. The EIN is necessary for reporting taxes and other documents to the IRS. In addition, the EIN is necessary when reporting information about your employees to state agencies. Apply for EIN online or contact the IRS at 1-800-829-4933.
Step 2. Set up Records for Withholding Taxes
According to the IRS, you must keep records of employment taxes for at least four years. Keeping good records can also help you monitor the progress of your business, prepare financial statements, identify sources of receipts, keep track of deductible expenses, prepare your tax returns, and support items reported on tax returns. A payroll system, like Zen Payroll (zenpayroll.com) can take care of everything for you for a monthly fee. There are others out there as well, but Zen will actually help with new hire paperwork and reporting, which is something many others don’t include.
Below are three types of withholding taxes you need for your business:
Federal Income Tax Withholding - Every employee must provide an employer with a signed withholding exemption certificate (Form W-4) on or before the date of employment. The employer must then submit Form W-4 to the IRS. For specific information, read the IRS' Employer's Tax Guide [PDF].
Federal Wage and Tax Statements - Every year, employers must report to the federal government wages paid and taxes withheld for each employee. This report is filed using Form W-2, wage and tax statement. Employers must complete a W-2 form for each employee who they pay a salary, wage or other compensation. Additionally, you will be required quarterly to file an IRS form 941 to indicate employment taxes due for that quarter and an IRS Form 940 annually to report any unemployment taxes due. Employers must send Copy A of W-2 forms to the Social Security Administration by the last day of February to report wages and taxes of your employees for the previous calendar year. In addition, employers should send copies of W-2 forms to their employees by Jan. 31 of the year following the reporting period. Visit SSA.gov/employer for more information.
State Taxes - Depending on the state where your employees are located, you may be required to withhold state income taxes. Visit the state and local tax page for more information. In Illinois, you’ll need to register for business tax payments at http://www.revenue.state.il.us/Businesses/register.htm
Step 3. Employee Eligibility Verification
Big thing to remember here is that you need to have each employee complete an I-9. Federal law requires employers to verify an employee's eligibility to work in the United States. Within three days of hire, employers must complete IRS Form I-9, employment eligibility verification, which requires employers to examine documents to confirm the employee's citizenship or eligibility to work in the U.S. Employers can only request documentation specified on the I-9 form.
Employers do not need to submit the I-9 form with the federal government but are required to keep them on file for three years after the date of hire or one year after the date of the employee's termination, whichever is later.
Employers can use information taken from the Form I-9 to electronically verify the employment eligibility of newly hired employees by registering with E-Verify. However, use of E-Verify is not required for private entities.
Visit the U.S. Immigration and Customs Enforcement agency’s I-9 website to download the form and find more information.
Step 4. Register with Your State's New Hire Reporting Program
All employers are required to report newly hired and re-hired employees to a state directory within 20 days of their hire or rehire date. In Illinois, you can register at http://www.ides.illinois.gov/Pages/New_Hire_Reporting.aspx If you go with Zen, I believe they will make the new hire report for you. In addition, in Illinois, once you pay out $1500 in wages over a 20 week period, you’ll be required to contribute to the state unemployment insurance fund. You will be able to make your reports and contributions here, otherwise, I believe Zen can help with that as well.
Step 5. Obtain Workers' Compensation Insurance
All businesses with employees (even a single part-time employee) are required to carry workers' compensation insurance coverage through a commercial carrier or on a self-insured basis.
Step 6. Post Required Notices
Employers are required to display certain posters in the workplace that inform employees of their rights and employer responsibilities under labor laws. If you will be having a principal place of business, you can purchase poster bundles here.
Step 7. File Your Taxes
Generally, employers who pay wages subject to income tax withholding, Social Security and Medicare taxes must file IRS Form 941, Employer's Quarterly Federal Tax Return. in addition to the state equivalents. Again, I’d invest in a good payroll system to automate this for you. For more information, visit IRS.gov.
New and existing employers should consult the IRS Employer's Tax Guide to understand all their federal tax filing requirements.
Step 8. Get Organized and Keep Yourself Informed
Being a good employer doesn't stop with fulfilling your various tax and reporting obligations. Maintaining a healthy and fair workplace, providing benefits and keeping employees informed about your company's policies are key to your business' success. Here are some additional steps you should take after you've hired your first employee:
Set up Recordkeeping
In addition to requirements for keeping payroll records of your employees for tax purposes, certain federal employment laws also require you to keep records about your employees. The following sites provide more information about federal reporting requirements:
Complying with standards for employee rights in regards to equal opportunity and fair labor standards is a requirement. Following statutes and regulations for minimum wage, overtime, and child labor will help you avoid error and a lawsuit. See the Department of Labor’s Employment Law Guide for up-to-date information on these statutes and regulations.
Overtime protections were first put into place by the Fair Labor Standards Act of 1938, and established the general standard that workers be paid time-and-a-half for any hours worked over 40 hours in a week. In general, all hourly employees are guaranteed overtime, and salaried employees are presumed to have the same guarantee unless they both: (1) make more than a salary threshold set by the Department of Labor, and (2) pass a test demonstrating that they primarily perform executive, administrative, or professional duties.
A limited number of occupations are not eligible for overtime pay (including teachers, doctors, and lawyers) or are subject to special provisions. But, in May of 2014, President Obama signed a memo requesting the Department of Labor to examine and update federal overtime regulations. They did. And, they have issued a new rule which will have a substantial effect on many small businesses throughout the country.
The final rule, which takes effect on December 1, 2016, doubles the salary threshold—from $23,660 to $47,476 per year—under which most salaried workers are guaranteed overtime (hourly workers are generally guaranteed overtime pay regardless of their earnings level). Additionally, this new level will be automatically updated every three years to ensure that workers continue to earn the pay they deserve.
Highlights of the new regulation, which all small businesses should be aware of include:
- it raises the salary threshold at which white-collar workers are exempt from overtime pay from $23,660 to $47,476.
- The Labor Department estimates an additional 4.2 million executive, administrative and professional workers who earn above the old threshold but below the new one will be entitled to time-and-a-half wages for each hour they work beyond 40 a week.
- both salaried and hourly workers eligible for overtime pay if they fall under the threshold, unless they meet very specific requirements which classify them as an executive, administrative, professional or outside sales employee.
- it is anticipated that there may be an increase in the conversion of salaried employees to hourly employees in order to enable employers to track overtime hours more easily.
So what should you do if you’re an employer?
-Learn about the new rules. The White House has a nice summary of the new overtime rules here.
-talk with an employment lawyer about how you may be affected with your current employees and determine what may need to be done in order to remain compliant.
Michael F. Brennan is an attorney at the Virtual Attorney™ a virtual law office helping clients in Illinois, Wisconsin, and Minnesota with estate planning and small business legal needs. He can be reached email@example.com with questions or comments, or check out his website atwww.thevirtualattorney.com.
The information contained herein is intended for informational purposes only and is not legal advice, nor is it intended to create an attorney-client relationship. For specific legal advice regarding a specific legal issue please contact me or another attorney for assistance.