Avoid Tax Problems Over Fringe Benefits

As many small business owners know, ignoring the small stuff is sometimes dangerous; small problems can become big ones and ultimately hold you back from accomplishing your goals.

One such issue is employee fringe benefits. But you can ensure this won’t become an impediment to long-range success by creating an effective system.

Advances and reimbursements

In addition to wages, your employees likely receive other types of payments. Accounting for each of these events depends upon the processes involved and the rules apply, even if you are the only employee.

Some payments are considered taxable fringe benefits, and these are treated the same as wages; income tax withholding and payroll taxes apply, and the amounts are included on payroll reports.

Corporations must receive substantiation for expense reimbursements to avoid having to report the payments as taxable fringe benefits. Even sole proprietors and partnerships must document expenses paid as reimbursement to business owners. Without supporting evidence, cash outlays are treated as owner or partner withdrawals of taxable profit rather than deductible business expenses.

Reimbursement made under the rules for an accountable plan is not considered income for the recipient. Corporations establish accountable plans by reimbursing only reasonable expenses that have a business connection, maintaining adequate records and assuring that employees return any advances in excess of incurred business expenses.

The same standards apply to proprietors and partners claiming tax-deductible expenses for amounts their businesses pay to them as reimbursements. Small businesses can escape serious aggravation by avoiding cash advances and only reimbursing costs that are supported by receipts.

Several exceptions exist. Ensure you discuss with your accounting professional the types of reimbursement your business provides.

Employee gifts

Most employee gifts are considered taxable compensation. However, those employee gifts that meet the de minimis exception are not taxed. These extremely small gifts are excluded from treatment as taxable employee fringe benefits. The primary factor in identifying a de minimis gift is that accounting for it is unreasonable or administratively impractical based upon its value and frequency.

Exceptions for de minimis gifts only apply to non-cash items. Gifts of cash to employees are always considered taxable compensation. This includes cash equivalents such as gift cards.

Awards and discounts

Employee achievement awards dodge treatment as taxable gifts if they comprise tangible property given for length of service, productivity or safety. The average awarded amount per employee cannot exceed $400, and no employee can receive more than $1,600 in a year.

Awards for other purposes are also exempt when no single employee receives more than $400 annually. To qualify for this exemption, the awards must be governed by a written plan that doesn’t discriminate in favor of highly compensated employees.

Employee discounts are not a taxable fringe benefit as long as items are sold to employees for at least the company’s gross cost. Non-taxable discounts may also extend to spouses and dependent children of employees.

Create an effective system of accounting for employee fringe benefits, and you’ll avoid being derailed on the road to success.

Misclassified Workers Can Spell Big IRS Problems

Small businesses that are tempted to act like solopreneurs while hiring independent contractors to do the work of employees should beware; the Internal Revenue Service (IRS) is on the case.

With the popularity of contract workers, the IRS has become more diligent in seeking out misclassified workers. They’ve discovered that many businesses have them…and that’s bad news for those businesses. If the IRS finds contract workers performing as employees, the employer will be billed for unpaid payroll taxes and incur severe penalties, after which the state will demand past due unemployment insurance contributions.

Employers don’t usually withhold taxes from independent contractors. So contract workers present the IRS with a problem at tax time; it’s a hassle to collect taxes from them. It’s easier to collect withheld taxes from a single employer than from multiple independent contractors. This is why the IRS is adamant about accurate worker classification. Here are three key features that define independent contractors:

  • Contractors themselves decide the time and the way they work.
  • When you hire an independent contractor, you specify the end result, not the way it will be achieved.
  • If you provide a fixed location and tools for the job, and dictate hours, it’s nearly impossible to claim a worker is an independent contractor.

The benefits of outsourcing makes hiring contractors worthwhile; however, be diligent about classifying contractors, or the IRS may come calling.

Plan Ahead for Death, Taxes and Your IRA

“In this world nothing can be said to be certain, except death and taxes.”

This truism, attributed to Ben Franklin, raises the unthinkable: What will happen to your spouse if you die first? Or, more specifically, how can you plan for the best disposition of your Individual Retirement Account (IRA) to make the changeover relatively painless?

An IRA allows you to save money for retirement, tax deferred. Only amounts actually withdrawn from an IRA in retirement are taxable; all remaining amounts continue to grow, tax deferred, until withdrawn.

If you have an IRA, are withdrawing income from it, and have listed your partner as your beneficiary, there are choices he or she will have: Your spouse won’t have to take a lump-sum withdrawal and pay all of the income tax on it at once.

Of course, he or she can take a lump-sum withdrawal and report that entire amount as taxable income in the year the account was liquidated. But another option is treating the IRA as an “inherited” IRA and taking required minimum distributions (RMDs.) Alternatively, he or she can create a “spousal rollover” IRA.

Under the spousal rollover option, your spouse can use his or her age to determine when RMDs must begin and the correct life expectancy factor to use when calculating the RMDs.

This may be the most appealing option, but the takeaway is that you and your spouse should plan ahead. As individual circumstances differ, also consult with your advisor before making a final decision.

Avoid the Probate Process With a Living Trust

Your will is one way to plan for the distribution of your assets on your death. But it’s only one tool in your estate-planning kit, and many people establish a revocable living trust as well as a will.

A revocable living trust establishes a legal entity with the power to hold title to assets. The trust agreement lists the assets held in the trust, the individual with the power to manage and distribute those assets (the trustee), and the individuals entitled to benefit from those assets (the beneficiaries).

It allows you the flexibility of making changes during your life as circumstances change. And, depending on state law, you may be able to act as trustee and receive income from the trust as a beneficiary during your life.

The advantage of a revocable living trust is that whereas a will must go through the probate process, a revocable living trust typically avoids this and the pitfalls usually associated with it.

Because the trust is unlikely to be subject to the probate process, distributions in accordance with the terms of the trust will not be delayed and can occur as soon as practicable after your death.

As well, relatives unhappy with the situation will find it difficult to challenge the provisions of the trust and will be forced to bring litigation against the trustee.

And, since it will pass outside the probate process, the trust agreement is more likely to remain confidential and will not be subject to public scrutiny.

A revocable living trust is not for everyone, however. Establishing one requires the services of an estate planning professional. There can be federal and state tax implications, depending on how the trust is structured.

As a result, individuals considering using a revocable living trust as part of their estate plan should consult their advisor and an attorney specializing in estate planning for advice and assistance.