The recent Senate tax reform legislation, which is in conference at the moment, includes the most significant tax cuts for small business and middle-income households in a generation. It is time for small businesses and other small business tax shelter companies, as well as many S-corporations and LLCs, to start planning for the increased economic growth and profitability that is now expected to result.
The legislation permanently lowers tax rates for all small business businesses to 25% and for most S-corporations, partnerships, and sole proprietorships to 20%. Despite this huge benefit to all small businesses, many businesses are still not taking advantage of these provisions, and this will not change until they realize how beneficial it will be for their bottom line.
The employee retention credit is a unique tax provision that can be passed down to family members. This can be a big windfall for someone who is working at a business that is a leading employer or mid-size company and plans to create jobs in the coming years. This tax provision was last passed by Congress in 2004. Since then, it has been part of the Small Business Tax Extender legislation, and many companies are unaware of its availability. The rules for the employee retention credit are pretty straightforward.
Eligibility Criteria
To be eligible to take this tax benefit, you must:
- Have a worker who works at least 40 hours a week or be a family member of the worker who works at least 20 hours a week;
- Or be the owner of a business that employs at least 1,000 workers that has been in business for at least the past 2 years and does not qualify for a research and development credit; and
- Or a business that is engaged in a trade or business, and that is owned, controlled, or operated by a family member or an individual who is acting as the employer for the business for the taxable year.
Payment Of The Credit
When you file your tax return for the tax year in which you qualify to take this credit, you are required to include a Form W-9, Employee Retention Payment, reporting the total amount paid by you for the year. However, you do not need to include a separate form for each employee who receives the credit.
Even if you are an owner and the business is not in the trade or business of being an employer of 1,000 or more workers for a taxable year, you must still report the Form W-9 on your tax return as an employer. You can claim the credit in any of the following years:
- 2021
- 2022
- 2023
If you are a sole proprietor, partner, partner in an LLC, or LLC partner, you do not need to include a separate Form W-9, Employee Retention Payment, for employees in your business. In addition, you don’t need to include a Form W-9 for eligible employees in a partnership or LLC.
If the employee’s primary job duty is to receive a paycheck for all of his or her work hours worked, and the employee did not receive a paycheck for some of the taxable year, or the employee is an eligible foster child, or the employee was an eligible participant in a W-2-EZ program, then you can claim the credit. In these cases, you can combine the two requirements and claim the credit. In addition, you don’t need to list the Form W-9.
Employee Retention Credit – Opportunity for Small and Medium Sized Businesses
According to the Small Business Administration, at least 19 million American workers are employed by a small business and generate more than $150 billion in revenue each year. If you own a small business, this can be a great opportunity to retain current employees and add more employees to your team.
Whether you qualify to take the employee retention credit, or if you know someone who does, you have until April 17, 2023, to make a tax-deductible contribution to the Small Business Association Disaster Relief Fund. If you decide to take advantage of this tax credit, contact at Carter & Associates, a CPA firm that specializes in helping small and mid-size businesses through tax planning and tax disputes.
Here is how Employee Retention Credit is beneficial to your business:
- Increases bottom line profits
- Lowers business costs
- Improves job security
- Reduces turnover
- Reduces employee turnover
In addition, by reducing employee turnover, your company is likely to receive a higher-quality employee who will be less costly to employ. The use of worker retention strategies can help offset the costs associated with hiring, training, and retaining qualified employees. Furthermore, the employee retention strategy may help decrease costs associated with training, recruiting, and securing employees.
Let’s discuss each of the above point in detail below:
- Increases bottom line profits
Employee retention has been linked to increased employee productivity, decreased turnover, and decreased expenses due to absenteeism. Employee turnover typically results in the loss of time that you would have spent training employees to perform certain tasks. Business owners have the opportunity to maintain high employee productivity while reducing costs associated with training and onboarding new employees. If an employee resigns, the owner will typically pay the former employee the full amount of wages that the employee is owed.
In some cases, the owner may require the employee to sign a waiver indicating that the employee is not entitled to a refund for any unused vacation or sick leave. The owner may also require the employee to sign a non-competition or non-solicitation agreement in order for the employee to receive payment. However, if the employee resigns before the employee leaves, you may be able to negotiate the amount of unused vacation and sick leave. This amount may be determined by your existing policies. If the former employee resigns before the end of the year, the employer is generally not required to pay anything for unused vacation time.
- Lowers business costs
If an employee is still with your company after they resign, the company is then obligated to pay that employee for any unpaid hours of work. Furthermore, you will also be required to pay severance, which may include unpaid time off, vacation, or holidays, depending on the employee’s agreement.
If you elect to pay the wages that the employee was owed upon resignation, the cost of payroll taxes can increase your payroll costs. With additional wages, you will also be required to pay unemployment insurance taxes, which can significantly increase your overall payroll costs. Business owners with high payroll costs may also elect to use automation or some type of payroll service.
For example, payroll software enables a company to view the tax obligations associated with a portion of the employee’s pay, in a format that is easy for employees to understand. This information is accessible online, so employees can easily complete the proper taxes. Furthermore, a payroll service will submit the payroll to the appropriate payer on time, reducing any delays and increasing accuracy.
- Improves job security
Employees who are not satisfied with their working environment have many choices when it comes to searching for a new job. If an employee resigns, the company is forced to pay a severance payment to the employee. If a worker quits without notice, the employer may have to pay the employee’s back pay, overtime pay, and job security bonus, as well as pay the employee a termination payment, as long as the worker was provided with a suitable reason to quit. As a result, the employee may be less inclined to start a new job with the same employer.
Business owners with high levels of absenteeism, turnover, and low employee morale are often concerned that their workforce may leave with a new company. To help prevent this, the company will most likely spend more money to train a new employee, which may prevent the employee from moving onto another job at the same company. As a result, business owners may be more motivated to hire, train, and retain high-performing employees.
- Increases morale
When business owners are satisfied with their business’ performance and employee morale, they are more likely to retain employees. Paying the former employee’s wages will help business owners retain their existing staff, and also increase morale. Employees who are unhappy are more likely to be disengaged and less productive.
If business owners suspect that their business is suffering from low morale, they should work with their human resource department to create a retention strategy. This strategy should include policies that create a positive work environment, enforce best practices, ensure a safe work environment, and respond to employee concerns. While it is not realistic to prevent unhappy employees from leaving, business owners can develop systems that will prevent them from leaving.
For example, the employee will be encouraged to complete a job well done before a performance review. This will help them feel appreciated for their work, and avoid performance reviews being perceived as punishment. If they feel that the company values their work, they will be less likely to start a new job.
- High payroll taxes
If business owners have high payroll taxes, they may be more likely to hire an outside payroll service to collect and submit the payroll taxes. The cost of payroll taxes may exceed the cost of paying the employee, and therefore may not be worth the effort. Payroll service companies generally charge around 1% of the employer’s total payroll, and take around 2-4 weeks to receive payment. Companies that hire outside payroll service companies can save a lot of time and effort.
They will not have to spend hours preparing and submitting tax returns to the IRS, providing wage verification and withholding, or having payroll reports prepared. These efforts will allow the company to focus on the operations of their business, while the payroll service company will focus on providing an excellent service. By using an outside payroll service, business owners will be able to focus on other strategic business objectives instead of taking on the administrative task of collecting and submitting payroll taxes.
- Payroll tax deductions
When an employee is paid, she is given a W-2 form. The IRS then looks at the income paid to the employee and uses this information to figure out the employee’s taxable income. If a business owner makes less than $157,000 per year, they do not have to pay taxes on their income.
However, if the business owner makes more than $157,000, they are required to withhold income tax from each paycheck. Business owners who don’t make enough to pay income taxes can still deduct the taxes paid to the IRS from their federal income tax return, therefore reducing their taxes. The business owner still has to file their tax return to claim the tax deduction.
- Employee taxation
If business owners make less than $157,000 per year, they do not have to pay income tax. In addition, the company can claim a $400,000 non-employee bonus under Section 199A. Section 199A allows businesses to deduct up to 20% of the total cost of goods sold for “qualified equipment” used in the business.
While the cost of equipment used by the business can be deducted, there are special rules for the part of the business where the equipment is used. Any part of the business that is “nonemployee-owned” may not be considered a qualifying equipment. For example, a repair shop is considered a nonemployee-owned business, even though the owner has an employee that makes repairs on their equipment.
- Accelerated depreciation
The IRS gives business owners a tax break by letting them deduct the cost of all qualified new equipment and real estate from their taxable income in the year the property is purchased. In the early years, business owners can generally deduct the cost of purchases from their taxable income over a period of up to 15 years, but in later years they can only deduct the amount over the life of the equipment or real estate, regardless of the actual period used.
In 2022, a new accelerated depreciation schedule has been introduced. Under the new schedule, business owners can now deduct 100% of the costs of qualified new equipment and qualified real estate up to five years, and 100% of the costs of qualified new equipment and qualified real estate over seven years.
- ERC Program refunds
Many business owners mistakenly think that the rules for “extended warranty plans” apply to all warranties. They do not. This misunderstanding costs business owners an extra $500 million per year in tax liability for extended warranties, and roughly $500 million more for manufactured homes and boats.
The IRS has issued guidance in the form of Publication 594 that clarifies that extended warranties are not subject to the rules for extended warranties, which could save business owners $750 million per year in tax liability.
- ERC can be paid in cash
Business owners can often be tempted to create complicated, lengthy payment plans in order to save money, but the tax laws allow for the electronic transfer of all or part of an ERC. In many cases, the ERC payment may be easier than the payments due on bills, saving business owners time and money.
- Home office deduction
Many business owners treat their home as a second place to conduct business, especially for nonemployees. As long as a business owner uses their home exclusively and permanently to conduct business, they don’t have to pay the cost of using their home office. Business owners must pay the cost of commuting to an office to conduct their business, but they don’t have to pay the cost of the home office. In fact, if the business owner lives in the house, they can depreciate the cost of the home office against the other home expenses they have.
- C Corporation
Businesses that are organized as C corporations are taxed at the business level. The advantage of being a corporation is that corporations are not required to pay federal income tax, even if they have a loss, even though they often pay federal income tax at the individual level.
- Fuel tax credit
Business owners that operate vehicles that are primarily used to transport goods may be able to claim a fuel tax credit equal to 30 cents per gallon of gas. In other words, a car used to transport goods and claim the credit must be under 20,000 miles. The fuel tax credit for the first year that it’s claimed is $0, and the amount of the credit increases each subsequent year.
- Inventory
Business owners often make mistakes when they think of inventory as being merely a physical thing, but the IRS treats inventory like a financial asset. That means business owners need to keep accurate records of the cost to obtain, and any expenditure necessary to maintain, the inventory. The cost is measured by a measure of the fair market value of the inventory and the expenses necessary to maintain and protect the inventory. When there is a sale, the business owner must account for the depreciation associated with the increase in fair market value.
- Partnership
Partnership taxes have always been a source of confusion for small businesses, and especially for sole proprietors. Sole proprietors must pay tax on all of their business income, but partnership income may be treated differently. The Tax Cuts and Jobs Act made a few minor changes to the tax laws related to partnerships, but it’s still easy to make a mistake.
ERC programs are treated as a partnership asset, even if the owner does not benefit from the partnership (pay taxes on the ERCs, but not on the partnership income). A common mistake is to have the owner fully participate in the partnership and pay taxes on the ERCs, but do not benefit from the partnership income. A mistake like this can lead to a large tax bill, so owners must be careful when deciding whether to continue to be a partner or to become an employee and pay taxes on the ERCs.
- Trade or business deduction
Business owners are able to deduct a certain amount of the cost of goods they’ve sold or made to others. If a business owner has a trade or business and takes this deduction, it must be counted as gross income (sales and profits). The deduction does not include other business expenses, and the tax return must itemize deductions to claim the deduction. Business owners should keep accurate records of the purchase and sale of all goods, and do so in chronological order, so that the deductions can be properly recorded.
- Paid time off
If you’re like many small business owners, you work so much, that you need to take time off from your business. If your business is seasonal, there may even be weeks each year when you take no time off from work, because there is no time to take it.
Plan for more vacation time if you are a full-time business owner, but don’t push it. Keeping a routine schedule of vacations and weekends may be helpful for your business. Many small business owners have three days a year set aside just to be off from work. One way to make more is ERC s. If you do take a vacation, make sure you have a plan so that you don’t lose the business.
Conclusion
ERC for small and medium level businesses was established to encourage people to start small businesses, because their tax burden can be reduced when they are operating under less than $600,000 in ERC s. ERC s and the deductibility of ERC s can be beneficial for people who are wanting to start a business.
You can qualify for ERC s even if you are self-employed, as long as you meet the requirements of the ERC program. A business owner needs to do the necessary work to prove his or her business can afford the ERC s. A business owner must have enough income to run his or her business, plus they need to use any income to contribute to their ERC and it must be positive.
If your business is not making enough money to pay the ERC s, you will need to pay the ERCs out of your own income. If the tax burden is too high for your business, it may not be worth the risk.