Managing payroll taxes requires meticulous records and adherence to strict IRS payment and reporting deadlines. Fortunately, with the right guidance and software, you can unlock significant tax savings for your business.
For example, establishing accountable plans to reimburse employee expenses can reduce overall taxable income and FICA taxes. Increasing employee retirement plan contributions also helps lower AGI.
Define Wages as Salary
Balancing the IRS’s “reasonable compensation” guidelines with your financial needs can be challenging as a small business owner. Paying yourself a salary is a popular method to ensure you can cover your expenses and invest in your company’s future. When you receive compensation, payroll taxes (federal, state, and social security) are automatically deducted, which reduces the taxes you’ll owe at tax time.
Furthermore, using the salary method makes managing your business finances easier. You can consult the Bureau of Labor Statistics for wage information broken down by industry, occupation, and state. This information can help you determine a reasonable salary for your position.
To comply with the IRS’s requirement that corporations establish a “reasonable salary” for their owners, businesses should research the salaries of others in similar positions at comparable enterprises. After gathering information, they can determine what their pay should be. Employment taxes for small businesses can be paid through various means, such as dividend payments, bonus distributions, and profit distributions. However, it’s important to remember that the timing of these transactions can affect your tax liability. Therefore, it’s recommended to consult an accountant or financial advisor before making decisions.
Define Wages as Dividends
As a business owner, you may be considering a switch from salary to dividends. This strategy is attractive because it can save you money on corporate income taxes. However, tips are considered investment income and not employment income. As such, they are not subject to CPP or RRSP deductions.
It is also important to remember that the CRA can go after shareholders for dividends paid if the company has unpaid payroll tax and GST. On the other hand, salaries are not subject to this same scrutiny.
Unlike salaries, which require a payroll account, reporting and withholding of employee taxes, distributing shareholder distributions is much simpler. This is because you do not need to withhold and remit employment taxes. However, it is important to remember that you will still need to file a T4A with the CRA for each profit distribution.
Define Wages as Expenses
Depending on the company’s structure, a small business owner can use several strategies to minimize payroll tax expenses. For example, a profitable business can distribute profits directly to owners rather than paying them a hefty salary. It reduces self-employment taxes while leaving enough cash to cover necessary business expenses.
Another strategy involves utilizing an accountable plan to reimburse employees for certain expenses. This method shifts income from higher to lower tax brackets, reducing the business’s tax burden. Business owners can also reduce their tax liability by setting up a solo 401(k) or SEP IRA account.
Another way to save money at tax time is to reduce employee turnover. This can save thousands in salaries, benefits and training costs. Employers can help prevent high turnover by thoroughly vetting all potential hires through a thorough background check. Additionally, businesses can offer various other incentive programs that can help attract and retain top talent.
Define Wages as Bonuses
One way to keep staff happy is to add bonuses to their compensation packages. Whether it’s an annual holiday bonus or a quarterly performance award, implementing a bonus program is a smart way to incentivize employees and keep them from leaving the company.
However, suppose you add the bonus amount to an employee’s gross wages without differentiating it from their regular salaries. In that case, the IRS treats it as supplemental income and taxes it accordingly (at 7.65% FICA rates designated by law and 22% income tax withholding). Another option is to pay the bonus in a separate paycheck, which avoids this issue.
It’s important to understand how the IRS taxes supplemental wage payments so you can ensure you’re accurately reporting and paying taxes. Other payroll tax considerations include using a reliable time tracking system, running employment background checks on new hires, and ensuring you’re familiar with federal and state labor laws.
Define Wages as Independent Contractors
A growing number of small businesses are choosing to hire independent contractors. This option provides benefits for business owners, including lower costs. However, it’s important to remember that independent contractors are not covered by employee benefits, such as health insurance and paid sick leave.
It’s also critical to understand that independent contractors are not treated the same as employees for tax purposes. The IRS has strict rules about what defines a contractor, and misclassifying workers can result in fines and penalties.
For example, if you have significant control over your worker’s work and how it’s completed, the IRS may see them as employees instead of independent contractors. This misclassification could require you to pay back any unpaid overtime the worker would have otherwise received.
Additionally, independent contractors do not qualify for a personal income tax deduction as employees do. This is because independent contractors pay self-employment taxes (which include Social Security and Medicare). Typically, you must factor this into your contract pricing when hiring an independent contractor. This is why screening all potential new hires thoroughly through a thorough background check process is important.
