Category Archives: Bookkeeping

Who in a small business can be hit with the “Trust Fund Recovery Penalty?”

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Trust Fund Recovery Penalty

There’s a harsh tax penalty that you could be at risk for paying personally if you own or manage a business with employees. It’s called the “Trust Fund Recovery Penalty” and it applies to the Social Security and income taxes required to be withheld by a business from its employees’ wages.

Because taxes are considered property of the government, the employer holds them in “trust” on the government’s behalf until they’re paid over. The penalty is also sometimes called the “100% penalty” because the person liable and responsible for the taxes will be penalized 100% of the taxes due. Accordingly, the amounts IRS seeks when the penalty is applied are usually substantial, and IRS is aggressive in enforcing the penalty.

Wide-ranging penalty

The Trust Fund Recovery Penalty is among the more dangerous tax penalties because it applies to a broad range of actions and to a wide range of people involved in a business.

Here are some answers to questions about the penalty so you can safely avoid it.

What actions are penalized?

The Trust Fund Recovery Penalty applies to any willful failure to collect, or truthfully account for, and pay over Social Security and income taxes required to be withheld from employees’ wages.

Who is at risk?

The penalty can be imposed on anyone “responsible” for collection and payment of the tax. This has been broadly defined to include a corporation’s officers, directors, and shareholders under a duty to collect and pay the tax as well as a partnership’s partners, or any employee of the business with such a duty. Even voluntary board members of tax-exempt organizations, who are generally exempt from responsibility, can be subject to this penalty under some circumstances. In some cases, responsibility has even been extended to family members close to the business, and to attorneys and accountants.

According to the IRS, responsibility is a matter of status, duty, and authority. Anyone with the power to see that the taxes are (or aren’t) paid may be responsible. There’s often more than one responsible person in a business, but each is at risk for the entire penalty. You may not be directly involved with the payroll tax withholding process in your business. But if you learn of a failure to pay over withheld taxes and have the power to pay them but instead make payments to creditors and others, you become a responsible person.

Although a taxpayer held liable can sue other responsible people for contribution, this action must be taken entirely on his or her own after the penalty is paid. It isn’t part of the IRS collection process.

What’s considered “willful?”

For actions to be willful, they don’t have to include an overt intent to evade taxes. Simply bending to business pressures and paying bills or obtaining supplies instead of paying over withheld taxes that are due the government is willful behavior. And just because you delegate responsibilities to someone else doesn’t necessarily mean you’re off the hook. Your failure to take care of the job yourself can be treated as the willful element.

Never borrow from taxes

Under no circumstances should you fail to withhold taxes or “borrow” from withheld amounts. All funds withheld should be paid over to the government on time. Contact us with any questions about making tax payments.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

The 2021 “Social Security wage base” is increasing

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“Social Security wage base” is increasing

If your small business is planning for payroll next year, be aware that the “Social Security wage base” is increasing.

The Social Security Administration recently announced that the maximum earnings subject to Social Security tax will increase from $137,700 in 2020 to $142,800 in 2021.

For 2021, the FICA tax rate for both employers and employees is 7.65% (6.2% for Social Security and 1.45% for Medicare).

For 2021, the Social Security tax rate is 6.2% each for the employer and employee (12.4% total) on the first $142,800 of employee wages. The tax rate for Medicare is 1.45% each for the employee and employer (2.9% total). There’s no wage base limit for Medicare tax so all covered wages are subject to Medicare tax.

In addition to withholding Medicare tax at 1.45%, an employer must withhold a 0.9% additional Medicare tax from wages paid to an employee in excess of $200,000 in a calendar year.

Employees working more than one job

You may have employees who work for your business and who also have a second job. They may ask if you can stop withholding Social Security taxes at a certain point in the year because they’ve already reached the Social Security wage base amount. Unfortunately, you generally can’t stop the withholding, but the employees will get a credit on their tax returns for any excess withheld.

Older employees

If your business has older employees, they may have to deal with the “retirement earnings test.” It remains in effect for individuals below normal retirement age (age 65 to 67 depending on the year of birth) who continue to work while collecting Social Security benefits. For affected individuals, $1 in benefits will be withheld for every $2 in earnings above $18,960 in 2021 (up from $18,240 in 2020).

For working individuals collecting benefits who reach normal retirement age in 2021, $1 in benefits will be withheld for every $3 in earnings above $46,920 (up from $48,600 in 2020), until the month that the individual reaches normal retirement age. After that month, there’s no limit on earnings.

Contact us if you have questions. We can assist you with the details of payroll taxes and keep you in compliance with payroll laws and regulations.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

The President’s action to defer payroll taxes: What does it mean for your business?

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defer payroll taxes

On August 8, President Trump signed four executive actions, including a Presidential Memorandum to defer the employee’s portion of Social Security taxes for some people. These actions were taken in an effort to offer more relief due to the COVID-19 pandemic.

The action only defers the taxes, which means they’ll have to be paid in the future. However, the action directs the U.S. Treasury Secretary to “explore avenues, including legislation, to eliminate the obligation to pay the taxes deferred pursuant to the implementation of this memorandum.”

Legislative history

On March 18, 2020, President Trump signed into law the Families First Coronavirus Response Act. A short time later, President Trump signed into law the Coronavirus, Aid, Relief and Economic Security (CARES) Act. Both laws contain economic relief provisions for employers and workers affected by the COVID-19 crisis.

The CARES Act allows employers to defer paying their portion of Social Security taxes through December 31, 2020. All 2020 deferred amounts are due in two equal installments — one at the end of 2021 and the other at the end of 2022.

New bill talks fall apart

Discussions of another COVID-19 stimulus bill between Democratic leaders and White House officials has been on and off again since August. As a result, President Trump signed the memorandum that provides a payroll tax deferral for many — but not all — employees.

The memorandum directs the U.S. Treasury Secretary to defer withholding, deposit, and payment of the tax on wages or compensation, as applicable, paid during the period of September 1, 2020, through December 31, 2020. This means that the employee’s share of Social Security tax will be deferred for that time period.

However, the memorandum contains the following two conditions:

  • The deferral is available with respect to any employee, the amount of whose wages or compensation, as applicable, payable during any biweekly pay period generally is less than $4,000, calculated on a pretax basis, or the equivalent amount with respect to other pay periods; and
  • Amounts will be deferred without any penalties, interest, additional amount, or addition to the tax.

The Treasury Secretary was ordered to provide guidance to implement the memorandum.

Legal authority

The memorandum (and the other executive actions signed on August 8) note that they’ll be implemented consistent with applicable law. However, some are questioning President Trump’s legal ability to implement the employee Social Security tax deferral.

Employer questions

Employers have questions and concerns about the payroll tax deferral. For example, since this is only a deferral, will employers have to withhold more taxes from employees’ paychecks to pay the taxes back, beginning January 1, 2021? Without a law from Congress to actually forgive the taxes, will employers be liable for paying them back? What if employers were unable to get their payroll software changed in time for the September 1 start of the deferral? Are employers and employees required to take part in the payroll tax deferral or is it optional?

Contact us if you have questions about how to proceed. And stay tuned for more details about this action and any legislation that may pass soon.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Launching a business? How to treat start-up expenses on your tax return

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start-up expenses on your tax return

While the COVID-19 crisis has devastated many existing businesses, the pandemic has also created opportunities for entrepreneurs to launch new businesses. For example, some businesses are being launched online to provide products and services to people staying at home.

Entrepreneurs often don’t know that many expenses incurred by start-ups can’t be currently deducted. You should be aware that the way you handle some of your initial expenses can make a large difference in your tax bill.

If you’re starting or planning a new enterprise, keep these key points in mind:

  • Start-up costs include those incurred or paid while creating an active trade or business — or investigating the creation or acquisition of one.
  • Under the Internal Revenue Code, taxpayers can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs in the year the business begins. As you know, $5,000 doesn’t get you very far today! And the $5,000 deduction is reduced dollar-for-dollar by the amount by which your total start-up or organizational costs exceed $50,000. Any remaining costs must be amortized over 180 months on a straight-line basis.
  • No deductions or amortization deductions are allowed until the year when “active conduct” of your new business begins. Generally, that means the year when the business has all the pieces in place to begin earning revenue. To determine if a taxpayer meets this test, the IRS and courts generally ask questions such as: Did the taxpayer undertake the activity intending to earn a profit? Was the taxpayer regularly and actively involved? Did the activity actually begin?

Expenses that qualify

In general, start-up expenses include all amounts you spend to:

  • Investigate the creation or acquisition of a business,
  • Create a business, or
  • Engage in a for-profit activity in anticipation of that activity becoming an active business.

To be eligible for the election, an expense also must be one that would be deductible if it were incurred after a business began. One example is money you spend analyzing potential markets for a new product or service.

To qualify as an “organization expense,” the expenditure must be related to creating a corporation or partnership. Some examples of organization expenses are legal and accounting fees for services related to organizing a new business and filing fees paid to the state of incorporation.

Thinking ahead

If you have start-up expenses that you’d like to deduct this year, you need to decide whether to take the elections described above. Recordkeeping is critical. Contact us about your start-up plans. We can help with tax-related and other aspects of your new business.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Good records are the key to tax deductions and trouble-free IRS audits

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business recordkeeping

If you operate a small business, or you’re starting a new one, you probably know you need to keep records of your income and expenses. In particular, you should carefully record your expenses in order to claim the full amount of the tax deductions to which you’re entitled. And you want to make sure you can defend the amounts reported on your tax returns if you’re ever audited by the IRS or state tax agencies.

Certain types of expenses, such as automobile, travel, meals, and office-at-home expenses, require special attention because they’re subject to special recordkeeping requirements or limitations on deductibility.

It’s interesting to note that there’s not one way to keep business records. In its publication “Starting a Business and Keeping Records,” the IRS states: “Except in a few cases, the law does not require any specific kind of records. You can choose any recordkeeping system suited to your business that clearly shows your income and expenses.”

That being said, many taxpayers don’t make the grade when it comes to recordkeeping. Here are three court cases to illustrate some of the issues.

Case 1: Without records, the IRS can reconstruct your income

If a taxpayer is audited and doesn’t have good records, the IRS can perform a “bank-deposits analysis” to reconstruct income. It assumes that all money deposited in accounts during a given period is taxable income. That’s what happened in the case of the business owner of a coin shop and precious metals business. The owner didn’t agree with the amount of income the IRS attributed to him after it conducted a bank-deposits analysis.

But the U.S. Tax Court noted that if the taxpayer kept adequate records, “he could have avoided the bank-deposits analysis altogether.” Because he didn’t, the court found the bank analysis was appropriate and the owner underreported his business income for the year. (TC Memo 2020-4)

Case 2: Expenses must be business related

In another case, an independent insurance agent’s claims for a variety of business deductions were largely denied. The Tax Court found that he had documentation in the form of cancelled checks and credit card statements that showed expenses were paid. But there was no proof of a business purpose.

For example, he made utility payments for natural gas, electricity, water, and sewer, but the records didn’t show whether the services were for his business or his home. (TC Memo 2020-25)

Case number 3: No records could mean no deductions

In this case, married taxpayers were partners in a travel agency and owners of a marketing company. The IRS denied their deductions involving auto expenses, gifts, meals, and travel because of insufficient documentation. The couple produced no evidence about the business purpose of gifts they had given. In addition, their credit card statements and other information didn’t detail the time, place, and business relationship for meal expenses or indicate that travel was conducted for business purposes.

“The disallowed deductions in this case are directly attributable to (the taxpayer’s) failure to maintain adequate records,“ the court stated. (TC Memo 2020-7)

We can help

Contact us if you need assistance retaining adequate business records. Taking a meticulous, proactive approach to how you keep records can protect your deductions and help make an audit much less painful.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.