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

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.

When are LLC members subject to self-employment tax?

LLC members

Limited liability company (LLC) members commonly claim that their distributive shares of LLC income — after deducting compensation for services in the form of guaranteed payments — aren’t subject to self-employment (SE) tax. But the IRS has been cracking down on LLC members it claims have underreported SE income, with some success in court.

SE tax background

Self-employment income is subject to a 12.4% Social Security tax (up to the wage base) and a 2.9% Medicare tax. Generally, if you’re a member of a partnership — including an LLC taxed as a partnership — that conducts a trade or business, you’re considered self-employed.

General partners pay SE tax on all their business income from the partnership, whether it’s distributed or not. Limited partners, however, are subject to SE tax only on any guaranteed payments for services they provide to the partnership. The rationale is that limited partners, who have no management authority, are more akin to passive investors.

(Note, however, that “service partners” in service partnerships, such as law firms, medical practices, and architecture and engineering firms, generally may not claim limited partner status regardless of their level of participation.)

LLC uncertainty

Over the years, many LLC members have taken the position that they’re equivalent to limited partners and, therefore, exempt from SE tax (except on guaranteed payments for services). But there’s a big difference between limited partners and LLC members. Both enjoy limited personal liability, but, unlike limited partners, LLC members can actively participate in management without jeopardizing their liability protection.

Arguably, LLC members who are active in management or perform substantial services related to the LLC’s business are subject to SE tax, while those who more closely resemble passive investors should be treated like limited partners. The IRS issued proposed regulations to that effect in 1997, but hasn’t finalized them — although it follows them as a matter of internal policy.

Some LLC members have argued that the IRS’s failure to finalize the regulations supports the claim that their distributive shares aren’t subject to SE tax. But the IRS routinely rejects this argument and has successfully litigated its position. The courts generally have imposed SE tax on LLC members unless, like traditional limited partners, they lack management authority and don’t provide significant services to the business.

Review your situation

The law in this area remains uncertain, particularly with regard to capital-intensive businesses. But given the IRS’s aggressiveness in collecting SE taxes from LLCs, LLC members should assess whether the IRS might claim that they’ve underpaid SE taxes.

Those who wish to avoid or reduce these taxes in the future may have some options, including converting to an S corporation or limited partnership, or restructuring their ownership interests. When evaluating these strategies, there are issues to consider beyond taxes. Contact us to discuss your specific situation.

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.

What businesses need to know about the tax treatment of bitcoin and other virtual currencies

virtual currency

Over the last several years, virtual currency has become increasingly popular. Bitcoin is the most widely recognized form of virtual currency, also commonly referred to as digital, electronic, or cryptocurrency.

While most small businesses aren’t yet accepting bitcoin or other virtual currency payments from their customers, more and more large businesses are. And the trend may trickle down to smaller businesses. Businesses also can pay employees or independent contractors with virtual currency. But what are the tax consequences of these transactions?

Bitcoin 101

Bitcoin has an equivalent value in real currency and can be digitally traded between users. It also can be purchased with real currencies or exchanged for real currencies. Bitcoin is most commonly obtained through virtual currency ATMs or online exchanges.

Goods or services can be purchased for using “bitcoin wallet” software. When a purchase is made, the software digitally posts the transaction to a global public ledger. This prevents the same unit of virtual currency from being used multiple times.

Tax impact

Questions about the tax impact of virtual currency abound. And the IRS has yet to offer much guidance.

The IRS did establish in a 2014 ruling that bitcoin and other convertible virtual currency should be treated as property, not currency, for federal income tax purposes. This means that businesses accepting bitcoin payments for goods and services must report gross income based on the fair market value of the virtual currency when it was received, measured in equivalent U.S. dollars.

When a business uses virtual currency to pay wages, the wages are taxable to the employees to the extent any other wage payment would be. You must, for example, report such wages on your employees’ W-2 forms. And they’re subject to federal income tax withholding and payroll taxes, based on the fair market value of the virtual currency on the date it was received by the employee.

When a business uses virtual currency to pay independent contractors or other service providers, those payments are also taxable to the recipient. Generally, the self-employment tax rules apply, based on the fair market value of the virtual currency on the date received, and payers must issue 1099-MISC forms to recipients.

Finally, payments made with virtual currency are subject to information reporting to the same extent as any other payment made in property.

Deciding whether to go virtual

Accepting bitcoin can be beneficial because it may avoid transaction fees charged by credit card companies and online payment providers (such as PayPal) and attract customers who want to use virtual currency. But the IRS is targeting virtual currency transactions in an effort to raise tax revenue, and it hasn’t issued much guidance on the tax treatment or reporting requirements. So bitcoin can also be a bit risky from a tax perspective.

To learn more about tax considerations when deciding whether your business should accept bitcoin or other virtual currencies — or use them to pay employees, independent contractors, or other service providers — contact us.

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.

Tax-Related Identity Theft: What You Need to Know

Identity theft continues to be a growing problem, with instances of tax-related identity theft increasing every year. This can be a frustrating, time-consuming issue for taxpayers. Here are some things you need to know about tax-related identity theft.

Tax-Related Identity Theft - Ramsay & Associates
What is Tax-Related Identity Theft?

Tax-related identify theft occurs when a social security number is stolen and used to file a tax return for a fraudulent refund. Many victims of tax-related identity theft are unaware that it has occurred until they file a return and discover that one has already been filed under their social security number. In other cases, taxpayers may receive a letter from the IRS stating that they have identified a suspicious return.

For 2017, the IRS, state agencies, and the tax industry enacted new safeguards and actions to combat tax-related identity theft.

Warning Signs

It is important to know the warning signs of possible tax-related identity theft. This is especially important if the IRS or your tax professional contact you regarding:

  • Use of your social security number for more than one return
  • Additional tax owed or a refund offset, as well as collection actions taken against you, for a year that you did not file a tax return
  • IRS records that indicate wages received or other income from an unknown employer

If You Become a Victim

The Federal Trade Commission recommends these steps if you become a victim of identity theft:

  • File a complaint with the FTC at www.identitytheft.gov
  • Contact one of the three major credit bureaus to place a “fraud alert” on your credit record
  • In addition, contact your financial institutions and close any financial or credit accounts opened without your permission or tampered with by identity thieves

If you know or suspect that you are a victim of tax-related identity theft, the IRS recommends that you:

  • Respond immediately to any IRS notices by calling the number provided
  • Complete IRS Form 14039, Identity Theft Affidavit
  • File your tax return and pay any taxes that you owe; you may also need to mail paper tax returns

Ways to Protect Yourself

  • Always use security software with firewall and anti-virus protections in addition to using strong passwords
  • Learn to recognize and avoid phishing or suspicious emails, threatening phone calls or text messages from thieves posing as legitimate organizations, such as credit card companies, financial institutions, and the IRS
  • Do not follow links or download attachments from suspicious or unknown email addresses
  • Protect your personal data by securing your tax records, social security number, and credit card and banking information
  • Do not carry your social security card with you
  • Finally, remember that the IRS does not initiate contact with taxpayers to obtain personal or financial information

Find more information from the IRS Taxpayer Guide to Identity Theft.

Minnesota Department of Revenue

With an increase in scams and stolen personal information, the Minnesota Department of Revenue has stated that it is taking the time necessary to ensure that the correct refund goes to the correct person. The department reviews every return to verify information provided, and therefore, the length of time to process that return may vary from year to year.

Learn more from the Minnesota Department of Revenue. For Wisconsin, visit the website of the State of Wisconsin Department of Revenue.

 

Tax-related identity theft may also occur when thieves use a stolen Employee Identification Number from a business to create fraudulent W-2s. The accounting and tax professionals at Ramsay & Associates can assist taxpayers with individual and business tax-related identity theft – both with taking preventive actions and correcting any issues after identity theft occurs. Contact us for more information or to schedule an appointment.

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.

Prepare Now for 2017 Tax Returns

Prepare for 2017 Tax Returns

With the April 18 Tax Day deadline behind us, you may be of the mindset that the last thing you want to do is start preparing for your 2017 income taxes. But there’s really no better time than now, when your most recent tax experience is still fresh. Here are a few things you can do now to prepare for 2017 tax returns. You’ll be glad you did.

File, Don’t Pile

Come tax season, a pile of receipts and documents shoved into a drawer or folder can be completely overwhelming. If you don’t already have an organized filing system in place, create one now. Mobile filing folders, boxes, or totes work well if you don’t have a filing cabinet and are available at office supplies stores. If possible, keep this separate from your non-tax related filing, such as credit card statements or correspondence. Take a look at your documents and receipts from your 2016 return to determine which categories you’ll need for each file folder, and keep up with your filing on a weekly or monthly basis. Next January and February when you receive your W-2, 1099s, mortgage interest statements, and other important documents, you’ll be ready to file them, and they’ll be easily accessible when the time comes.

Identify Areas of Weakness

Were there any specific items that caused delays or other issues with your 2016 tax returns? For example, were your mileage records incomplete? Did you neglect to thoroughly document clothing or household goods donations with photographs and receipts? If you haven’t already logged your mileage or documented donations for 2017 – or any other items that you may have missed – start now.

Electronic Documentation

Spreadsheets provide another excellent method of tracking expenses, tax deductible donations, mileage, and other important information. The more detailed the information captured, the better. If you have online receipts, include the hyperlink for easy access. Scan and save paper receipts electronically. Be sure to back up all your files.

Review Taxable Income

Did you withhold too little in 2016? Too much? Now is the time to review your taxable income and make necessary adjustments to your current withholdings, 401(k) contributions, and other components that determine your taxable income – and subsequently, your tax bracket. If you’re unsure of the best course of action to most positively impact your 2017 income tax return, contact Ramsay & Associates. Our tax planning services – for both individuals and businesses – allow you to make the best financial decisions for your family or your business. Contact us for more information or to set up a tax planning appointment.

Take the stress out of tax season – a little preparation now will go a long way in early 2018.

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.