Top Frequently Asked Questions for Small Business, Self-Employed, Other Business

Can a husband and wife operate a business as a sole proprietorship or do they need to be a partnership?

Answer:

Unless a business meets the requirements listed below to be a qualified joint venture, a sole proprietorship must be solely owned by one spouse, and the other spouse can work in the business as an employee. A business jointly owned and operated by a husband and wife is a partnership (and should file Form 1065, U.S. Return of Partnership Income) unless the spouses qualify and elect to have the business be treated as a qualified joint venture, or they operate their business in one of the nine community property states.

A married couple who jointly own and operate a trade or business may choose for each spouse to be treated as a sole proprietor by electing to file as a qualified joint venture. Requirements for a qualified joint venture:

  • The only members in the joint venture are a husband and wife who file a joint tax return,
  • The spouses own and operate the trade or business as co-owners (and not in the name of a state law entity such as an LLC or LLP),
  • The husband and wife must each materially participate in the trade or business, or maintain a farm as a rental business without materially participating (for self-employment tax purposes) in the operation or management of the farm, and
  • Both spouses must elect qualified joint venture status on Form 1040, U.S. Individual Income Tax Return, by dividing the items of income, gain, loss, deduction, credit, and expenses in accordance with their respective interests in such venture. Each spouse files with the Form 1040 a separate Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship), Schedule C-EZ (Form 1040), Net Profit From Business (Sole Proprietorship), Schedule F (Form 1040), Profit of Loss From Farming, or Form 4835, Farm Rental Income and Expenses, accordingly, and if required, a separate Schedule SE (Form 1040), Self-Employment Tax, to pay self-employment tax.

For more information about the qualified joint venture rules, see Election for Husband and Wife Unincorporated Businesses.

Husband and wife businesses in community property states may sometimes qualify to be treated similarly to a sole proprietorship. For Special Rules for Spouses in Community States, see Revenue Procedure 2002-69 and the Instructions for Schedule C.

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Must a partnership or corporation file a tax return even though it had no income for the year?

Answer:

Partnerships and corporations have different standards for filing an income tax return.

  • A domestic partnership must file an information return, unless it neither receives gross income nor pays or incurs any amount treated as a deduction or credit for federal tax purposes.
  • A foreign partnership generally must file an information return if:
    • It has gross income effectively connected with the conduct of a trade or business within the United States,
    • It has gross income derived from sources in the United States, or
    • It or its U.S. partner is making an election, such as an election to amortize organization expenses.

Refer to the Instructions for Form 1065, U.S. Return of Partnership Income, for exceptions to filing requirements.

  • A domestic corporation (including a Subchapter S corporation) must file an income tax return whether it has taxable income or not, unless it's exempt from filing under section 501.
  • A foreign corporation generally must file an income tax return if it:
    • Engages in a trade or business in the United States, even if it has no income effectively connected with the conduct of a trade or business in the United States during the taxable year,
    • Has income, gains or losses treated as if effectively connected with the conduct of a U.S. trade or business and subject to taxation under subtitle A of the Internal Revenue Code (relating to income taxes), or
    • Doesn't engage in a trade or business in the United States at any time during the taxable year but has U.S. source income, and the withholding at source under Chapter 3 of the Internal Revenue Code didn't fully satisfy its taxation.

Refer to the Instructions for Form 1120-F, U.S. Income Tax Return of a Foreign Corporation, for other reasons a foreign corporation may file a return and exceptions to filing requirements.

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What's the difference between a Form W-2 and a Form 1099-MISC?

Answer:

Although both of these forms are called information returns, they serve different functions.

Employers use Form W-2, Wage and Tax Statement, to:

  • Report wages, tips, and other compensation paid to an employee.
  • Report the employee's income and social security taxes withheld and other information.
  • Report wage and withholding information to the employee and the Social Security Administration. The Social Security Administration shares the information with the Internal Revenue Service.

Payers use Form 1099-MISC, Miscellaneous Income, to:

  • Report payments made in the course of a trade or business to a person who's not an employee or to an unincorporated business.
  • Report payments of $10 or more in gross royalties or $600 or more in rents or compensation. Report payment information to the IRS and the person or business that received the payment.
How do you determine if a worker is an employee or an independent contractor?

Answer:

The determination can be complex and depends on the facts and circumstances of each case. The determination is based on whether the person for whom the services are performed has the right to control how the worker performs the services. It's not based merely on how the worker is paid, how often the worker is paid, or whether the work is part-time or full-time.

There are three basic categories of factors that are relevant to determining a worker's classification:

  • Behavioral control (whether there's a right to direct or control how the worker does the work),
  • Financial control (whether there's a right to direct or control the business part of the work), and
  • Relationship of the parties (how the business and worker perceive the relationship).

For more information on employer-employee relationships, refer to Publication 15, (Circular E), Employer's Tax Guide, and Publication 15-A, Employer's Supplemental Tax Guide. Also, refer to Publication 1779, Independent Contractor or Employee.

If you would like the IRS to determine whether services are performed as an employee or independent contractor, you may submit Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

Generally, if you're an independent contractor you're considered self-employed and should report your income (nonemployee compensation) on Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship), or Schedule C-EZ (Form 1040), Net Profit From Business (Sole Proprietorship). Most self-employed individuals will need to pay self-employment tax (comprised of social security and Medicare taxes) if their income (net earnings from self-employment) is $400 or more. Use Schedule SE (Form 1040), Self-Employment Tax, to figure the tax due.

Generally, there's no tax withholding on income you receive as a self-employed individual as long as you provide your taxpayer identification number (TIN) to the payer. However, you may be subject to the requirement to make quarterly estimated tax payments. If you don't make timely estimated tax payments, the IRS may assess a penalty for an underpayment of estimated tax. For more information on estimated tax, refer to Publication 505, Tax Withholding and Estimated Tax, and Do You Have to Pay Estimated Tax? Unlike independent contractors, employees generally pay income tax and their share of social security and Medicare taxes through payroll deductions (withholding).

As an employer, do I have any liability for social security and Medicare taxes if my employees receive tips but don't report them to me?

Answer:

Yes. Employers in industries where tipping is common know that they must report and pay taxes on tips employees report to them. However, many employers don't realize that they're liable for the employer share of social security and Medicare taxes on tips employees don't report to them.

  • Tipped employees are required to report their tips to their employers by the 10th of the following month if they receive cash tips of $20 or more in the month. Cash tips include tips they receive directly from customers, charged tips (e.g., credit and debit card charges) you distribute to them, and tips they receive from other employees under any tip-sharing arrangement. Thus, both directly and indirectly tipped employees must report tips received to their employer.
  • You, as an employer, must withhold and pay the employee share of social security and Medicare taxes on tips your employee reports to you to the extent the employee’s non-tip wages or funds the employee provides you are available. You must also pay the employer share of social security and Medicare taxes on all reported tips.
  • For unreported tips, your liability for the employer share of social security and Medicare taxes doesn't arise until the Service issues you a Section 3121(q) Notice and Demand. The tax due shown on the notice and demand may be based on tip audits, data from Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips, or Forms 4137, Social Security and Medicare Tax on Unreported Tip Income. The employer isn't liable to withhold and pay the employee share of social security and Medicare taxes on unreported tips.
  • You must file Form 8027 if you operate a large food or beverage establishment. A large food or beverage establishment is a food or beverage operation located in the 50 states or in the District of Columbia that provides food or beverages for consumption on the premises and has employees who customarily receive tips. Additionally, the employer must normally employ more than 10 employees on a typical business day during the previous year. If you're the employer at a food or beverage operation, see the Instructions for Form 8027 to determine if you must file this form. You may also be required to allocate tips if the total tips reported to you are less than 8% of gross receipts. Report the allocated amount on the employee's Form W-2, Wage and Tax Statement.
  • Form 4137 is used by employees to report and pay their share of social security and Medicare taxes on tips they didn't report to you. This should include any allocated tips shown on Form W-2, unless the employee has adequate records (a daily tip record or other credible evidence) to show that the employee didn't receive the allocated tips.
If an employee claims more than 10 allowances on their Form W-4, does the employer have to report this to the IRS?

Answer:

No, this requirement has been eliminated. However, Forms W-4, Employee's Withholding Allowance Certificate, are still subject to review. Employers may be directed (in a written notice or in future published guidance) to send certain Forms W-4 to the IRS. The IRS will also continue to review employee withholding compliance. The IRS may send you a letter (commonly called a lock-in-letter) specifying the withholding rate and allowances to use to calculate the amount of tax to withhold from wages paid to a specific employee.

Does a small company that operates as a sole proprietorship need a tax ID number?

Answer:

  • A sole proprietor without employees and who doesn't file any excise or pension plan tax returns doesn't need an employer identification number (EIN) (but can get one if they choose). In this instance, the sole proprietor uses his or her social security number as the taxpayer identification number. However, at any time the sole proprietor hires an employee or has to file an excise tax return, the sole proprietor will need an EIN for the business and can't use his or her social security number.
  • If you have an existing EIN as a sole proprietor and become a sole owner of an LLC (Limited Liability Company) that has employees, you need to get a separate EIN for the LLC to file employment taxes.
I'm a sole proprietor and pay personal expenses out of my business bank account. Should I include the money used for personal expenses as part of my business income? Can I write these expenses off?

Answer:

  • You would include the money used to pay personal expenses in your business income when your business earned it.
  • You wouldn't write off these expenses as business expenses because they're not ordinary and necessary costs of carrying on your trade or business.
  • Personal, living, or family expenses are generally not deductible.
  • It's a good idea to keep separate business and personal accounts as this makes it easier to keep records.

Subcategory:

For business travel, are there limits on the amounts deductible for meals?

Answer:

  • Meal expenses are deductible if your business trip is overnight or long enough that you need to stop for substantial sleep or rest to properly perform your duties. Meal expenses are also deductible if the meal is business-related entertainment. You can figure all your travel meal expenses using either of the following methods:
    • Actual cost. If you use this method, you must keep records of your actual cost.
    • The standard meal allowance, which is the federal meals and incidental expense (M&IE) per diem rate. The GSA website lists these rates by location. Note that lower rates apply for the first and last days of travel.
  • The deduction for unreimbursed business meals is generally subject to a 50% limitation.

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We hired a nanny to look after our baby while we work. How do we pay her social security taxes and properly report her income?

Answer:

Your nanny is considered your household employee and you're her household employer:

  • As a household employer, you only withhold and pay social security and Medicare taxes if the cash wages you paid her exceed the threshold amount for the year. See Publication 926, Household Employer's Tax Guide.
  • If the amount paid is less than the threshold, you don't owe social security or Medicare taxes.
  • If the amount paid is more than the threshold, you must withhold your employee's share of social security and Medicare taxes unless you choose to pay both her share and your share. The taxes are 15.3% of cash wages. Your share is 7.65% and her share is 7.65%.
  • You may also be responsible for paying federal unemployment tax. Federal unemployment tax isn't withheld from employees' wages.
  • You're not required to withhold income tax from her wages. However, you and your nanny may agree for you to withhold income tax from her wages.
  • If you must pay social security and Medicare taxes or federal unemployment taxes, or if you withhold income tax, you'll need to file Schedule H (Form 1040), Household Employment Taxes. You'll also need to file a Form W-2, Wage and Tax Statement, and furnish a copy of the form to your nanny.
  • If you choose, you may pay your household employment taxes with your business or farm employment taxes, and you must include your household employment taxes with those other employment taxes on Form 941, Employer’s QUARTERLY Federal Tax Return, Form 944, Employer’s ANNUAL Federal Tax Return, or Form 943, Employer’s Annual Federal Tax Return for Agricultural Employees, and on Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return.
How does my business become an S Corporation?

Answer:

A corporation, or other business entity that elected to be treated as a corporation (by filing a Form 8832, Entity Classification Election), must use Form 2553, Election by a Small Business Corporation, to make an S corporation election. A business entity treated as a corporation must meet certain tests in order to qualify to be an S corporation. To learn more, see the Instructions for Form 2553 and the Instructions for Form 1120S, U.S. Income Tax Return for an S Corporation.

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Frequently Asked Question Subcategories for Small Business, Self-Employed, Other Business