This is another posting in the MinistryCPA Top 10 series:
Understanding payroll can be a difficult task in any business. Knowing how to onboard new employees, pay them, file tax documents, and deal with other benefits is a daunting task. We have created a list of some of the top payroll compliance issues that we see here at MinistryCPA.
1. Employee vs Independent Contractor
Understanding the difference between an employee and an independent contractor is essential to the payroll process. If a person is classified as an employee, then the business is responsible for employment taxes such as social security, Medicare, unemployment, and income tax withholding. If the person is classified as an independent contractor, the business is not responsible for any of these taxes. There are three factors that help a business determine whether an individual is an employee or an independent contractor. These three factors are the degree of behavioral control, financial control, and the type of relationship. Please see the IRS website for more information on these factors. We have also posted a number of other blog posts to help determine whether a person is an employee or independent contractor, such as Employee or Independent Contractor.
2. Missing proper on-boarding documents
When hiring a new employee, the business must obtain certain information from him or her to process payroll. First, the employee should fill out and sign Form I-9. This document verifies that the person is eligible to be employed in the US. Next the new employee should fill out a State and Federal Form W-4. This document tells the business how much to withhold for income taxes. If using direct deposit the business also must collect the new employee's bank routing and account numbers along with a direct deposit authorization form. Finally, the business should have the employee fill out any internal business documents (e.g., benefits).
3. Failing to file and issue Forms W-2 and W-3
Every business that has employees must file Forms W-2 and Form W-3. Form W-2 must be filled out and mailed or e-filed by January 31st, and W-2 copies B, C, and 2 must be provided to the employees by February 1st.
Form W-3 must also be filed by the employer, but is not provided to employees. Form W-3 is a summary of the W-2's. The IRS provides additional information on preparing and filing Forms W-2 and W-3, including details on font and corrections. Please see the IRS's Topic No. 752 for additional information.
4. Incorrect reporting of ministers' housing allowance on Form W-2
Incorrect reporting of ministers' housing allowance on Form W-2 is an issue that we frequently see. A housing allowance is reported in box 14 and should not be included in any other box on Form W-2. It is additional income that may not be subject to income tax, and therefore should not be reported in box 1.
5. Failing to File Forms 941 or Form 944
All businesses that have employees must file either Form 941 or Form 944. Form 944 is reserved for businesses that meet certain requirements. It can be used by employers who have less than $1,000 in annual social security, Medicare, and income tax withholdings. Form 944 is due annually on January 31st. All employers that exceed $1,000 in withholdings must file Form 941. Form 941 is due quarterly.
6. Not obtaining W-9's from necessary entities
When a business pays a non-employee more than $600 for services, then it must file a Form 1099 and provide a copy to that individual or business. A good habit for the business to practice is to request a copy of Form W-9 from the other entity as soon as the payments to that entity cross the $600 threshold. If the business delays until the end of the year to request W-9's, it will be more difficult to file all of the necessary 1099's on time.
7. Using the wrong Form 1099
There are multiple types of Form 1099. If the payments were compensation for work that was done by an independent contractor, then the business must complete Form 1099-NEC. Form 1099-MISC is used to report payments to other entities for expenses such as rent, prize money, and other situations. The IRS gives comprehensive instructions for 1099-NEC and 1099-MISC.
8. Accountable vs Non-Accountable Plan
Employee expense reimbursements through accountable versus non-accountable plans are recorded differently. If an accountable reimbursement plan is used, meaning that all reimbursements are in connection to the business and supported using receipts and other documents, then those payments are not counted as income to the employee. That means that the reimbursements are not taxable. If a business uses a non-accountable plan, which means that any one requirement of an accountable reimbursement plan is not met, then the payments that the employee receives are taxable. The non-accountable plan reimbursement is then reported on the employee's W-2 and income, social security, and Medicare taxes are all withheld.
9. Unemployment for nonprofit organizations
Unlike for-profit businesses, many not-for-profit organizations are not required to pay unemployment tax for their employees. Employees of these organizations should be apprised of their ineligibility for unemployment benefits in the unfortunate event of employment layoffs.
10. Assuring benefits subject to discriminatory requirements are followed
If a business chooses to offer benefits to only one group of employees, then it must follow specific rules in order to avoid violating statutory non-discriminatory requirements. These requirements vary depending on the type of benefit offered, so it is important to review the specific rules and requirements related to each benefit. We have written a number of blog posts about cafeteria plans, retirement options, and discriminatory HRAs. These blog posts help to better explain the requirements and some additional factors to take into consideration.
While this list represents the top 10 payroll compliance issues that we see here at MinistryCPA, we recognize that there are certainly more compliance issues. Please leave your thoughts and suggestions in the comments below, including additional topics that you would like us to cover. Contact us if we can help you address any of the issues above.