OTHER BUSINESS TOPICS

IRS Tax Tips for Starting a Business

When you start a business, a key to your success is to know your tax obligations.  You may not only need to know about income tax rules, but also about payroll tax rules.  Here are IRS tax tips that can help you get your business off to a good start.

  • Business Structure.  An early choice you need to make is to decide on the type of structure for your business.  The most common types are sole proprietor, partnership and corporation.  The type of business you choose will determine which tax forms you will file.

  • Business Taxes.  There are four general types of business taxes.  They are income tax, self-employment tax, employment tax and excise tax.  In most cases, the types of tax your business pays depends on the type of business structure you set up.  You may need to make estimated tax payments.  If you do, use IRS Direct Pay to pay them.  It's the fast, easy and secure way to pay from your checking or savings account.

  • Employer Identification Number.  You may need to get an Employers Identification Number (EIN) for federal tax purposes.

  • Accounting Method.  An accounting method is a set of rules that you use to determine when to report income and expenses.  You must use a consistent method.  The two that are most common are the cash and accrual methods.  Under the cash method, you normally report income and deduct expenses in the year that you receive or pay them.  Under the accrual method, you generally report income and deduct expenses in the year that your earn or incur them.  This is true even if you get the income or pay the expense in a later year.

  • Employee Health Care.  The Small Business Health Care Tax Credit helps small businesses and tax-exempt organizations pay for health care coverage they offer their employees.  A small employer is eligible for the credit if it has fewer than 25 employees who work full-time, or a combination of full-time and part-time.  The maximum credit is 50 percent of premiums paid for small business employers and 35 percent of premiums paid for small tax-exempt employers, such as charities.

The employer shared responsibility provisions of the Affordable Care Act affect employers employing at least a certain number of employees (generally 50 full-time employees or a combination of full-time and part-time employees).  These employers' are called Applicable Large Employers  (ALEs).  ALEs must either offer minimum essential coverage that is "affordable" and the provides "minimum value" to their full-time employees (and their dependents), or potentially make an employers shared responsibility payment to the IRS.  The bast majority of employers will fall below the ALE threshold number of employees and, therefore, will not be subject to the employer shared responsibility provisions.

Employers also have information reporting responsibilities regarding minimum essential coverage they offer or provide to their full-time employees.  Employers must send reports to employees and to the IRS on new forms the IRS created for this purpose.

Five Basic Tax Tips for New Businesses

If you start a business, one key to success is to know about your federal tax obligations.  You may need to know not only about income taxes but also about payroll taxes.  Here are five basic tax tips that can help get your business off to a good start.

  • 1.  Business Structure.  As you start out, you’ll need to choose the structure of your business.  Some common types include sole proprietorship, partnership and corporation.  You may also choose to be an S corporation or Limited Liability Company. You’ll report your business activity using the IRS forms which are right for your business type.

  • 2.  Business Taxes.  There are four general types of business taxes.  They are income tax, self-employment tax, employment tax and excise tax.  The type of taxes your business pays usually depends on which type of business you choose to set up.  You may need to pay your taxes by making estimated tax payments.

  • 3.  Employer Identification Number.  You may need to get an EIN for federal tax purposes.  Search “do you need an EIN” on IRS.gov to find out if you need this number.  If you do need one, you can apply for it online.

  • 4.  Accounting Method.  An accounting method is a set of rules that determine when to report income and expenses.  Your business must use a consistent method.  The two that are most common are the cash method and the accrual method.  Under the cash method, you normally report income in the year that you receive it and deduct expenses in the year that you pay them.  Under the accrual method, you generally report income in the year that you earn it and deduct expenses in the year that you incur them.  This is true even if you receive the income or pay the expenses in a future year.

  • 5.  Employee Health Care.  The Small Business Health Care Tax Credit helps small businesses and tax-exempt organizations pay for health care coverage they offer their employees.  A small employer is eligible for the credit if it has fewer than 25 employees who work full-time, or a combination of full-time and part-time.  Beginning in 2014, the maximum credit is 50 percent of premiums paid for small business employers and 35 percent of premiums paid for small tax-exempt employers, such as charities.

For 2015 and after, employers employing at least a certain number of employees (generally 50 full-time employees or a combination of full-time and part-time employees that is equivalent to 50 full-time employees) will be subject to the Employer Shared Responsibility provision.

Tax Tips if You’re Starting a Business

If you plan to start a new business, or you've just opened your doors, it is important for you to know your federal tax responsibilities.  Here are five basic tips from the IRS that can help you get started. 

  • 1.  Type of Business  Early on, you will need to decide the type of business you are going to establish.  The most common types are sole proprietorship, partnership, corporation, S corporation and Limited Liability Company.  Each type reports its business activity on a different federal tax form.

  • 2.  Types of Taxes  The type of business you run usually determines the type of taxes you pay.  The four general types of business taxes are income tax, self-employment tax, employment tax and excise tax.

  • 3.  Employer Identification Number  A business often needs to get a federal EIN for tax purposes.  Check IRS.gov to find out whether you need this number.  If you do, you can apply for an EIN online.

  • 4.  Record-keeping  Keeping good records will help you when it’s time to file your business tax forms at the end of the year. They help track deductible expenses and support all the items you report on your tax return.  Good records will also help you monitor your business’ progress and prepare your financial statements.  You may choose any record keeping system that clearly shows your income and expenses.

  • 5.  Accounting Method  Each taxpayer must also use a consistent accounting method, which is a set of rules that determine when to report income and expenses.  The most common are the cash method and accrual method.  Under the cash method, you normally report income in the year you receive it and deduct expenses in the year you pay them.  Under the accrual method, you generally report income in the year you earn it and deduct expenses in the year you incur them.  This is true even if you receive the income or pay the expenses in a future year.

Four Things You Should Know if You Barter

Small businesses sometimes barter to get products or services they need.  Bartering is the trading of one product or service for another.  Usually there is no exchange of cash.  An example of bartering is a plumber doing repair work for a dentist in exchange for dental services.

The IRS reminds all taxpayers that the fair market value of property or services received through a barter is taxable income. Both parties must report as income the value of the goods and services received in the exchange.

Here are four facts about bartering:

  • 1.  Barter exchanges.  A barter exchange is an organized marketplace where members barter products or services.  Some exchanges operate out of an office and others over the internet.  All barter exchanges are required to issue Form 1099-B, Proceeds from Broker and Barter Exchange Transactions, annually.  The exchange must give a copy of the form to its members and file a copy with the IRS.

  • 2.  Bartering income.  Barter and trade dollars are the same as real dollars for tax reporting purposes.  If you barter, you must report on your tax return the fair market value of the products or services you received.

  • 3.  Tax implications.  Bartering is taxable in the year it occurs.  The tax rules may vary based on the type of bartering that takes place.  Barterers may owe income taxes, self-employment taxes, employment taxes or excise taxes on their bartering income.

  • 4.  Reporting rules.  How you report bartering varies depending on which form of bartering takes place.  Generally, if you are in a trade or business you report bartering income on Form 1040, Schedule C, Profit or Loss from Business.  You may be able to deduct certain costs you incurred to perform the bartering.

Employee Retirement Plans: Tax Advantages and Other Benefits

Clearly, your employees are winners when you sponsor a retirement plan. But there are advantages for you, too.

A few decades ago, many employees could look forward to comfortable retirements. Interest rates on savings vehicles were high.  Pensions were well-funded. The economy hummed along.

Today's retirement scenarios for a good portion of the population are not as rosy. Rates on savings accounts, CDs, government bonds and other interest-bearing accounts are dismal.  Pension funds are struggling. And while there are positive signs of recovery, the U.S. economy has just been through the ringer.

As an employer, you can't do anything about these unpleasant realities.  But both you and your employees do stand to gain if you provide an employer-sponsored retirement plan.

A Win-Win Situation

As the economy continues to improve, it's still likely that employees who have to wait years or decades before leaving the workforce will not be as financially secure as their parents. So individual retirement planning is absolutely critical.

By offering an employee retirement plan, you'll be providing one of the pieces in that fiscal road map for the future. Both you and your employees benefit in numerous ways, including these:

·         Tax savings. Your contributions – as well as those of your employees – are often tax-deductible.

·         Rapid growth of wealth. Because of this tax-free compounding, savings will grow faster.

·         Tax credits.  As an employer may be eligible for a tax credit for the expenses involved in launching a retirement plan.

·      Fewer staffing problems.  An employee retirement plan can be another positive element of your company's total benefits package. And the most desirable employees expect financial "extras" from employers. So you will likely attract a higher caliber of applicants.

Numerous Choices

Considering all of the affordable options that are available, your company will be able to select the plan(s) that meets your expectations, your budget and your employees' needs. There are the familiar (Traditional and Roth IRAs, 401(k)s and 403(b)s and Employee Stock Ownership Plans (ESOPs), as well as the less common, like 409A Non-Qualified Deferred Compensation Plans, IRC 457(b) Deferred Compensation Plans and Money Purchase Plans.

Each, of course, has its own requirements and regulations, and launching one can be a complex process which must be completed with absolute accuracy. We've dealt with these plans – and, certainly, the IRS – before, and we'd be happy to help get you started.

Beyond all of the benefits already discussed here, offering an employee retirement plan can be an inexpensive, fruitful way to build goodwill around your company. These days, that's worth a great deal.

5 Business Tax Credits You May Be Missing

Though we're a few months off from having finalized IRS forms for tax year 2012, it's a good idea to start thinking now about how your financial obligation for this year is shaping up.  Barring any legislation that affects them, here are five business tax credits (not deductions) that you may want to explore.

1.  The Small Business Health Care Tax Credit for Small Employers

As a part of the Affordable Care Act of 2010, this credit has been available since the 2010 tax year to businesses that:

  • Have fewer than 25 full-time equivalent employees (FTEs)
  • Pay average wages of less than $50,000/year
  • Contribute at least 50 percent of the cost of single (not family) health care coverage for all employees.

The amount of the credit varies depending on the size of the company; smaller businesses actually get larger credits. The current maximum credit is 35 percent for small business employers and 25 percent for tax-exempt organizations like charities (these rates will increase on January 1, 2014). Click here to see if you qualify. The tax is refundable to eligible businesses that have no taxable income.  You can file an amended return for 2011 if you didn't claim it and could have.

2.  Work Opportunity Credit for Qualified Tax-Exempt Organizations Hiring Qualified Veterans

If your company has hired a veteran (or you plan to employ one before December 31, 2012), you may be eligible for a Work Opportunity Tax Credit (WOTC). This credit is claimed on the Form 5884-C.  According to the IRS, the credit can be as high as $9,600 per veteran when offered by for-profit employers or up to $6,240 per veteran for tax-exempt organizations.

Employers must file a Form 8850 within 28 days of hiring a qualified veteran.

3.  Credit for Increasing Research Activities

To qualify for this credit, your company must be involved in research that is technological in nature. Your work must relate to a new or improved function or level of quality, performance or reliability, and must ultimately be of business benefit to taxpayers. You would file a Form 6765.

4.  Credit for Small Employer Pension Plan Start-up Costs

You can report this credit on Form 3800 (General Business Credit); it gives eligible employers an up to 50 percent (maximum $500, for three years) credit on costs incurred for initiating an employee retirement savings plan. President Obama's fiscal 2013 budget plan proposes an increase in this amount.

5.  Credit for Employer-Provided Childcare Facilities and Services

Also reported on Form 3800, this credit pertains to qualified childcare expenditures made by an employer.  It's 25 percent of these expenses plus 10 percent of the qualified childcare resource and referral expenditures, and is limited to $150,000 per tax year.

New Business In 2012?  Start Thinking About Taxes Now

There are more questions than answers about the 2012 tax year; start planning now.

If ever there was a year when you needed to be starting on your business income tax planning early, this is it.

The measures enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (more commonly known as the Bush-era tax cuts) are scheduled to sunset at the end of 2012.  If Congress does not act, you'll be in for a rude surprise if you haven't prepared for this possibility.

Individuals would be affected tremendously; they would face a significant across-the-board hike in individual marginal tax rates.  But businesses, too, would have to deal with a different set of IRS rules regarding, for example:

  • Small business stock
  • Estate tax rates
  • Employer-Provided Child Care Credit
  • Gift Tax and GST Tax
If you started a business this year, it's especially critical that you start planning for taxes now.  Not only will you be facing a whole new, complex sets of forms and regulations, but like every other business, you don't know which way Congress will go – and when it will decide.

We're already halfway through the year, so it's critical that you put contingency plans in place that prepare you for an outcome that would increase your tax obligation for 2012.  Do you need to accelerate income?  Complete the anticipated sale of a major asset so that you're taxed at the current capital gains rate?  Do more gifting?  Transfer wealth?  We can run through numerous what-if scenarios with you and strategize.

Certainly, we will work with you on your tax preparation needs next year if the Acts sunset and you haven't prepared.  We always thoroughly examine our clients' financials and look for every legal tax advantage.

But if you start working with us now -- while there's still time to take action that will reduce your 2012 tax obligation – you'll be in an enviable position whatever happens.

Is It a Bad Debt or a Simple Revenue Loss?  Telling the Difference

YOU GAVE SOMEONE MONEY OR OFFERED THEM CREDIT.  THEY NEVER PAID YOU BACK.  CAN YOU DEDUCT THE LOSS ON YOUR INCOME TAXES?  Offering credit to customers can be a good thing for your business.  It increases your accounts receivable.  It can lock in a long-term relationship with a customer.  It provides extra income in the form of finance charges. And it promotes good will for your company.

But how do you reflect the loss on your business income taxes if this money isn't paid back?  If you are structured as any kind of corporation other than an S Corporation, all uncollectible debt is considered business bad debt.

 According to the IRS, you have a business bad debt if:

  • The debt was formalized as gross income from  sources like sales, service, rents or interest, and was recorded using the accrual method
  • The financial obligation was created or acquired in the course of operating your company, or you took it on primarily for business-related reasons.
If an unpaid financial obligation meets certain conditions, the IRS consider it a business bad debt. 

Bad debt that does not fit this definition is considered non business bad debt, and can be deducted as a short-term capital loss.  Many restrictions apply here.

 
Credit Often Responsible

Credit is usually the culprit, and a debtor bankruptcy is often the reason for the financial default.  If not, you must be able to prove that you took reasonable steps to collect on the obligation.  You can consider the debt worthless even prior to the debt’s due date if you've done so.

Business bad debts are entered on the IRS Form 1040X (sole proprietor or farmer), Form 1120X (corporation), Form 1120S (S corporation) or Form 1065 (partnership).  Most businesses will use the specific charge-off method to claim the debt, but you may qualify for the nonaccrual-experience method.

This element of your business income tax preparation is quite complex; we can help you sort it out.  Give us a call.

IRS Issues Guidance on Tax Treatment of Cell Phones; Provides Small Business Recordkeeping Relief

WASHINGTON — The Internal Revenue Service today issued guidance designed to clarify the tax treatment of employer-provided cell phones.

The guidance relates to a provision in the Small Business Jobs Act of 2010, enacted last fall, that removed cell phones from the definition of listed property, a category under tax law that normally requires additional record keeping by taxpayers.

The Notice issued today provides guidance on the treatment of employer-provided cell phones as an excludible fringe benefit. The Notice provides that when an employer provides an employee with a cell phone primarily for non compensatory business reasons, the business and personal use of the cell phone is generally nontaxable to the employee. The IRS will not require record keeping of business use in order to receive this tax-free treatment.

Simultaneously with the Notice, the IRS announced in a memo to its examiners a similar administrative approach that applies with respect to arrangements common to small businesses that provide cash allowances and reimbursements for work-related use of personally-owned cell phones. Under this approach, employers that require employees, primarily for non compensatory business reasons, to use their personal cell phones for business purposes may treat reimbursements of the employees’ expenses for reasonable cell phone coverage as nontaxable. This treatment does not apply to reimbursements of unusual or excessive expenses or to reimbursements made as a substitute for a portion of the employee’s regular wages.

Under the guidance issued today, where employers provide cell phones to their employees or where employers reimburse employees for business use of their personal cell phones, tax-free treatment is available without burdensome record keeping requirements. The guidance does not apply to the provision of cell phones or reimbursement for cell-phone use that is not primarily business related, as such arrangements are generally taxable.

Details are in the memo and in Notice 2011-72, posted today on IRS.gov.

Three Tips for Employers Outsourcing Their Payroll

Outsourcing payroll duties to third-party service providers can streamline business operations, but the IRS reminds employers that they are ultimately responsible for paying federal tax liabilities.

Recent prosecutions of individuals and companies who – acting under the guise of a payroll service provider – have stolen funds intended for payment of employment taxes makes it important that employers who outsource payroll are aware of the following three tips from the IRS:

1. Employer Responsibility The employer is ultimately responsible for the deposit and payment of federal tax liabilities. Even though you forward the tax payments to the third party to make the tax deposits, you – the employer – are the responsible party.

If the third party fails to make the federal tax payments, the IRS may assess penalties and interest. The employer is liable for all taxes, penalties and interest due. The IRS can also hold you personally liable for certain unpaid federal taxes.

2. Correspondence If there are any issues with an account, the IRS will send correspondence to the address of record. The IRS strongly suggests you do not change the address of record to that of the payroll service provider. That could limit your ability to stay informed of tax matters involving your business.

3. EFTPS Choose a payroll service provider that uses the Electronic Federal Tax Payment System. You can register on the EFTPS system to get your own PIN to verify the payments.

The IRS web site – IRS.gov has more information on the responsibilities of employers outsourcing payroll, payroll service providers and EFTPS.

Outsourcing Payroll Duties - More Information

Outsourcing Payroll Duties Can Be a Sound Business Practice, But… Know Your Tax Responsibilities as an Employer

Many employers outsource some or all of their payroll and related tax duties (i.e., withholding, reporting, and paying social security, Medicare, and income taxes) to third-party payroll service providers. Third-party payroll service providers can help assure filing deadlines and deposit requirements are met and greatly streamline business operations. Some of the services they provide are:

  • Administering payroll and employment taxes on behalf of the employer, where the employer provides the funds initially to the third-party.
  • Reporting, collecting and depositing employment taxes with state and federal authorities.
Employers who outsource some or all of their payroll responsibilities should consider the following:

  • The employer is ultimately responsible for the deposit and payment of federal tax liabilities. Even though the employer may forward the tax amounts to the third-party to make the tax deposits, the employer is the responsible party. If the third-party fails to make the federal tax payments, the IRS may assess penalties and interest on the employer’s account. The employer is liable for all taxes, penalties and interest due.  The employer may also be held personally liable for certain unpaid federal taxes.
  • If there are any issues with an account, the IRS will send correspondence to the employer at the address of record.  The IRS strongly suggests that the employer does not change their address of record to that of the payroll service provider as it may significantly limit the employer’s ability to be informed of tax matters involving their business.
  • Employers should ensure their payroll service providers are using EFTPS (Electronic Federal Tax Payment System) so the employers can confirm that payments are being made on their behalf.  Everyone should use EFTPS and Treasury regulations require electronic payment for payroll taxes over $200,000 in a calendar year.  Employers should register on the EFTPS system to get their own PIN and use this PIN to periodically verify payments. A red flag should go up the first time a service provider misses or makes a late payment. When an employer registers on EFTPS they will have on-line access to their payment history for 16 months. In addition, EFTPS allows employers to make any additional tax payments that their third-party provider is not making on their behalf such as estimated tax payments.
EFTPS is secure, accurate, easy to use and provides an immediate confirmation for each transaction.  The service is offered free of charge from the U.S. Department of Treasury and enables employers to make and verify federal tax payments electronically 24 hours a day, 7 days a week through the Internet, or by phone.  For more information, employers can enroll online at EFTPS.gov, or call EFTPS Customer Service at (800) 555-4477 for an enrollment form.

There have been recent prosecutions of individuals and companies who, acting under the guise of a payroll service provider, have stolen funds intended for payment of employment taxes. For more information, visit the Examples of Employment Tax Fraud Investigations – Fiscal Year 2011.

Remember, employers are ultimately the parties responsible for the payment of income tax withheld and both the employer and employee portions of social security and Medicare taxes.

Employers who believe that a bill or notice received is a result of a problem with their payroll service provider should contact the IRS as soon as possible by calling the number on the bill, writing to the IRS office that sent the bill, calling 1-800-829-4933, or visiting a local IRS office.

Business Taxes Add Complexity:  How Will This Affect You?

Still scrambling to prepare your 2011 taxes?  One thing you don't have to worry about is a lot of changes in the income tax code for businesses.  It was a fairly quiet year.

The biggest news, of course, was the introduction of the 1099-K form.  This must be filed by  payment settlement entities, which are financial institutions that issue credit cards, as well as third-party payment processors like PayPal.

If you accept payment using one of these entities and have processed $20,000 or more and at least 200 transactions in 2011, you should have received one, or will soon, and you must file it with your taxes like you would any other 1099.

Several forms and schedules have been altered to accommodate this.  Only gross amounts will be reported, so you need to have an easy way to track transactions that could affect this total (like chargebacks). We can help with this.

 Other changes?  A few, including:

 The 1099-B has changed.  Brokers are now required to report the basis for transactions, which you'll enter on the new Form 8949 rather than on the Schedule D.

  • The New Hire Retention Credit may affect some of your employees, if they've been kept on for at least 52 weeks. You would get $1,000 or 6.2 % of the newly-retained employee's wages for that year, whichever is less.
  • The upper limit for the Section 179 deduction is $500,00 for the 2011 tax year.  It goes down again for 2012.

You may be too mired in 2011 taxes to even think about your 2012 obligations.  But you'd be wise to start thinking about them now.  Year-round tax planning will minimize the drama of those dreaded IRS deadlines. Congress will undoubtedly be busy throughout 2012 and beyond, tweaking the tax code.  So talk to us about making smarter tax-related business decisions in 2012.

Article from:  The Wall Street Journal - Article

By ANGUS LOTEN

Small businesses whose books are audited—by a hired certified public accountant, not the Internal Revenue Service—improve their chances of getting a loan, and at far better terms, than businesses with less scrutinized financial statements, a new study shows.

. . . "Banks love when you have audited financials because they view it as a form of insurance," says Buzz Rose, a certified public accountant in Pittsburgh . . .

Get details here:  Audits Add Shine to Firms

What kind of records should I keep?

You may choose any recordkeeping system suited to your business that clearly shows your income and expenses.  Except in a few cases, the law does not require any special kind of records.  However, the business you are in affects the type of records you need to keep for federal tax purposes.  Your recordkeeping system should also include a summary of your business transactions.  This summary is ordinarily made in your business books (for example, accounting journals and ledgers).  Your books must show your gross income, as well as your deductions and credits.  For most small businesses, the business checkbook is the main source for entries in the business books.

Supporting Business Documents

Purchases, sales, payroll, and other transactions you have in your business will generate supporting documents such as invoices and receipts.  Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks.  These documents contain the information you need to record in your books.  It is important to keep these documents because they support the entries in your books and on your tax return.  You should keep them in an orderly fashion and in a safe place.  For instance, organize them by year and type of income or expense.  For more detailed information refer to Publication 583, Starting a Business and Keeping Records.

The following are some of the types of records you should keep:

  • Gross receipts are the income you receive from your business.  You should keep supporting documents that show the amounts and sources of your gross receipts.  Documents for gross receipts include the following:
  1. Cash register tapes
  2. Bank deposit slips
  3. Receipt books
  4. Invoices
  5. Credit card charge slips
  6. Forms 1099-MISC
  • Purchases are the items you busy and resell to customers.  If you are a manufacturer or producer, this includes the cost of all raw materials or parts purchased for manufacture into finished products.  Your supporting documents should show the amount paid and that the amount was for purchases.  Documents for purchases include the following:
  1. Canceled checks
  2. Cash register tape receipts
  3. Credit card sales slips
  4. Invoices
  • Expenses are the costs you incur (other than purchases) to carry on your business.  Your supporting documents should show the amount paid and that the amount was for a business expense.  Documents for expenses include the following:
  1. Canceled chekcs
  2. Cash register tapes
  3. Account statements
  4. Credit card sales slips
  5. Invoices
  6. Petty cash slips for small cash payments
  • Travel, Transportation, Entertainment, and Gift Expenses If you deduct travel, entertainment, gift or transportation expenses, you must be able to prove (substantiate) certain elements of expenses.  For additional information on how to prove certain business expenses, refer to Publication 463, Travel, Entertainent, Gift, and Car Expenses.
  • Assets are the property, such as machinery and furniture, that you own and use in your business.  You must keep records to verify certain information about your business assets.  You need records to compute the annual depreciation and the gain or loss when you sell the assets.  Documents for assets include the following:
  1. When and how you acquired the assets.
  2. Purchase price
  3. Cost of any improvements
  4. Section 179 deduction taken
  5. Deductions taken for depreciation
  6. Deductions taken for casualty losses, such as losses resulting from fires or storms
  7. How you used the asset
  8. When and how you disposed of the asset
  9. Selling price
  10. Expenses of sale
The following documents may show this information

  1. Purchase and sales invoices
  2. Real estate closing statements
  3. Cancel check

Form W-4 – Employee's Withholding Allowance Certificate

When you hire an employee, you must have the employee complete a Form W-4 (PDF), Employee's Withholding Allowance Certificate. Form W-4 tells you, as an employer, which marital status, how many withholding allowances, and any additional amount to use when you deduct Federal income tax from the employees' pay. If an employee fails to give you a properly completed Form W-4, you must withhold federal income taxes from his or her wages as if he or she were single and claiming no withholding allowances.

An employee may want to change the number of withholding allowances or his or her withholding rate (marital status) on Form W-4 for any number of reasons, such as marriage, a change in the number of dependents, or a change in the amount of itemized deductions or tax credits anticipated for the tax year. If you receive a revised Form W-4 from an employee, you must put it into effect no later than the start of the first payroll period ending on or after the 30th day from the date you received the revised Form W-4. An exception is made when you receive a notice (commonly referred to as a "lock-in-letter") from the IRS specifying the withholding rate (marital status) and maximum number of withholding allowances permitted for the employee. You must then honor the lock-in letter. See the Lock-in Letter section below for further information. Also see the discussions on Exemption from Withholding and Invalid Form W-4.

Form W-4 includes detailed worksheets to help the employee figure his or her correct number of withholding allowances. Employees may also want to access the withholding calculator on the IRS website at www.irs.gov/individuals for help in completing Form W-4. Tell any nonresident alien employees to see the Form 8233 Instructions before completing a Form W-4.

You should keep blank Forms W-4 for the current year on hand so you can provide them to your current and new employees. An employer can download and print Form W-4 from the IRS website at www.irs.gov. Taxpayers may also order Forms W-4 by calling 800-TAX-FORM (800-829-3676). TTY/TDD users may call 800-829-4059 to order Forms W-4. A substitute Form W-4, developed by the employer, may be used instead of the official Form W-4, if the employer also provides the tables, instructions, and worksheets contained in the Form W-4 in effect at that time. Employers may not accept a substitute form developed by an employee and the employee submitting such form will be treated as failing to furnish a Form W-4.

You should inform your employees of the importance of submitting an accurate Form W-4. An employee may be subject to a $500 penalty if he or she submits, with no reasonable basis, a Form W-4 that results in less tax being withheld than is required.

For additional information, refer to Publication 15, (Circular E), Employer's Tax Guide, Publication 505, Tax Withholding and Estimated Tax, Publication 919, How Do I Adjust My Tax Withholding?, and the Withholding Compliance Questions & Answers on the IRS website at IRS.gov. For the procedures for withholding income taxes on the wages of nonresident alien employees, refer to Notice 2005-76 and Aliens Employed in the U.S. on the IRS website at IRS.gov.

Exemption from Withholding

If an employee qualifies, Form W-4 is also used by the employee to tell you not to deduct any Federal income tax from his or her wages. To qualify for this exempt status, the employee must have had no tax liability for the previous year and must expect to have no tax liability for the current year. However, if the employee can be claimed as a dependent on a parent's or another person's tax return, additional limitations may apply. See the instructions for Form W-4. A Form W-4 claiming exemption from withholding is valid for only one calendar year. To continue to be exempt from withholding in the next year, an employee must give you a new Form W-4 claiming exempt status by February 15 of that year. If the employee does not give you a new Form W-4, withhold tax as if he or she is single, with no withholding allowances. However, if you have an earlier Form W-4 (not claiming exempt status) for this employee that is valid, withhold as you did before.

Invalid Form W-4

Any unauthorized change or addition to Form W-4 makes it invalid. This includes taking out any language by which the employee certifies that the form is correct. A Form W-4 is also invalid if, by the date an employee gives it to you, he or she indicates in any way that it is false. When you get an invalid Form W-4, do not use it to determine Federal income tax withholding. Tell the employee that it is invalid and ask for another one. If the employee does not give you a valid one, withhold taxes as if the employee was single and claiming no withholding allowances. However, if you have an earlier Form W-4 for this employee that is valid, withhold as you did before.

Record Keeping Requirements

After the employee completes and signs the Form W-4, you must keep it in your records. This form serves as verification that you are withholding federal income tax according to the employee's instructions and needs to be available for inspection should the IRS ever request it. Form W-4 is 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.

Lock-in Letters

The IRS uses information reported on Forms W-2, Wage and Tax Statement, to identify employees with withholding compliance problems. In some cases, where a serious under-withholding problem is found to exist for a particular employee, the IRS may issue a notice (commonly referred to as a "lock-in-letter") to you specifying the withholding rate (marital status) and maximum number of withholding allowances permitted for a specific employee for purposes of calculating the required withholding. The IRS will provide the employee with an opportunity to dispute the determination before you adjust withholding based on the lock-in letter.

The IRS will send a letter to the employee explaining that the IRS will require the employer to start withholding additional income tax unless the employee contacts the IRS to explain why the employee should not have withholding increased. A toll-free number and address for the unit handling this program will be provided in the letter. As an additional safeguard, the employer will also receive a notice to provide to the employee.

After the lock-in letter takes effect, you must disregard any Form W-4 that results in less tax withheld, until the IRS notifies you otherwise. However, you must honor any Form W-4 that results in more income tax withheld than at the withholding rate (marital status) and withholding allowances specified in the lock-in letter. Employers who use electronic Form W-4 systems must make sure the employee can not override the lock-in letter to decrease withholding via an electronic Form W-4 system. Lock-in letter provisions also apply to employees rehired within 12 months from the date of the notice.

After the lock-in letter takes effect, if the employee wants to claim complete exemption from withholding or claim a withholding rate, withholding allowances, and additional amount that results in less income tax withheld than the lock-in letter, the employee must contact the IRS. A toll-free number and address for the unit handling this program will be provided in the lock-in letter.

Form W-2 – Where, When, and How to File

It is your responsibility, as an employer, to file Copy A of Form W-2 (PDF), Wage and Tax Statement, with the Social Security Administration (SSA) for your employees, showing the wages paid and taxes withheld for the year. Because Form W-2 is the only document used to transmit information on your employees' social security and Medicare wages for the year, it is very important to prepare the forms correctly and timely.

There are separate Form W-2 and W-3 Instructions. Use Form W-3, Transmittal of Wage and Tax Statements, as a cover sheet when filing one or more Forms W-2 with the SSA. Be sure to order Form W-3 when you order your W-2 forms. If you have questions about a particular box on Forms W-2 or W-3, refer to the instructions, which give a detailed explanation of each box. Here are a few important items to keep in mind when preparing Form W-2:

  1. Type all entries using black ink and, if possible, a 12-point Courier font.
  2. Use decimal points followed by cents (or zeroes for no cents). Do not use dollar signs or commas.
  3. Please do not make any erasures, cross-outs, or white-outs. Copy A, which is the first page, must be error free. If you make an error on a form, put an "X" in the "Void" box, go to the next Form W-2 and start again. Do not write "corrected" on the next Form W-2.
  4. Form W-2 is printed with two forms on a page. Send in the whole Copy A page (the page printed with red ink) even if one form is blank or void. Do not cut or fold the page. Do not staple Forms W-2 to each other, or to Form W-3.
The official Form W-2 comes in 6 copies. Copy A must be sent to the SSA with the transmittal Form W-3 by the last day of February of the year succeeding the tax year to which the forms relate. Special due dates apply if you have terminated your business. See Form W-2 and W-3 Instructions for additional information. Form W-3 is used to transmit the Forms W-2 and contains figures reflecting the box totals of all the Forms W-2 being sent. The address for mailing Copy A of the Forms W-2 and W-3 is listed in the separate Form W-2 and W-3 Instructions.

Keep Copy D of Form W-2 for your own records. Send Copy 1 to your state tax department. Contact that department for requirements and transmittal information. You must give the remaining copies of Form W-2 to the employee by January 31 of the succeeding calendar year. If an employee stops working for you before the end of the year, you may give your former employee Form W-2 anytime prior to January 31, but no later than January 31. If the employee asks for the Form W-2, you must give Copy B, Copy C, and Copy 2 to the employee within 30 days of the request, or within 30 days of the final wage payment, whichever is later.

The totals for amounts reported on the related forms, ( Form 941 (PDF), Form 943 (PDF), Form 944, Form CT-1 (PDF) or Form 1040, Schedule H (PDF) for the year) should equal those same totals reported on your Form W-2. If the totals do not match, you should generally make corrections. If you discover an error on an employee's Form W-2 after sending it to the SSA, submit a Form W-2c, Corrected Wage and Tax Statement. You must submit a transmittal Form W-3c, Transmittal of Corrected Wage and Tax Statements, with any Forms W-2c.

Employers filing 250 or more Forms W-2 must file electronically unless granted a waiver by the IRS. However, all employers are encouraged to file Forms W-2 electronically, even if filing fewer than 250 Forms W-2. If you file your Forms W-2 electronically, the due date is March 31st. For more information on electronic filing, refer to Topic 801, Topic 802, Topic 803, Topic 804, and Topic 805. Additionally, by using a personal computer and a modem, you may obtain additional information on electronic filing of Forms W-2 from the SSA's Business Services Online (BSO). You can access BSO at www.socialsecurity.gov/employer. You can also get electronic specifications by contacting the SSA's Employee Reporting Branch at 800-772-6270. SSA no longer accepts magnetic tapes, cartridges, or 3 1/2" diskettes. All Forms W-2 must be filed either electronically or on paper.

You may also want to refer to Publication 15, (Circular E), Employer's Tax Guide, Publication 51, ( Circular A), Agricultural Employer's Tax Guide, Publication 15-A (PDF), Employer's Supplemental Tax Guide, Publication 393 (PDF), Federal Employment Tax Forms, Form 8809 (PDF), Application for Extension of Time To File Information Returns, and Form 8508 (PDF), Request for Waiver From Filing Information Returns Electronically.

Form 941 and 944 – Deposit Requirements

If you are required to file Form 941 and you accumulate a liability for these taxes of less than $2,500 per quarter, you may submit payment of taxes due with your timely filed return. Similarly, if you are required to file Form 944 and you accumulate a liability for these taxes of less than $2,500 a year, you may submit payment of taxes due with your timely filed return. However, if you accumulate a liability for these taxes of $2,500 or more per quarter, and you are required to file Form 941, you generally must deposit your taxes periodically according to your deposit schedule (i.e., monthly or semiweekly). You generally must make tax deposits in the same manner if you are required to file the annual Form 944 and accumulate a liability of $2,500 or more per year. Some exceptions apply, as discussed below.

Even if an employer's employment tax liability is $2,500 or more per quarter (for Form 941 filers) or per year (for Form 944 filers), the employer can make a payment with the return if the employer is a monthly schedule depositor making a payment in accordance with the Accuracy of Deposits Rule. For more information, refer to Chapter 11 of Publication 15, (Circular E), Employer's Tax Guide.

Furthermore, beginning January 2010, employers who file Form 941 will not have to make deposits during a quarter if their accumulated tax liability for either the current quarter or the prior quarter is less than $2,500 and they full pay the amount due with a timely filed return for the current quarter.

An additional exception applies to Form 944 filers. Even if a Form 944 filer's employment tax liability is $2,500 or more for the year, it may pay the fourth quarter employment tax liability with the return if it is less than $2,500, as long as the employment taxes for the first, second, and third quarters were previously deposited.

If you are required to deposit your employment taxes, you must deposit them according to one of two deposit schedules, monthly or semiweekly. Which schedule you use for the current calendar year is based on the amount of taxes you reported during the four quarters (for 941 filers) or year (for 944 filers) in your lookback period. For details on lookback periods refer to Chapter 11 of Publication 15.

If you reported taxes of $50,000 or less during the lookback period, you are a monthly schedule depositor, and generally must deposit each month's accumulated employment taxes on or before the 15th day of the following month. For example, taxes for January must be deposited by February 15th.

If you reported taxes greater than $50,000 for the lookback period, you are a semiweekly schedule depositor, and generally must deposit your employment taxes on Wednesday or Friday, of each week, based on the following schedule:

  1. The employment taxes on payments made to your employees on Wednesday, Thursday, and/or Friday, must be deposited by the following Wednesday.
  2. The employment taxes on payments made to your employees on Saturday, Sunday, Monday, and/or Tuesday, must be deposited by the following Friday.
Semiweekly depositors always have at least 3 banking days to make a deposit. If any of the 3 weekdays after the end of the semiweekly period is a holiday on which banks are closed, you have one additional day to deposit.

Regardless of whether you are a monthly depositor or a semiweekly schedule depositor, if you accumulate taxes of $100,000 or more on any day during a deposit period, you must deposit them on the next banking day. If this happens, you become a semiweekly depositor for the remainder of the calendar year and for the following calendar year.

If any deposit due date falls on a Saturday, Sunday, or legal holiday, the deposit will be considered timely if made by the next banking day.

If you are a new employer, your taxes in the lookback period are considered to be zero for any quarter your business did not exist. Therefore, in the first year of business you are a monthly schedule depositor unless the $100,000 next day deposit rule applies.

Deposits are made either by using the Electronic Federal Tax Payment System (EFTPS), or by making payment to an authorized financial institution with a Form 8109, Federal Tax Deposit Coupon. If you use Form 8109, it is very important that it show the correct employer identification number, name, and type of tax and tax period, as this information is used by the IRS to credit your account. Your check or money order should be made payable to the financial institution where you make your deposit, not to the IRS. There are penalties for depositing late, or for mailing payments directly to the IRS that are required to be deposited, unless you have reasonable cause for doing so.

You must make deposits using EFTPS for all depository tax liabilities for the current year if you made more than $200,000 in aggregate deposits for all types of Federal depository taxes in the year two years before the current year or if you were required to make electronic deposits in the previous year.

If you are required to make electronic deposits through EFTPS and fail to do so, or make your deposit using a paper coupon Form 8109, you may be subject to a 10% penalty. Refer to Chapter 11 in Publication 15 for rules on depositing taxes.

Even if you do not have to make electronic deposits, you may voluntarily participate in EFTPS. To enroll in EFTPS, call 800-555-4477, or to enroll online, visit www.eftps.gov. For general information about EFTPS, call 800-829-1040 for individuals or 800-829-4933 for businesses.

Refer to Publication 966 (PDF) for Electronic Federal Tax Payment System information and Publication 15, (Circular E), Employer's Tax Guide, for deposit requirements.

Employer Identification Number (EIN) – How to Apply

Generally, an employer is a person or organization for whom a worker performs services as an employee. As an employer, you are generally required to withhold, deposit and report employment taxes. To file the various tax returns, including employment tax returns, you need an Employer Identification Number (EIN). However, a sole proprietor may use his or her social security number in lieu of an EIN if the business has no employees and is not required to file excise, employment, alcohol, tobacco, or firearms returns. A sole proprietorship is the only type of business that may use a social security number rather than an EIN.

An entity is considered to be a sole proprietorship for Federal tax purposes if an individual operates his or her business through a domestic Limited Liability Company (LLC) owned solely by the individual and does not elect for that LLC to be taxed as a corporation by filing Form 8832 (PDF), Entity Classification Election. In such a case, the LLC is disregarded for federal tax purposes. Generally, the LLC without employees should not request its own EIN. However, the owner of a LLC that elects to be disregarded for federal tax purposes must pay all employment taxes and file employment tax returns with respect to wages paid to employees performing services for the LLC using the LLC's name and EIN.

There are four ways to apply for an EIN:

  1. The Internet EIN application is the preferred method for customers to apply for and obtain an EIN. Once the application is completed, the information is validated during the online session, and an EIN is issued immediately. The online application process is available for all entities whose principle business, office, or agency, or legal residence (in the case of an individual) is located in the United States or U.S. Territories. The principal officer, general partner, grantor, owner, trustee, etc. must have a valid Taxpayer Identification Number (Social Security Number, Employer Identification Number, or Individual Taxpayer Identification number) in order to use the online application.
  2. You may obtain an EIN immediately by telephone 5 days a week, Monday through Friday from 7:00 a.m. to 10:00 p.m. (local time), by calling IRS at 800–829–4933. You may use this EIN immediately to file a paper return or make a payment of tax.
  3. You may obtain an EIN by completing Form SS-4 (PDF), Application for Employer Identification Number, and faxing it to the IRS for processing. The IRS Fax numbers are provided in the Form SS-4 Instructions. An EIN applied for by fax will be issued within 4 business days.
  4. You may also obtain an EIN by completing the Form SS-4 and mailing it to the IRS service center address listed on the Form SS-4 Instructions. By mailing the completed Form SS-4 to the appropriate service center, you can obtain an EIN within 4 to 5 weeks.
If you already have an EIN and the organization or ownership of your business changes, you may need to apply for a new number. For more information, refer to Publication 1635 (PDF), Understanding Your EIN. If you prefer, you may call 800–829–4933 for more information.

Form W-5 – Advance Earned Income Credit

Would you like to help your employees increase their take–home pay at no cost to you? You can do this by giving eligible employees part of the earned income credit with their pay and subtracting the payments you make from payroll taxes. This is possible through the Advance Earned Income Credit (Advance EIC) program.

The earned income credit is a refundable credit for certain qualified workers. It is intended to help offset some of the increases in living expenses and social security taxes. This credit reduces the amount of tax owed, if any, and may result in a refund to the taxpayer.

Eligible employees can receive part of their earned income credit for current year in their paychecks throughout the year, instead of waiting until they file their tax returns. To be eligible for this Advance EIC payment, an employee must expect to have a qualifying child, expect to fall within certain income limits, and expect to meet other specific requirements, which are explained on Form W-5, Earned Income Credit Advance Payment Certificate, and in more detail in Publication 596, Earned Income Credit.

Here's how it works: An eligible employee who wants the credit with his or her pay must give you a completed and signed Form W-5 (PDF). You are required by law to make advance payments to most eligible employees who provide the form. If your employee expects to be eligible the following year, he or she must give you a new form.

To figure the amount of credit to include with the employees' pay, use the Tables for Percentage Method or Tables for Wage Bracket Method of Advance EIC Payments in Publication 15, (Circular E), Employer's Tax Guide.

The advance payment is added to the employee's net pay for the pay period. Since the EIC isn't wages, you don't withhold any income, social security, or Medicare taxes from the payment. Generally, you make the advance payments from withheld income tax and employee and employer social security and Medicare taxes. However, the payment doesn't change the amount of employment taxes you would usually withhold from the employee's pay. If the employee is entitled to an advance payment that is more than his or her withholding, you can still make a payment to the employee.

You report the payments you made to your employees by showing the total payments on the advance EIC line of your employment tax return, Form 941 (PDF), Form 943 (PDF), Form 944 (PDF) or Form 1040, Schedule H (PDF), whichever applies, and subtract this amount from your total employment taxes. Publication 15, and the specific instructions for the form you file, will give you more information.

The IRS offers Outreach seminars to explain Advance EIC and EIC to interested groups. If you are interested in having an IRS employee speak to your payroll personnel and employees on Advance EIC and EIC, call 800–829–1040, and ask for the Taxpayer Education Coordinator for your area.

Bartering Income

Bartering occurs when you exchange goods or services without exchanging money. An example of bartering is a plumber doing repair work for a dentist in exchange for dental services. The fair market value of goods and services received in exchange for goods or services you provide must be included in income in the year received.

Generally, you report this income on Form 1040, Schedule C (PDF), Profit or Loss from Business. If you failed to report this income, correct your return by filing a Form 1040X. Refer to Topic 308 for Amended Return information.

A barter exchange or barter club is any person or organization with members or clients that contract with each other (or with the barter exchange) to jointly trade or barter property or services. The term does not include arrangements that provide solely for the informal exchange of similar services on a noncommercial basis.

The Internet has provided a medium for new growth in the bartering exchange industry. This growth prompts the following reminder: Barter exchanges are required to file Form 1099-B for all transactions unless certain exceptions are met. Refer to Barter Exchanges for additional information on this subject. If you are in a business or trade, you may be able to deduct certain costs you incurred to perform the work that was bartered. If you exchanged property or services through a barter exchange, you should receive a Form 1099-B (PDF), Proceeds From Broker and Barter Exchange Transactions. The IRS also will receive the same information.

Please refer to our Bartering page for more information on bartering income and bartering exchanges.

If you receive income from bartering, you may be required to make estimated tax payments. Refer to Publication 525, Taxable and Nontaxable Income, for additional information.

Business Income

Business income is income received from the sale of products or services. For example, fees received by a professional person are considered business income. Rents received by a person in the real estate business are business income. Payments received in the form of property or services must be included in income at their fair market value.

Normally a business is organized as a sole proprietorship, partnership, or corporation. A sole proprietorship has no existence apart from its owner. Business debts are personal debts of the owner. A sole proprietor files Form 1040 Schedule C (PDF), or Form 1040 Schedule C-EZ (PDF), (with Form 1040), to report the income and expenses of the business. A sole proprietor who had net earnings (from Schedule C or C-EZ) of $400 or more or had church employee income of $108.28 or more must file Form 1040 Schedule SE (PDF). Schedule SE is used to figure self-employment tax, which is the combined social security and Medicare tax on self-employment income. For more information on sole proprietorships refer to Publication 334, Tax Guide for Small Business.

A partnership is an unincorporated business organization that is the result of two or more persons joining together to carry on a trade or business. Each person contributes money, property, services, or a combination thereof in return for a right to share in the profits and losses of the partnership. A limited liability company with more than one owner is generally treated as a partnership for tax purposes. A partnership's income and expenses are generally reported on Form 1065 (PDF), U. S. Return of Partnership Income, annually. No income tax is paid by the partnership itself. Each partner receives a Form 1065 Schedule K-1 (PDF), Partner's Share of Income, Deductions, Credits, etc., which indicates the partner's distributive share of partnership income, expenses, and other items, determined in accordance with the terms of the partnership agreement. For more information, refer to Form 1065 Instructions. For more information on partnerships, in general, refer to Publication 541, Partnerships.

The term "corporation", for Federal income tax purposes, generally includes legal entities separate from the people who formed them under Federal or state law or the shareholders who own them. It also includes certain businesses that elect to be taxed as a corporation by filing Form 8832 (PDF), Entity Classification Election. The tax on a corporation's income is figured on Form 1120 (PDF), U. S. Corporation Income Tax Return. Form 1120-A is now obsolete for tax years beginning in 2007. For more information on corporations in general, refer to Publication 542, Corporations. Corporations that meet certain requirements may elect to become S corporations, which are treated in a manner similar to partnerships. An S corporation files Form 1120S (PDF), U. S. Income Tax Return for an S Corporation, and is generally not subject to tax. Most income and expenses of an S corporation are "passed through" to the shareholders on Form 1120S Schedule K-1 (PDF), Shareholder's Share of Income, Deductions, Credits, etc. The shareholders include the amounts indicated on the K-1 on their individual returns. For more information on S corporations, refer to Form 1120S Instructions.

Closing a Business Checklist

There are typical actions that are taken when closing a business. You must file an annual return for the year you go out of business. If you have employees, you must file the final employment tax returns, in addition to making final federal tax deposits of these taxes. Also attach a statement to your return showing the name of the person keeping the payroll records and the address where those records will be kept.

The annual tax return for a partnership, corporation, S corporation, limited liability company or trust includes check boxes near the top front page just below the entity information. For the tax year in which your business ceases to exist, check the box that indicates this tax return is a final return. If there are Schedule K-1s, repeat the same procedure on the Schedule K-1.

You will also need to file returns to report disposing of business property, reporting the exchange of like-kind property, and/or changing the form of your business. If you do not have a pre-printed envelope in which to send your taxes, refer to the Where To File page for a list of addresses. Below is a list of typical actions to take when closing a business, depending on your type of business structure:

Checklist

Self-Employment Tax

You are self-employed for this purpose if you are a sole proprietor, an independent contractor, a partner in a partnership, a member of a single-member LLC or are otherwise in business for yourself. You usually must pay self-employment tax if you had net earnings from self-employment of $400 or more. Generally, the amount subject to self-employment tax is 92.35% of your net earnings from self-employment. Net earnings are calculated by subtracting ordinary and necessary trade or business expenses from the gross income you derived from your trade or business. You can be liable for paying self-employment tax even if you are currently receiving social security benefits.

If you had a small profit or net loss from your business but want to receive credit toward your social security coverage you may be eligible to use one of the two optional methods to compute your net earnings from self-employment. Refer to the Form 1040, Schedule SE Instructions to see if you qualify to use an optional method. An optional method may increase your earned income credit or the child and dependent care credit.

The self-employment tax rate is a percentage set by law of your net earnings from self-employment. This rate consists of 12.4% for Social Security and 2.9% for Medicare. The maximum amount of net earnings subject to the social security tax is set by law and changes annually. All of your net earnings are subject to the Medicare tax. Self-employment tax is computed on Form 1040, Schedule SE (PDF). When figuring your adjusted gross income on Form 1040, you can deduct one-half of your self-employment tax. This deduction is taken on Schedule SE. The Social Security Administration uses the information from Schedule SE to compute your benefits under the social security program.

If you are an employee of a church or qualified church-controlled organization that elected exemption from social security and Medicare taxes, and you are not yourself exempt from self-employment tax, you must pay self-employment tax if you are paid more than $108.28 in a year from the church or qualified church-controlled organization. If you are required to pay self–employment tax, you must file Form 1040 and attach Schedule SE. For more information on church related income and self–employment taxes, refer to Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers.

More information on self–employment tax can be found in Publication 334, Tax Guide for Small Business.