So you’ve made it through your first (or second) year of operation and your start up has hired an employee or two. Now, in the face of tax season, you’re probably left wondering where to turn and suddenly realizing you may owe Uncle Sam some coin.
Two major documents are at the heart of your company’s tax plan: the W-2 and the W-4. While these only pertain to employees and not independent contractors, it’s important to understand the difference between the two forms and how to stay in compliance with the IRS.
About the W-4
Small business owners are required to withhold money from employee paychecks to cover their tax liability at the end of the year. The W-4 is the form issued to employees upon hiring in order to claim allowances, deductions, credits, and alternative forms of income in addition to their paycheck. Every allowance an employee claims reduces the amount you may withhold from their paycheck. If an employee won’t or didn’t fill out a W-4 upon being hired, you should withhold their taxes as if they were single and claiming zero allowances.
W-4 forms may be updated at any time within the tax year, though they often don’t require updating until a life change occurs such as marriage or the birth of a child.
About the W-2
The W-2 is the form you must issue to each employee by January 31 of every year and report to the IRS shortly thereafter.
W-2 forms include an employee’s taxable income, the amount subjected to state and federal income taxes, and the amount withheld. This form also contains information about financial contributions to retirement funds and other benefits. W-2 forms shouldn’t be changed unless they contain an error.
What About Independent Contractors?
In this economy, the perks of hiring independent contractors lead many startups to rely on additional help on an as-needed basis. However, you should not withhold any income from independent contractors. Independent contractors should receive a 1099-MISC form instead of a W-2.
The IRS considers independent contractors carefully and uses three determining factors when an employer files a 1099-MISC: behavior, finances, and the relationship with the worker. If you’re unsure as to whether you should file a W-2 or a 1099-MISC, the IRS has a determining process that you may submit a case to, the results of which are provided within 6 months.
Hopefully your tax picture is coming into clear focus and the stress of your first tax season is beginning to ease. If it’s not and you’re unsure where to turn, consider calling Honest Buck in Seattle and Bellevue. Our experienced bookkeeping and tax experts specialize in helping small businesses and startups of every size and scale, so don’t hesitate to reach out.
Image source, labelled for reuse