If you’re an employer, it’s crucial to manage your tax liabilities effectively. While you may be aware of the business expense deductions you can take, it’s important not to overlook the tax opportunities available in connection with employee compensation and benefits. It’s essential to work closely with a knowledgeable tax professional who can help you navigate the tax challenges associated with employee compensation and identify opportunities for savings.
How is Employee Compensation Taxed?
Employers must withhold federal income tax from an employee’s compensation. For Social Security tax and Medicare tax, the employer and employee each pay half. Most compensation types are subject to taxes, including wages, salaries, commissions, and bonuses. However, there is an exception for certain non-taxable fringe benefits specifically provided for in the Internal Revenue Code.
What are Common Tax Challenges for Employers?
Tax challenges for employers primarily revolve around compliance with payroll and employment tax. Common pitfalls can include uncertainty about worker classification, not knowing which benefits are considered taxable, and failure to keep up with the constantly changing regulations. Specifically, employers should be aware of the following tax challenges and be prepared to implement strategies to ensure compliance:
- Misclassification of workers — This is a big one. Misclassifying employees as independent contractors is a common mistake made by employers. This can lead to liability for unpaid payroll taxes, penalties and interest imposed by the IRS, and even litigation commenced by the employee. To avoid misclassification, employers should conduct regular audits, create clear contracts, and maintain accurate documentation.
- Distinguishing between taxable and non-taxable employee benefits — Employers may face challenges distinguishing between taxable and non-taxable employee benefits. Generally, all fringe benefits are considered taxable unless there is a specific section of the Internal Revenue Code that specifies an exclusion.
- Compliance across jurisdictions — Employers who operate across jurisdictions, whether in different states or globally, can face significant tax challenges due to the variation in tax laws and reporting requirements. To avoid cross-jurisdictional tax errors, an employer should work closely with an experienced tax professional who can best advise them.
- Determining the timing for reporting income — Determining when income should be reported for tax purposes can be difficult. The IRS applies the rule of constructive receipt. This means income is taxable once it is made available to the employee, regardless of whether they have physically received it. Employers should be mindful when reporting bonuses paid close to the year-end payroll cutoff and stock-based awards with special timing rules.
- Shifts in regulatory changes — Federal, state, and local governments constantly update tax rates, wage thresholds, and compliance requirements. Employers must monitor these regulatory changes and adjust the payroll systems to remain current. Failure to stay up to date can lead to underpayment or overpayment of taxes, which can potentially lead to an audit.
Maintaining thorough records, staying informed about changing tax laws, and using professional tax services are some critical ways employers can remain compliant and avoid complications.
How Can Employers Take Advantage of Tax Opportunities?
Employers can take proactive steps to turn tax compliance challenges into strategic opportunities. For instance, employers may be entitled to a wide range of tax credits for their employees that can be leveraged. These can include the Work Opportunity Tax Credit, the Disabled Access Credit, and the Employer-Provided Childcare Credit. Employers can also structure benefit plans for tax-efficiency and manage cash flow with deferral opportunities.
Additionally, a Section 125 cafeteria plan can provide significant tax savings for employers and offset plan costs. By allowing employees to use pre-tax dollars to pay for health insurance premiums, flexible spending accounts, or other benefits, employees can reduce their taxable income. While the total taxable payroll amount is reduced for employees who opt in to these plans, employers can save substantially on payroll taxes.
These are just a few of the tax opportunities that may be available to employers. It’s best to work with a skilled tax professional who can help ensure you take advantage of all the tax opportunities that are available in your specific situation.
Contact an Experienced Tax Professional
The tax code is complex. It’s vital for an employer to have the guidance they need to ensure they remain compliant and their business thrives. Based in Fairfield, Rolleri & Sheppard CPAs, LLP, provides a wide range of tax services to business owners and individuals. Contact us online or call (203) 259-CPAS to schedule a consultation to learn how we can assist you.
