Wachovia Small Business: Three to Five Employees

We know a lot of Turbo Tax users are small business owners with just a handful of employees, maybe half a dozen or fewer. If that describes your business, here are some things you'll want to keep in mind to stay out of hot water with the IRS and save on taxes.

IRS requires you to pay the employer share of your employees' Social Security and Medicare tax liability, and to withhold their share of those taxes from their wages. For 2007, you and your employee each must pay 7.65% on the first $97,500 of the worker's pay. For income above that level, you both must keep paying the Medicare portion of the tax, which is 1.45% for each of you. The good news is that the employer share of these taxes is deductible as a business expense.

What about your own employment tax liability? You must pay the full freight—15.3% in 2007 —on the first $97,500 of your net earnings from self-employment. For earnings above that amount, you'll still owe Medicare tax of 2.9%. You can deduct one-half of your self-employment tax on your 1040.

Even before you start withholding and paying employment taxes, you'll need to apply to the IRS for an employer identification number, or EIN. This must be on your tax return and on other documents you file with the Service.

Estimated taxes. You must make estimated tax payments for your own income tax liability, unless you expect to owe the IRS less than $1,000 for the year. Generally the payments must be in four installments. For the 2007 tax year, the due dates are: April 17, June 15 and September 17, 2007, and January 5, 2008. If you're paying by mail, use Form 1040-ES. Or, you can pay electronically by enrolling in the Electronic Federal Tax Payment System (EFTPS). When you start up your business and request an employer identification number, the IRS automatically enrolls you in EFTPS.

Payroll taxes. The income and employment taxes you withhold from employees (and your share of their employment tax liability) must be deposited periodically with a financial institution authorized by IRS. Deposits are made quarterly if a firm's total amount per quarter is less than $2,500. If it's $2,500 or more, businesses usually make deposits monthly or several times a month. If you don't want the hassle of handling deposits yourself, you may choose to hire an outside firm to take care of this chore for you. But be forewarned: If you hook up with a payroll agent who defrauds you and absconds with your payroll tax money, you are still on the hook for the deposit. So you'll have to keep tabs on your payroll agent and check periodically to make sure IRS is getting its due.

There's plenty of paperwork to go along with the taxes you must pay for yourself and on behalf of your workers. When you hire employees, you must make sure they fill out a W-4 form, to let you know how much income tax to withhold from their paychecks. At the end of the year, you will issue a W-2 to them, which reports such things as how much they made and how much you withheld for both income and employment tax. You supply the same information to IRS. If your workers are independent contractors, you use Form 1099-MISC instead, and you don't need to withhold any taxes from the payments you make to them.

You also have to file information returns for your deposits of payroll taxes. Most businesses have to file these returns quarterly and use Form 941, but very small firms that deposit $1,000 a year or less can file just once a year, using Form 944.

Compensation you provide your employees for producing goods and services is deductible. This includes salaries, awards, bonuses, sick pay and vacation pay. And a whole array of fringe benefits is deductible as well. You can write off the cost of benefits under programs that provide: Accident, health and group-term life insurance; adoption assistance; dependent-care assistance; and educational assistance.

Other deductible fringe benefits include: Employee discounts on goods or services; memberships in professional organizations; tickets to entertainment or sporting events; and use of a car. Also, you can usually deduct the cost of furnishing meals and lodging to your employees, but your write-off for meals is limited to 50% of your cost.

Offering a pension or other retirement savings plan to your employees doesn't just help them; it also lets you save on your taxes, since you can deduct your plan contributions.

You might think the write-off you get for a retirement plan isn't worth the time and expense of setting up and running a plan. But here are two types of plans designed specifically for small businesses, because the paperwork burden and administrative costs of both are much less than for regular pensions and 401(k) plans. An added bonus: You can make contributions for yourself, too.

SEP (Simplified Employee Pension): This is a type of IRA for businesses with at least one employee. You use a bank or other financial institution to set up the plan and administer it, and you generally don't need to file any plan documents with the federal government. The plan accepts only employer contributions. For 2007, the limit on how much you can put in for yourself or for an employee is $45,000 or 25% of pay, whichever is less. You're not required to contribute every year, but when you do make payins, you have to contribute a uniform percentage of pay for all participants.

SIMPLE (Savings Incentive Match Plan): This is another IRA-like plan, but it's limited to businesses with 100 or fewer employees. They can contribute to the plan via payroll deduction. For 2007, employee payins are capped at $10,500 per worker. (Employees age 50 and over can contribute an additional $2,500.)You the employer pay into the plan in one of two ways: You must either match dollar-for-dollar the payins of those employees who actually participate (up to 3% of pay), or you contribute 2% of pay for all employees eligible to be in the plan. You can have each employee individually set up a SIMPLE IRA at his or her own bank or you can have all accounts maintained at one financial institution of your choice.

For more information about these plans and on how to set one up for your business, see IRS Publication 560, Retirement Plans for Small Businesses and IRS Publication 590, Individual Retirement Arrangements.

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SMALL BUSINESS: THREE TO FIVE EMPLOYEES