Batley CPA Tax & Business Alert July 2024

Independent contractors: handle with care

Many businesses use independent contractors to help keep their costs down and provide flexibility for short-term needs.  If you’re among those businesses, be careful that these workers are properly classified for federal tax purposes. If the IRS reclassifies them as employees, it can be an expensive mistake.

The question of whether a worker is an independent contractor or an employee for federal income and employment tax purposes is a complex one. If a worker is an employee, your company must withhold federal income and payroll taxes, pay the employer’s share of Social Security and Medicare taxes on the wages, and pay federal unemployment tax. A business may also provide the worker with fringe benefits if it makes them available to other employees. In addition, there may be state tax obligations.

On the other hand, if a worker is an independent contractor, these obligations don’t apply. In that case, the business simply sends the contractor a Form 1099-NEC for the year showing the amount paid (if it’s $600 or more).

Key factors

Who’s an “employee?” Unfortunately, there’s no one definition of the term. The IRS and courts have generally ruled that one of the key factors that determines the difference between an employee and a contractor is the right to control and direct the person in the jobs they’re performing, even if that control isn’t exercised. The issue of control is evaluated by asking several questions, including:

• Who sets the worker’s schedule?
• Are the worker’s activities subject to supervision?
• Is the work technical in nature?
• Is the worker free to work for others?

Another important factor is whether the worker has the opportunity for profit or loss based on his or her managerial skills. That is, can the worker apply independent judgment and business acumen to affect the success or failure of the work being performed? If there’s a lack of such opportunity, that’s one indication of employee status.

Some employers that have misclassified workers as independent contractors may get some relief from employment tax liabilities under Section 530. This protection generally applies only if an employer meets certain requirements. For example, the employer must file all federal returns consistent with its treatment of a worker as a contractor and it must treat all similarly situated workers as contractors. Note: Section 530 doesn’t apply to certain types of workers.

Be wary before asking the IRS

You can ask the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee. However, you should also be aware that the IRS has a history of classifying workers as employees rather than independent contractors. So, before you file Form SS-8, contact us for a consultation. Filing this form may alert the IRS that your business has worker classification issues — and it may unintentionally trigger an employment tax audit. It may be better to properly set up a relationship with workers to treat them as independent contractors so that your business complies with the tax rules.

Workers who want an official determination of their status can also file Form SS-8. Dissatisfied independent contractors may do so because they feel entitled to employee benefits and want to eliminate their self-employment tax liabilities. If a worker files Form SS-8, the IRS will notify the business with a letter that identifies the worker and includes a blank Form SS-8. The business will be asked to complete and return the form to the IRS, which will render a classification decision.

Need more help?

This article lists the basic rules. If you have questions, contact us to assist you in ensuring that your workers are properly classified.

6 strategies for improving collections

Businesses that operate in the retail or restaurant spheres have it relatively easy when it comes to collections. They generally take payments right at a point-of-sale terminal and customers go on their merry way. Of course, these enterprises face many other challenges.

For other types of companies, it’s not so easy. Collections can be particularly challenging for business-to-business operations, which often find themselves in complex relationships with key customers. In these businesses, it’s not as simple as “pay up or hit the road.”

If your company is dealing with slow-paying customers, which isn’t uncommon in today’s inflationary environment where everyone is trying to preserve cash flow, it helps to review the basics. Here are six tried-and-true strategies for increasing your chances of getting paid:

1. Request payment up front. For new customers or those with a documented history of collection issues, consider asking for a deposit on each order. This would generally be a small but noticeable percentage of the contract or order price. You could also explore the concept of asking for a service retainer fee, similar to how law firms typically operate.
2. Charge fees. Most customers are likely familiar with the concept of late-payment fees from dealing with their credit card companies. Consider implementing fees or finance charges on past due accounts. Place extremely delinquent accounts on credit hold or adjust their payment terms to cash on delivery.
3. Reward timely payments. An effective collection strategy isn’t only about “penalizing” slow-paying customers. It’s also about incentivizing those who pay on time or who represent a potentially lucrative long-term relationship. Crunch the numbers to determine the feasibility of giving discounts to customers with strong payment histories or to those who have improved the timeliness of payments over a given period.
4. Communicate proactively. Set up regular e-mail reminders and place live phone calls to customers who haven’t settled their accounts. If the employees who work directly with the delinquent customers can’t resolve payment issues, elevate the matter to a manager or even to you, the business owner. If necessary, consider executing a promissory note to prevent the customer from disputing the charges in the future.
5. Get external help. If, after repeated tries, your collection efforts appear unsuccessful, it might be time to get outside help. This typically means engaging either an attorney who specializes in debt collection or a collections agency. View this as a last resort, however, because third-party fees may consume much of the collected amount and you’re unlikely to continue doing business with the customer.
6. Claim a tax break. One last important point about collections: If an outstanding debt is uncollectible, you may be able to write it off on your tax return. Be sure to document each customer’s promises to pay, details of your collection efforts and why you believe the debt is worthless.

We’re here to answer questions about tax deductions and other collection activity. We can also help in improving your overall accounts receivable processes.

Renting to family members

As rents continue to rise in many areas, you may decide to help your financially challenged family members by renting your property to them at a discount. But these arrangements can be fraught with tax perils.

A misstep can lead to the loss of significant tax deductions. Here’s a look at the tax treatment that applies when you rent to unrelated parties and how the rules change when you rent to relatives.

Business vs. personal

If you use real estate strictly for business purposes — that is, as a rental property, you must report the income and can deduct mortgage interest, property taxes, utilities, depreciation, maintenance and other expenses. If your expenses exceed your rental income, you can claim a loss (subject to limitations).

If you use property as a personal residence and rent it out for fewer than 15 days per year, you don’t need to report the rental income but you can’t deduct related expenses. If you itemize, you can still claim personal deductions — to the extent allowable — for mortgage interest and property taxes.

If you rent out your personal residence for 15 or more days per year, it’s treated as a mixed-use property. You must report the rental income and allocate your expenses between the property’s personal and business uses. You can claim the personal use portion as itemized deductions. The business use portion of these and other expenses are deductible as rental expenses, but they can’t create a loss. Disallowed deductions may be carried forward to future years.

Family matters

Renting property to family members means you risk losing the ability to deduct rental expenses. That’s because use by family members is considered personal use, even if your relative pays rent, unless both of these requirements are met. The family member:

1. Uses the property as a principal residence, and
2. Pays fair market rent (not discounted).

If these requirements aren’t met, then you must report the rental income (if you rented the property for 15 days or more per year).  But related expenses won’t be deductible.

To avoid losing valuable tax benefits, set the rent at or above fair market value and document fair market rent with comparable local rental rates. If you give family members financial gifts to help with the rent, the IRS will likely view this as discounted rent.

Know what you’re getting into

Helping family members with housing expenses is a good thing — but be aware of the tax consequences of renting to relatives. Your tax advisor can be a valuable resource as you make these decisions.  

HSAs can be powerful retirement saving tools

Health Savings Accounts (HSAs) are designed as tax-advantaged savings vehicles for funding uninsured health care expenses. But for those in relatively good health, they also may serve as attractive retirement savings vehicles.

Using an HSA, an eligible individual can cut his or her federal income tax bill. HSAs are available to people covered by high-deductible health plans. (In 2024, a high-deductible plan is defined as one with a deductible of at least $1,600 or more for individual coverage or $3,200 or more for family coverage.) Contributions are tax-deductible and withdrawals used to pay for qualified unreimbursed medical expenses are tax-free. You can make tax-deductible contributions to an HSA and take tax-free withdrawals to pay for uninsured medical expenses.

This year, you can contribute up to $4,150 to an HSA — $8,300 if you have family coverage — plus an additional $1,000 if you’ll be 55 or older by the end of the year. If you’re fortunate enough not to need all the funds in the account for medical expenses, they’ll continue to grow on a tax-deferred basis, providing a valuable supplement to your other retirement accounts in several ways. For instance, you can use HSA funds to pay the premiums for a long-term care policy if you have one.

If you retire (or lose your job) before you qualify for Medicare, you may need to bridge the gap until you reach Medicare eligibility at age 65. During that time, there is an exception that allows HSA funds to be used for private health insurance premiums in addition to the expenses that are generally allowed, such as deductibles and your share of other costs. Once Medicare kicks in, your HSA can be used to pay Medicare premiums.   In general, once you reach age 65, you can use your HSA funds to pay for anything. However, if your purchases are not qualified medical expenses, those amounts will be subject to state and federal taxes.

Contact our office with questions about adding an HSA to your plans for retirement.