As this year comes to a close, I thought it would be helpful to provide you with a summary of two key items to wrap up for 2020 and prepare you well for 2021: PPP loan forgiveness and how to handle independent contractors.
The 411 on PPP loan forgiveness
Completing a loan forgiveness application is on the minds of many business owners who received an SBA loan through the Paycheck Protection Program. However, things continue to change and there are still plenty of unanswered questions about how it will all shake out in the long run.
Originally, the qualified expenses paid from the PPP funds were supposed to be tax deductible; this is no longer the case. The IRS has stated that regardless of whether you apply for loan forgiveness or not, expenses incurred in 2020 are not deductible for 2020; therefore, companies that used the money to pay employees are losing the benefit and are creating taxable income in the forgivable portion of the loan.
However, if you are a Schedule C filer, the situation may be different. As the business owner, that PPP money is your salary that you take as distribution. It never hits your company’s profit & loss statement, so it is not a business expense that you will deduct. Therefore, you are not losing that expense on your tax return because those funds were never an expense to begin with. This has not been specifically addressed in the guidance so be on the lookout for clarification.
This all points to the importance of knowing what your cash flow is and where your revenue comes from. We can’t say enough to plan, plan, plan—especially now, with so much uncertainty about the markets and the business environment, consumer confidence and spending . . . under these extraordinary circumstances, businesses must have a firm handle on income and expenses, and plan ahead for 2021.
Do You Engage Independent Contractors? Prepare Your 1099s for Year End
The classification of workers as employees or independent contractors has come under scrutiny and is on legislators’ radar (again) with the rise of the “gig economy.” It is crucial that business owners make sure they are paying people properly. Someone on the payroll gets a W-2; someone who is truly an independent contractor according to the ABC test gets a 1099 if that person was paid more than $600 for his/her services. Now is the time to make sure you have all relevant information on file with a Form W-9 for each individual to generate and submit Form 1099 for all appropriate workers.
One complication is that employees who live in other states create a nexus (a tax presence) for employers in other states (such as we commonly see in the NY/NJ area, where New Jersey residents work in New York, and pay income tax in both states); companies are trying to get around that by calling those employees contractors in hopes of avoiding additional payroll taxes. However, this worker misclassification is a violation that carries big fines.
What’s a Form 1099?
It is the information filing form used to report non-salary income to the IRS for federal tax purposes. Beginning with tax year 2020, the IRS has stipulated that employers use Form 1099-NEC, Nonemployee Compensation. In addition to freelancers, other nonemployees may be attorneys and accountants who perform professional services for a business. A copy of 1099-NEC must be provided to the independent contractor and the IRS by January 31 of the year following payment. Independent contractors who subcontract work to others also have filing and reporting requirements.
What’s the ABC test?
This is the set of criteria to determine if a worker is an employee as opposed to a contractor. The employer must satisfy all three conditions to classify someone as an independent contractor.
- The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;
- The worker performs work that is outside the usual course of the hiring entity’s business; and
- The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
Assess your employee and contractor records and make any necessary corrections before January 1, 2021.
A note on tax liabilities
When someone is an employee, he or she shares the Social Security and Medicare (FICA) payments with the employer. In this case, both employer and employee (by way of paycheck deductions) pay 7.65% of compensation (up to certain limits) to FICA. Independent contractors and the self-employed pay the entire 15.3% FICA responsibility. Therefore, employers who use independent contractors are saving their share of FICA, which is why some try to classify workers as contractors rather than payroll employees.
If you’re still feeling confused or unsure and welcome help unraveling it all or pulling together your year-end financial statements for your accountant, contact CFO Your Way about our on-demand support services: email@example.com or (973) 897-0650.