I’ve seen startups that want to pay everyone as contractors, showing a zero in the payroll tax expense box of their USA tax return. This would be a mistake!
Officers, or those with the duties of an officer, must be considered employees, not contractors. (26 CFR § 31.3121(d)-1(b) and Joseph M. Grey Public Accountant, P.c.; 119 TC 121 (2002))
* Willful failure to pay payroll tax is a felony with jail time!
* Any responsible person can be assessed the penalty
* already a clerk or outside bookkeeper or CPA can be held responsible
* Once assessed, a person is presumed guilty
* The penalty is not dischargeable in bankruptcy
* There is no statute of limitations for unfiled payroll tax returns
* Officers, directors, and responsible persons have personal liability
* It is difficult to hire good people when there are such payroll tax problems
* It is difficult to sell or exit an entity when there are such payroll tax problems
* The IRS has been aggressive in assessing and collecting payroll tax penalties, more so than with most other types of tax
* California passed AB5 in 2019, limiting the ability to classify workers as contractors and bringing more scrutiny to the classification of workers
Don’t get burned by this nor related problems!
* Pay officers as employees
* Don’t let contractors nor consultants call themselves officers (e.g. I have seen “consulting CXO” on a business card, but an officer is generally considered an employee not a consultant)
* Use a reputable payroll processor (ask to see their “SSAE16” certification!)
* Timely notify the payroll processor of stock options, restricted stock, other deferred or equity compensation
If there is a problem with employee classification and consequential underpaid payroll tax, consider the availability of voluntary compliance amnesty programs such as Voluntary Classification Settlement Program (VCSP, form 8952).
Move quickly to include professionals to fix this kind problem. Tax problems, in general, do not enhance with age, and are not easily fixed without expert assistance.
One client of mine once had a slight unexpected delay in transferring funds to their retirement fund. There was a DOL audit. Their penalty was under $200, but the staff time required to probe the problem and generate the necessary corrective paperwork cost over $10,000 with meaningful personal stress and grief to their CEO.
Some small businesses have recently (in 2020) discovered a new recognition of the importance of payroll, when they were unable to acquire a paycheck protection program (PPP) loan as part of the Coronavirus (COVID-19) stimulus due to being unable to properly document their past year payroll expense. Many PPP loan applications were prepared in haste and applications with already small errors were rejected, often without explanation.
Payroll, especially multistate payroll with benefits and/or payroll in local jurisdictions such as San Francisco or NYC is complicated and unprotected to frequent rule changes mid year, and details are very easy to miss or to get wrong unless using experienced specialists who manager a very large quantity of different paychecks.
If you ever have the good fortune to have a public company suitor seeking to buy your business, they usually require 3 past years of SSAE16 certification from your payroll processor (What, your payroll processor has no SSAE16? Most do not!) Not being able to produce this certification, or doing payroll in house with uncertain accuracy, will likely kill the deal as the acquiring company officers and directors do not want problems with their own auditors over your payroll, nor personal liability as responsible persons for possible mistakes in your payroll.
Don’t risk experiencing any of these problems first hand. Give your payroll the respect it deserves!