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  • Rebecca Tabert

Do I need to open payroll for my company? (Form 940 and Form 941)

Were you told that you need to open a payroll account for your company? Why consider payroll? From S-corps to sole proprietors, the necessity varies. Dive in to discover where you fit.

While many believe that payroll filings are a responsibility solely for large-scale enterprises, the reality is different. If you're an S-corp, filing payroll is obligatory. However, entities like LLCs, C-Corps, general partnerships, and sole proprietors have the choice to do so. Each entity type has its unique requirements and benefits tied to payroll, so it's essential to understand where your business fits.

Business taxes, Form 1065, Form 1120S, Form 2553, llc converted, llc converted to scop, Tax and Ledger Professionals, TLP, Tax, Payroll, Accounting, Escondido, San Marcos, San Diego, California

Who MUST have payroll?

  • S-corps: Mandatory payroll filers. It's essential for these corporations due to the way they're structured and their tax implications.

  • LLCs: While not required, they can choose to file payroll. The decision often depends on their operational scale and the benefits they seek from payroll processes.

  • C-Corps: Again, not a strict requirement. But filing payroll can offer advantages in terms of tax breaks and structured employee payments.

  • General Partnerships: Not obliged, but depending on the partnership agreement and the number of employees, it might be a wise choice.

  • Sole Proprietors: Typically, sole proprietors don't have to file payroll for themselves. However, if they hire employees, it becomes a necessity.

Who must file payroll, who must be included on the payroll, and how much they must be paid to be compliant with the IRS to avoid penalties is very client specific. As S-Corps have mandatory payroll, it is important to understand the 60/40 with how much of the company's net profits must be paid out to the shareholders. It will be also important to structure your payroll and estimated taxes to take them both in account.


What does it mean to file payroll?

It is important to understand all the implications of filing payroll. This will mean opening up a separate bank account for payroll and maintaining a balance in that account to pay out payroll. It can also be crucial to understand the difference of having employees paid by check or direct deposit.


To get started with payroll, you should first determine what are the important aspects of your payroll. Shopping around for the right payroll company to fit your needs. If you are ever unsure what you need, it is best to consult an accounting professional.


In addition, once payroll is started, you will need to file various other forms, which may include the following (not an exclusive list):

  • Form W-4: Employee's Withholding Certificate. You will need this for all your employees when you start. New employees fill it out to dictate how much federal income tax should be withheld from their pay.

  • Form 940: An annual federal unemployment (FUTA) tax return form. Employers use this to report the FUTA tax, which provides funds for paying unemployment compensation to workers who've lost their jobs.

  • Form 941: Filed quarterly, this is the employer's federal tax return. It reports income taxes, social security tax, or Medicare tax withheld from employee's paychecks and pays the employer's portion of social security or Medicare tax.

  • Form 944: Employer's Annual Federal Tax Return. Designed for employers who owe $1,000 or less in yearly employment taxes.

  • Workers' Comp (WC): An insurance that provides wage replacement and medical benefits to employees injured in the course of employment. It's a state-mandated program, and requirements can vary.

  • Employment Development Department (EDD): In certain states, businesses report employee wages, pay state unemployment insurance, disability insurance, and other state payroll taxes through the EDD.

  • Form W-2: This is the Wage and Tax Statement that employers must send to employees and the Social Security Administration (SSA) at the end of the year. It reports an employee's annual wages and the amount of taxes withheld from their paycheck.

  • Form W-3: The Transmittal of Wage and Tax Statements. It's a summary of all W-2 forms issued by the employer.

What are "Pay Periods" and which kind is best?

Bi-weekly:

  • Frequency: 26 payments a year.

  • Pros: Aligns well with employees paid on an hourly basis, especially those working consistent hours; aligns with many bill payment schedules (like mortgages that are often set bi-weekly).

  • Cons: Two months in the year will have three pay periods, which can complicate budgeting; more frequent than monthly processing.

  • This is usually the most often recommended pay period to employers for ease of convenience and employee satisfaction.

Monthly:

  • Frequency: 12 payments a year.

  • Pros: Simplified and minimal paperwork; consistent cash flow management.

  • Cons: Might not align with employee preferences; can be a longer wait for employees used to more frequent pay.

Weekly:

  • Frequency: 52 payments a year.

  • Pros: Preferred by many hourly workers as it provides consistent cash flow for them; can help with overtime calculations.

  • Cons: More administrative work and costs; more frequent tax withholdings to manage.

Semi-monthly:

  • Frequency: 24 payments a year (twice a month).

  • Pros: Consistency, as employees are paid on specific dates (like the 1st and 15th); slightly fewer payrolls than bi-weekly can reduce administrative tasks.

  • Cons: Doesn't align perfectly with weekly schedules; can cause complications with hourly employee overtime calculations.


Most common myths about Converting to an S-Corp

Myth: Only large companies need to handle payroll taxes and filings.

Reality: Regardless of size, any business with employees is generally required to handle payroll taxes and appropriate filings. Even if you're a small business owner or sole proprietor with a single employee, you're still responsible for withholding, reporting, and paying payroll taxes.


Myth: All employees prefer monthly paychecks.

Reality: Payment frequency preference varies widely among employees. Some prefer weekly or bi-weekly paychecks, especially hourly workers, as it helps with personal budgeting and expenses. It's essential to understand your employees' needs and preferences when setting a pay schedule.


Myth: Using payroll software guarantees 100% compliance.

Reality: While payroll software can significantly assist in ensuring compliance and accuracy, it's not foolproof. Business owners and payroll managers still need to stay updated on tax codes, local regulations, and other changes that might not be immediately reflected in the software.


Myth: Outsourcing payroll is too expensive for small businesses.

Reality: The cost of outsourcing can often be offset by the time and resources saved in managing payroll in-house. Additionally, using a professional service can reduce the risks of errors, missed filings, and non-compliance penalties.


Myth: Bonuses, tips, and overtime don't need to be included in payroll calculations.

Reality: All forms of compensation, including bonuses, overtime, tips commissions, and even certain benefits, must be included in payroll calculations. These earnings are subject to taxes and must be reported accurately to avoid potential legal and financial issues.


Who you are filing with and why:

Federal Filings:

Internal Revenue Service (IRS):

  • Forms: 940 (Employer's Annual Federal Unemployment Tax Return), 941 (Employer's Quarterly Federal Tax Return), W-2, W-3, 1099-MISC (for independent contractors), and possibly 944 or 945 depending on specific situations.

  • Purpose: These forms report federal income tax, Social Security, and Medicare taxes withheld from employee paychecks. They also report the employer's portion of Social Security and Medicare taxes.

U.S. Department of Labor:

  • Ensure you're complying with the Fair Labor Standards Act (FLSA) which covers minimum wage, overtime, and child labor provisions.

U.S. Citizenship and Immigration Services:

  • Form: I-9 (Employment Eligibility Verification)

  • Purpose: Verifies the identity and employment eligibility of individuals hired in the U.S.

State of California Filings:

Employment Development Department (EDD):

  • Forms: DE 9 (Quarterly Contribution Return and Report of Wages), DE 9C (Quarterly Contribution Return and Report of Wages - Continuation), DE 34 (Report of New Employees), among others.

  • Purpose: Reports state income tax withheld, unemployment insurance, and state disability insurance.

California Department of Industrial Relations:

  • Ensure you're adhering to California's wage and hour laws, which can be more stringent than federal laws. This includes understanding the state's minimum wage, overtime provisions, and meal and rest breaks.

What is the difference between a subcontractor and employee?

Subcontractor:

  • Hired for specific tasks or projects.

  • Has autonomy over how and when they work.

  • Paid per job or project without company benefits.

  • Responsible for their own taxes.

  • Not covered by labor laws like minimum wage or overtime.

Employee:

  • Continuous, ongoing relationship with an employer.

  • Work hours, tasks, and methods dictated by the employer.

  • Receives regular wages/salary and often company benefits.

  • Employers withhold and pay taxes on their behalf.

  • Protected by labor laws and often entitled to benefits.

Does the Distinction Matter?

Absolutely. Misclassifying can lead to legal repercussions, tax penalties, and labor law violations. It's essential for employers to understand the differences to ensure compliance and avoid potential pitfalls.


Minimum Wage Rules

  • Federal Minimum Wage: If state and local laws set a higher minimum wage, employers must pay the higher amount, regardless of what the federal wage dictates.

  • California Minimum Wage: California's minimum wage varies depending on the size of the employer. For businesses with 25 employees or fewer, the minimum wage is currently set differently than those with 26 employees or more. It will also matter what county and city the business is registered in.

  • Exemptions: Certain workers, like those receiving tips or students working in certain capacities, may be subject to different wage laws.

Always stay informed of annual updates or changes to minimum wage laws, both at the federal and state levels.


More Reading


Final Thoughts

Navigating the payroll waters might seem daunting, but with a clear understanding of the requirements and the right resources, it becomes a breeze. Always remember to circle back to your business's unique needs and consult with a tax professional to ensure you're on the right track.


Contact Us

We are here to help with any questions you have. Just give us a call.


Tax and Ledger Professionals, Inc

Email Address: info@taxtl.com

Phone Number: (760) 480-1040

Address: 365 W 2nd Ave, Escondido, CA 92025


About Us

For over 35 years, we've been the go-to for tax, accounting, bookkeeping, and payroll services that keep businesses running smoothly and lower individuals' and businesses' tax burden. See for yourself how we've transformed numerous businesses across San Diego and throughout the United States.


What do we prepare?

  • Income Taxes:

    • Individuals

    • Businesses

    • Estates and Trusts

    • Nonprofits

  • Foreign Tax Reporting

    • FBAR

    • 3520

    • 5471 & 5472

  • Payroll

  • Accounting and Bookkeeping

  • Business Consulting





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