8 Steps to Follow When Becoming an Employer

Payroll Training, Tips, and News

8 Steps to Follow When Becoming an Employer
by Shalleen Mayes on May 8, 2019
Hiring your first employee is a huge milestone for you and your business. However, becoming an employer comes with many additional responsibilities. If you’re ready to become an employer, you must know which steps to follow.

8 Steps for becoming an employer
Use these eight steps to learn how to become an employer.

1. Find out state and local requirements
Every state and locality has different rules for small businesses. Depending on your location and type of business, requirements can vary.
State requirements

New employer requirements differ from state to state. Most businesses need to register
with their state for new employer accounts. Your small business might also need to register for certain licenses, permits, and other registrations. In most cases, you can apply for this information online.

Employers need to register for state unemployment tax insurance, otherwise known as SUTA (State Unemployment Tax Act) tax. After you sign up, your business receives a SUTA tax rate. Your rate is a state unemployment percentage based on your industry and experience (e.g., 2.7%).
Some states may also require state disability insurance. For example, New York requires most employers to have disability insurance for their employees.
View our state payroll guide to see requirements for your state. Contact your state for additional new employer requirements.

Local requirements
Your city or locality may require additional types of employment registration. And, you might need to withhold local taxes from your employees’ wages.
Some states with local income tax include Alabama, Colorado, Delaware, and Indiana. Other states, like Ohio and Pennsylvania, have specific types of local taxes, such as school district tax.

Oftentimes, employers are responsible for withholding and depositing local income taxes for their employees.
Contact your local government office for more information about whether you or not you must register.

2. Apply for an Employer Identification Number
After you decide to become an employer, you need to apply for an Employer Identification Number (EIN). An EIN is a unique nine-digit number the IRS assigns your business. You must apply for an EIN if you plan to hire employees.
EINs are formatted like this: 12-3456789.
There is no charge for applying for an EIN. You can apply online for your EIN. Or, you can mail or fax Form SS-4, Application for Employer Identification Number, to the IRS.
The quickest way to apply for an EIN is online. You don’t need to fill out any forms. And, you can print an instant confirmation for your records.
If you choose to apply with a paper application, complete Form SS-4 and mail or fax it to the IRS. Keep in mind that mailing or faxing your application takes more time to receive your EIN.

3. Get workers’ compensation insurance
Regardless of your type of business, employees stand the chance of getting a job-related illness or injury. To cover unpredictable events (e.g., falling on a wet floor), you must have workers’ compensation insurance.
So, what is workers’ compensation insurance? Workers’ compensation, also known as workers’ comp or workmans’ comp, is insurance that provides wage replacement and medical benefits to employees who get sick or hurt while at work. And, workers’ compensation covers employees regardless of who causes the incident (e.g., you, a co-worker, the employee, etc.).
Workers’ compensation may cover the following issues for employees:
Chronic back pain
Carpal tunnel
Hearing loss
Lung disease
Injuries caused by work-related stress
Your employees may be eligible for workers’ comp benefits like payment for diagnosis, treatment, and rehabilitation.
The cost of workers’ comp varies depending on your business, payroll amounts, type of work, and past workers’ comp claims.

State requirements
Each state has its own workers’ compensation programs and laws to follow.
Most states require that you get workers’ compensation insurance. However, some states let employers elect coverage until they have a certain number of employees.
Many states give employers the freedom to choose their workers’ compensation coverage. However, employers in North Dakota, Ohio, Washington, and Wyoming must purchase workers’ comp coverage through their own state fund.
Check with your state for more information about workers’ compensation requirements.

4. Determine how to handle payroll
Before you can begin hiring and paying employees, determine how you plan to handle payroll. Consider aspects like cost and how much time it takes to run payroll.
Some ways to manage payroll include:
Running payroll by hand
Outsourcing payroll (e.g., accountant or bookkeeper)

Using a payroll software or provider
Running payroll by hand is the most cost-effective way to manage payroll. However, it can also be the most time-consuming option and lead to costly mistakes. When you run payroll by hand, you need to calculate the taxes to withhold for each employee. And, you must file and deposit your payroll taxes to the correct agencies.
Using an accountant or bookkeeper to handle payroll requires you to give up control of your payroll. And, outsourcing your payroll can be expensive for your small business.

Although it’s more costly than other options, outsourcing payroll can save you a lot of time. And, you can have peace of mind knowing that your payroll deposits are accurate.
Payroll software can be a happy medium between running payroll by hand and outsourcing it. Software is a less expensive option than outsourcing payroll. And, payroll software is accurate and saves time. Most payroll software systems allow you to run payroll within a few minutes. When looking at payroll software, compare your options. Look at providers’ pricing, features, ease of use, security, and reviews.

5. Hire employees
Now that you’ve laid the groundwork, it’s time to begin hiring some employees.
Many new employers use traditional hiring methods (e.g., direct hiring). When hiring your first employee, determine what characteristics and requirements you’re looking for in an employee.

Create a clear and appealing job description. Pinpoint position requirements and qualifications to include in your description. Some qualifications you may list include experience (e.g., two years in an IT-related position) and education (e.g., Bachelor’s degree in Marketing).
If possible, include things like benefits (e.g., retirement contributions) to encourage candidates to apply.

Post your job description to platforms like your business website, online job boards, and social media pages. Review applications that candidates submit. Weed out unqualified applicants and contact candidates who seem like a good fit.
Interview the qualified candidates. The interview process might consist of several rounds of interviews until you find your ideal candidate.
When you are ready to hire, extend a job offer to the candidate. If the candidate accepts your offer, begin the on-boarding process and new hire paperwork (which we talk about more in the next step).
As your business grows, you can form a hiring committee to hire additional employees.

6. Complete new hire paperwork
Before new employees can begin working at your business, you and your employee both need to complete new hire paperwork.
As an employer, you must report new hires. Federal law states that you must report new hires within 20 days of hiring them. However, state laws for new hires can differ. Check with your state to find out new hire time frames and laws.
Employees must complete Form W-4, Employee’s Withholding Allowance Certificate, for federal tax withholding. Form W-4 determines how much you withhold from employee wages for federal income taxes. Some information an employee needs to list on their Form W-4 includes their name, address, Social Security number, marital status, and number of withholding allowances.

Many states also have state income tax. If your employee works in a state with income tax, they must also fill out a state W-4 form.
To ensure employees are eligible to work in the United States, they must fill out Form I-9, Employment Eligibility Verification. When you collect an I-9 form, the employee must also provide documents proving their identity and eligibility (e.g., driver’s license, passport, Social Security card, etc.).
You might also need to collect additional documents from employees, such as a signed employee handbook, benefits information, and emergency contact forms.

7. Pay payroll taxes
One of the biggest employer responsibilities you have is paying payroll taxes. If you don’t pay your payroll taxes on time, you may receive penalties such as fines or imprisonment.
Payroll taxes include federal income, Social Security and Medicare, and federal unemployment taxes. As mentioned, some employers might need to pay state and local taxes, too.

Federal income tax
How frequently you pay federal income tax varies from business to business. You must withhold federal income tax from employee wages. And, you must pay it on a monthly or semiweekly basis on behalf of the employee.

Your schedule for paying federal income tax is based on a lookback period of Form 941. Form 941 reports your federal income, Social Security, and Medicare tax liabilities.
New businesses automatically have a monthly depositing frequency. Keep in mind that your deposit schedule can change each year.
For monthly depositors, the federal income tax payment is due the 15th of each following month. For example, federal income tax withheld for November is due by December 15.
Federal income tax deposits must be made through an electronic funds transfer (e.g., EFTPS).

Social Security and Medicare taxes
Social Security and Medicare taxes make up FICA tax. Both you and your employees contribute Social Security and Medicare taxes.
The Social Security tax withholding rate is 6.2%. You must withhold 6.2% from each employee’s wages for Social Security. And, pay the matching employer contribution of 6.2%.

Medicare tax is 1.45% for both you and your employees. Withhold 1.45% from employee wages and contribute a matching employer portion of 1.45%.
Deposit FICA tax along with federal income tax. Use the same deposit frequencies as federal income tax (e.g., monthly or semiweekly). Be sure you deposit both the employee and employer portions of FICA.

Federal unemployment tax
Most employers must also pay federal unemployment tax, otherwise known as FUTA tax.
You must pay FUTA tax if one of the following is true:
You paid $1,500 or more in wages during any calendar quarter
You had at least one employee for at least part of a day in any 20 or more different weeks
Federal payroll deposit rules state you must make quarterly deposits. However, only make a FUTA deposit if your federal unemployment tax liability is more than $500 during a quarter.
Like federal income and FICA taxes, you must deposit FUTA tax via electronic funds transfer.
Here is the schedule for FUTA tax deposit due dates:
April 30 for Quarter 1 (January – March)
July 31 for Quarter 2 (April – June)
October 31 for Quarter 3 (July – September)
January 31 for Quarter 4 (October – December)
State and local taxes
Again, depending on your state, you might also need to withhold state and local income taxes and state unemployment tax.
Check with your state and local departments of taxation for payment information about state and local payroll taxes.

8. File payroll reports
In addition to paying payroll taxes, you must also file payroll reports. Payroll reports are forms that notify the government of your payroll tax liabilities.
The payroll reports you need to file depend on your business. Report both the taxes you withhold from employee wages and the taxes you contribute. You need to submit payroll reports for both federal and state taxes.
How frequently you file payroll forms depends on the type of form. Some forms might be due quarterly, while others are due annually.

Quarterly payroll reports
Form 941, Employer’s Quarterly Federal Tax Return, reports federal income, Social Security, and Medicare taxes along with employee wages.
File Form 941 every quarter if you have employees, even if you do not have taxes or wages to report. Do not file Form 941 if you’re a seasonal employer or employ household (e.g., nanny tax) or farm employees (e.g., Form 943).
Due dates for Form 941 include:
April 30 for Quarter 1
July 31 for Quarter 2
October 31 for Quarter 3
January 31 for Quarter 4
State payroll reports

You might also need to file quarterly reports for state income and state unemployment taxes (SUTA).
Due dates can range widely from state to state. Although most states require you to file quarterly, you should contact your state for specific payroll reporting requirements.
Annual payroll reports
Annual payroll reports are due once per year by January 31. Some common annual payroll reports include Forms 944, 940, and W-2 and W-3.
Form 944

Some employers might be able to file Form 944, Employer’s Annual Federal Tax Return, instead of Form 941.
Like Form 941, you can use Form 944 to report federal income, Social Security, and Medicare taxes on an annual basis.
The IRS tells you if you’re allowed to use Form 944. Typically, you qualify if your business’s annual liability for Social Security, Medicare, and federal income taxes are $1,000 or less.

Form 940
Use Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, to report federal unemployment tax (FUTA).
File Form 940 annually to report your federal unemployment tax liability. Remember, only employers pay FUTA taxes.
Form W-2 and Form W-3
Form W-2, Wage and Tax Statement, is an annual tax form you must give each employee by January 31. Form W-2 summarizes an employee’s wages and taxes for the year. Employees use Form W-2 to file their individual tax return. You must also file a copy of Form W-2 with the IRS.
Form W-3, Transmittal of Wage and Tax Statement, is the transmittal form for Form W-2. Form W-3 is a summary of the information from your employees’ Forms W-2. Do not send Form W-3 to your employees. Send a copy of Form W-3 to the IRS each year by January 31.

Looking for an easy way to process payroll after becoming an employer? Patriot Software lets you run accurate payrolls in three simple steps. And our expert support is only a phone call, chat or email away. Get started with your self-guided demo today!
This article has been updated from its original publication date of July 5, 2013.
This is not intended as legal advice; for more information, please click here.

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100 CORPORATION CHALLENGE

Basics of Executive Compensation

What Is Executive Compensation?

Executive compensation differs substantially from typical pay packages for either hourly workers or salaried management and professionals in that executive pay is heavily biased toward rewards for actual results. Hence if a company underperforms, the executives typically receive a smaller fraction of their potential pay. Conversely, if a company meets its annual objectives and the stock price responds long term, the executives stand to receive a much larger payout.

This section of the site describes the typical Executive Compensation program and explains the most commonly used terms. It includes several charts, including one below that shows the share of compensation that is at risk by executives, as compared with managers and hourly employees.

The pay packages given to the senior executives of corporations often consist of six components:

Executive pay is structured to reward company performance and align executive pay with shareholder value. As a result, unlike most other employees, a majority of executive pay is at-risk; in other words, executives may never receive it. However, if executives and the company perform well, they along with the company’s shareholders stand to gain much more from superior performance.

Workers Comp Coverage for Executive Officers and Other Principals

BY MARIANNE BONNER Updated August 14, 2018

Most business owners are aware that workers compensation insurance is compulsory for employees. Employers must protect their employees against job-related injuries by purchasing a workers compensation policy. But what about corporate officers, partners, and sole proprietors? Must they be covered as well?

Executive Officers

In most states, executive officers are considered employees of the corporate entity. Like other employees, they are automatically covered by workers compensation laws. However, many states permit at least some executive officers to opt out of coverage. The laws vary from state to state but here is a general overview.

A number of states permit officers to exclude themselves from workers compensation coverage if the company has less than a specified number of officers, such as two or four. If the business has at least the stated number of officers, all must be covered. Some states permit officers to opt out of coverage only if the company has no other employees. If the company employs other workers, all officers must be covered.
Some states permit all officers to exempt themselves from coverage. Others allow only a specified number of officers to opt out.

Special rules may apply to officers of closely-held private corporations. Workers compensation laws in some states specifically exclude executive officers who are the sole shareholders of the company’s stock. In other states, such officers are automatically covered under the laws but may choose to opt out.
Special rules may apply to non-profit companies. Some states do not require executives to be covered if they are not compensated for their services. Depending on the state, the executives may opt out or the organization may decide not to cover them.

A few states have enacted special rules that apply to executives in the construction industry.
Executive officer exemptions may need to be renewed periodically, such as every two years.

States that allow executive officers to opt out of (or in some cases, opt into) workers compensation coverage have devised forms for this purpose. These forms should be available from your insurer. Officers who wish to reject workers compensation coverage must complete the form and return it to the insurance company. The insurer will forward the form to your state workers compensation authority.

Sole Proprietors, Partners, and Members

In contrast to executive officers, other company principals like sole proprietors, partners, and members of limited liability companies are typically excluded under state workers compensation laws. Nevertheless, such individuals may be permitted to elect coverage by completing a state-designated form. The form must be sent to the insurer, which will then forward it to the applicable state workers compensation authority.

Some states exclude partners and sole proprietors but cover members of limited liability companies. Some states automatically cover family members of sole proprietors and partners even though the sole proprietors and partners themselves are excluded. To opt out of coverage, family members must complete a form and forward it to the insurer.

Classifications

When executive officers are covered under the employer’s workers compensation policy, either by choice or a statute, they are generally assigned the classification that best describes their duties. For example, suppose that Winsome Wines has four executive officers, all of whom work in the company’s winery business. The officers will likely be assigned the same classification as winery employees.

Some executive officers perform mainly clerical duties in an office. These individuals may be assigned a separate classification, Executive Officers NOC (NOC means not otherwise classified).

When sole proprietors, partners, or members are covered under a workers compensation policy, they should be classified and rated based on their job functions. In most cases, these individuals will be classified in the same manner as the firm’s employees.

Minimum and Maximum Payrolls

Workers compensation premiums are calculated based on rates and payroll. When executive officers, sole proprietors, partners, or members are covered by the policy, the payrolls assigned to these individuals are usually determined by state law. Many states specify minimum and maximum payrolls for company principals. If the actual payroll is less than the specified minimum, the minimum payroll will be used for rating purposes.

For example, suppose a workers compensation law specifies a minimum annual payroll of $52,000 for each executive officer. The maximum payroll is $125,000. If an officer earns less than $52,000, the insurer will calculate a premium for that officer based on a payroll of $52,000. If the officer’s annual salary is $150,000, the premium for that officer will be calculated based on a payroll of $125,000. Because the officer’s actual salary ($150,000) exceeds the $125,000 maximum, the maximum payroll applies.

Likewise, suppose that Max, a sole proprietor, has opted to be covered under his company’s workers compensation policy. Max takes a $50,000 annual salary. However, the law in his state specifies a flat amount of $45,000 for a sole proprietor’s payroll. Even though Max’s actual payroll is $50,000, the mandated $45,000 is used for rating purposes.

Cost of Missing Forms

Workers compensation policies are subject to an annual audit. When conducting the audit, the auditor will ensure that any company principals who have opted in or out of coverage have signed the required forms. If one or more forms are missing, the auditor will add or subtract payroll accordingly. For example, suppose your firm has three executive officers, all of whom have elected to be excluded from workers compensation insurance. Unfortunately, none has signed the state-required form. The auditor will include payroll for the three officers when calculating your final premium.

Elect or Reject Coverage With Care

Finally, workers compensation insurance provides medical, disability, and other benefits to injured workers. When deciding whether to opt in or out of workers compensation coverage, executive officers and other principals should evaluate other possible sources of benefits. Examples are health, disability, and accident insurance.

For instance, executive officers may reject workers compensation coverage because they assume they are covered for work-related injuries under company-sponsored health and disability insurance. Yet, this assumption may be wrong. Some health and disability policies exclude injuries that occur on the job.

Executive Compensation Plan Design
Executive Compensation Plan Design
Executive pay is typically structured to incentivize executives to achieve company performance consistent with increases in shareholder value. As a result, unlike most other employees, a majority of executive pay is contingent on performance; in other words, if the company or the executive fails to perform, the pay may never be received. However, if executives and the company perform well, they along with the company’s shareholders stand to gain
much more from exceptional performance. The pay packages
given to the senior
executives of corporations often consist of several components:

Global Executive Compensation Issues
Long-Term Cash Incentives
Long-Term Incentive Plans
Peer Groups
Performance Metrics
Performance Shares
Perquisites
Restricted Stock
Severance & Change-in-Control (Golden Parachutes)
Short-Term Incentive Plans
Simplification of Executive Compensation
Stock Options

Please click
on any of the issues above or see the issues section of this site for further information on each of these components.

Workers Comp Coverage for Executive Officers and Other Principals

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Pin

Email

BY MARIANNE BONNER

Updated August 14, 2018
Most business owners are aware that workers compensation insurance is compulsory for employees. Employers must protect their employees against job-related injuries by purchasing a workers compensation policy. But what about corporate officers, partners, and sole proprietors? Must they be covered as well?

Executive Officers
In most states, executive officers are considered employees of the corporate entity. Like other employees, they are automatically covered by workers compensation laws. However, many states permit at least some executive officers to opt out of coverage. The laws vary from state to state but here is a general overview.

A number of states permit officers to exclude themselves from workers compensation coverage if the company has less than a specified number of officers, such as two or four. If the business has at least the stated number of officers, all must be covered. Some states permit officers to opt out of coverage only if the company has no other employees. If the company employs other workers, all officers must be covered.
Some states permit all officers to exempt themselves from coverage. Others allow only a specified number of officers to opt out.

Special rules may apply to officers of closely-held private corporations. Workers compensation laws in some states specifically exclude executive officers who are the sole shareholders of the company’s stock. In other states, such officers are automatically covered under the laws but may choose to opt out.
Special rules may apply to non-profit companies. Some states do not require executives to be covered if they are not compensated for their services. Depending on the state, the executives may opt out or the organization may decide not to cover them.

A few states have enacted special rules that apply to executives in the construction industry.
Executive officer exemptions may need to be renewed periodically, such as every two years.

States that allow executive officers to opt out of (or in some cases, opt into) workers compensation coverage have devised forms for this purpose. These forms should be available from your insurer. Officers who wish to reject workers compensation coverage must complete the form and return it to the insurance company. The insurer will forward the form to your state workers compensation authority.

Sole Proprietors, Partners, and Members
In contrast to executive officers, other company principals like sole proprietors, partners, and members of limited liability companies
are typically excluded under state workers compensation laws. Nevertheless, such individuals may be permitted to elect coverage by completing a state-designated form. The form must be sent to the insurer, which will then forward it to the applicable state workers compensation authority.

Some states exclude partners and sole proprietors but cover members of limited liability companies. Some states automatically cover family members of sole proprietors and partners even though the sole proprietors and partners themselves are excluded. To opt out of coverage, family members must complete a form and forward it to the insurer.

Classifications
When executive officers are covered under the employer’s workers compensation policy, either by choice or a statute, they are generally assigned the classification that best describes their duties. For example, suppose that Winsome Wines has four executive officers, all of whom work in the company’s winery business. The officers will likely be assigned the same classification as winery employees.

Some executive officers perform mainly clerical duties in an office. These individuals may be assigned a separate classification, Executive Officers NOC (NOC means not otherwise classified).

When sole proprietors, partners, or members are covered under a workers compensation policy, they should be classified and rated based on their job functions. In most cases, these individuals will be classified in the same manner as the firm’s employees.

Minimum and Maximum Payrolls
Workers compensation premiums are calculated based on rates and payroll. When executive officers, sole proprietors, partners, or members are covered by the policy, the payrolls assigned to these individuals are usually determined by state law. Many states specify minimum and maximum payrolls for company principals. If the actual payroll is less than the specified minimum, the minimum payroll will be used for rating purposes.

For example, suppose a workers compensation law specifies a minimum annual payroll of $52,000 for each executive officer. The maximum payroll is $125,000. If an officer earns less than $52,000, the insurer will calculate a premium for that officer based on a payroll of $52,000. If the officer’s annual salary is $150,000, the premium for that officer will be calculated based on a payroll of $125,000. Because the officer’s actual salary ($150,000) exceeds the $125,000 maximum, the maximum payroll applies.

Likewise, suppose that Max, a sole proprietor, has opted to be covered under his company’s workers compensation policy. Max takes a $50,000 annual salary. However, the law in his state specifies a flat amount of $45,000 for a sole proprietor’s payroll. Even though Max’s actual payroll is $50,000, the mandated $45,000 is used for rating purposes.

Cost of Missing Forms
Workers compensation policies are subject to an annual audit. When conducting the audit, the auditor will ensure that any company principals who have opted in or out of coverage have signed the required forms. If one or more forms are missing, the auditor will add or subtract payroll accordingly. For example, suppose your firm has three executive officers, all of whom have elected to be excluded from workers compensation insurance. Unfortunately, none has signed the state-required form. The auditor will include payroll for the three officers when calculating your final premium.

Elect or Reject Coverage With Care
Finally, workers compensation insurance provides medical, disability, and other benefits to injured workers. When deciding whether to opt in or out of workers compensation coverage, executive officers and other principals should evaluate other possible sources of benefits. Examples are health, disability, and accident insurance.

For instance, executive officers may reject workers compensation coverage because they assume they are covered for work-related injuries under company-sponsored health and
disability insurance
. Yet, this assumption may be wrong. Some health and disability policies exclude injuries
that occur on the job.

ARTICLE TABLE OF CONTENTSSkip to section
Executive Officers
Sole Proprietors, Partners, and Members
Classifications
Minimum and Maximum Payrolls
Cost of Missing Forms
Elect or Reject Coverage With Care

Executive Compensation Plan Design

Executive Compensation Plan Design
Executive pay is typically structured to incentive executives to achieve company performance consistent with increases in shareholder value. As a result, unlike most other employees, a majority of executive pay is contingent on performance; in other words, if the company or the executive fails to perform, the pay may never be received. However, if executives and the company perform well, they along with the company’s shareholders stand to gain
much more from exceptional performance. The pay packages
given to the senior
executives of corporations often consist of several components:

Global Executive Compensation Issues
Long-Term Cash Incentives
Long-Term Incentive Plans
Peer Groups
Performance Metrics
Performance Shares
Perquisites
Restricted Stock
Severance & Change-in-Control (Golden Parachutes)
Short-Term Incentive Plans
Simplification of Executive Compensation
Stock Options

Please click on any of the issues above or see the issues section of this site for further information on each of these components.

Workers Comp Coverage for Executive Officers and Other Principals

Share
Pin

Email

BY MARIANNE BONNER

Updated August 14, 2018
Most business owners are aware that workers compensation insurance is compulsory for employees. Employers must protect their employees against job-related injuries by purchasing a workers compensation policy. But what about corporate officers, partners, and sole proprietors? Must they be covered as well?

Executive Officers
In most states, executive officers are considered employees of the corporate entity. Like other employees, they are automatically covered by workers compensation laws. However, many states permit at least some executive officers to opt out of coverage. The laws vary from state to state but here is a general overview.

A number of states permit officers to exclude themselves from workers compensation coverage if the company has less than a specified number of officers, such as two or four. If the business has at least the stated number of officers, all must be covered. Some states permit officers to opt out of coverage only if the company has no other employees. If the company employs other workers, all officers must be covered.
Some states permit all officers to exempt themselves from coverage. Others allow only a specified number of officers to opt out.

Special rules may apply to officers of closely-held private corporations. Workers compensation laws in some states specifically exclude executive officers who are the sole shareholders of the company’s stock. In other states, such officers are automatically covered under the laws but may choose to opt out.
Special rules may apply to non-profit companies. Some states do not require executives to be covered if they are not compensated for their services. Depending on the state, the executives may opt out or the organization may decide not to cover them.

A few states have enacted special rules that apply to executives in the construction industry.
Executive officer exemptions may need to be renewed periodically, such as every two years.

States that allow executive officers to opt out of (or in some cases, opt into) workers compensation coverage have devised forms for this purpose. These forms should be available from your insurer. Officers who wish to reject workers compensation coverage must complete the form and return it to the insurance company. The insurer will forward the form to your state workers compensation authority.

Sole Proprietors, Partners, and Members
In contrast to executive officers, other company principals like sole proprietors, partners, and members of limited liability companies
are typically excluded under state workers compensation laws. Nevertheless, such individuals may be permitted to elect coverage by completing a state-designated form. The form must be sent to the insurer, which will then forward it to the applicable state workers compensation authority.

Some states exclude partners and sole proprietors but cover members of limited liability companies. Some states automatically cover family members of sole proprietors and partners even though the sole proprietors and partners themselves are excluded. To opt out of coverage, family members must complete a form and forward it to the insurer.

Classifications
When executive officers are covered under the employer’s workers compensation policy, either by choice or a statute, they are generally assigned the classification that best describes their duties. For example, suppose that Winsome Wines has four executive officers, all of whom work in the company’s winery business. The officers will likely be assigned the same classification as winery employees.

Some executive officers perform mainly clerical duties in an office. These individuals may be assigned a separate classification, Executive Officers NOC (NOC means not otherwise classified).

When sole proprietors, partners, or members are covered under a workers compensation policy, they should be classified and rated based on their job functions. In most cases, these individuals will be classified in the same manner as the firm’s employees.

Minimum and Maximum Payrolls
Workers compensation premiums are calculated based on rates and payroll. When executive officers, sole proprietors, partners, or members are covered by the policy, the payrolls assigned to these individuals are usually determined by state law. Many states specify minimum and maximum payrolls for company principals. If the actual payroll is less than the specified minimum, the minimum payroll will be used for rating purposes.

For example, suppose a workers compensation law specifies a minimum annual payroll of $52,000 for each executive officer. The maximum payroll is $125,000. If an officer earns less than $52,000, the insurer will calculate a premium for that officer based on a payroll of $52,000. If the officer’s annual salary is $150,000, the premium for that officer will be calculated based on a payroll of $125,000. Because the officer’s actual salary ($150,000) exceeds the $125,000 maximum, the maximum payroll applies.

Likewise, suppose that Max, a sole proprietor, has opted to be covered under his company’s workers compensation policy. Max takes a $50,000 annual salary. However, the law in his state specifies a flat amount of $45,000 for a sole proprietor’s payroll. Even though Max’s actual payroll is $50,000, the mandated $45,000 is used for rating purposes.

Cost of Missing Forms
Workers compensation policies are subject to an annual audit. When conducting the audit, the auditor will ensure that any company principals who have opted in or out of coverage have signed the required forms. If one or more forms are missing, the auditor will add or subtract payroll accordingly. For example, suppose your firm has three executive officers, all of whom have elected to be excluded from workers compensation insurance. Unfortunately, none has signed the state-required form. The auditor will include payroll for the three officers when calculating your final premium.

Elect or Reject Coverage With Care
Finally, workers compensation insurance provides medical, disability, and other benefits to injured workers. When deciding whether to opt in or out of workers compensation coverage, executive officers and other principals should evaluate other possible sources of benefits. Examples are health, disability, and accident insurance.

For instance, executive officers may reject workers compensation coverage because they assume they are covered for work-related injuries under company-sponsored health and
disability insurance
. Yet, this assumption may be wrong. Some health and disability policies exclude injuries
that occur on the job.

ARTICLE TABLE OF CONTENTSSkip to section
Executive Officers
Sole Proprietors, Partners, and Members
Classifications
Minimum and Maximum Payrolls
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How the R&D Credit Can Help New Companies Offset Payroll Taxes

New businesses or start-up companies may be eligible to apply the R&D tax credit against their payroll taxes for up to five years.

The R&D credit was permanently extended as part of the Protecting Americans from Tax Hikes (PATH) Act of 2015. The bill included enhancements starting in 2016, including offsets to the alternative minimum tax and payroll tax for eligible businesses.

While the credit used to offset payroll taxes is based on eligible R&D expenses, it only applies to costs incurred after the bill was signed into law. The maximum benefit an eligible company can claim against payroll taxes each year under the PATH Act is $250,000.

An infographic titled R&D Payroll Tax at a Glance serves as a quick reference to help simplify the process of determining eligibility and applying the credit.

Questions and Answers

The most common questions and answers related to the R&D credit and how to apply it against payroll taxes are provided below.

When does the payroll-tax offset take effect?

The payroll-tax offset is currently available for qualified expenses incurred in 2017. The R&D credit must be calculated and shown on a taxpayer’s 2017 federal income tax return with the portion of the credit applied to offset payroll taxes identified and elected when the return is filed in 2018. The offset is then available on a quarterly basis beginning in the first calendar quarter after a taxpayer files their federal income tax return.

For example, taxpayers need to file their 2017 federal income tax return by June 30, 2018, to apply the payroll-tax offset to the third quarter. As a result, the earliest taxpayers are likely to see a benefit is October 2018 when they file their quarterly payroll tax return for the third quarter.

How quickly does a company need to move on this? When does it need to get started?

The current opportunity to offset payroll taxes is based on 2017 expenses, which means companies can benefit from acting quickly to determine their eligibility under the new rules and start planning. This will help ensure companies understand what types of information will need to be gathered at the end of the year.

This credit must be specified, elected, and filed in the original 2017 tax return before it can be used to offset payroll taxes. Under the current rules, taxpayers can’t take advantage of this opportunity on an amended return.

What companies qualify for the offset?

The new payroll-tax offset allows companies to receive a benefit for research activities even if they aren’t profitable. To be eligible for the credit, companies must meet these qualifications:

Gross receipts for five years or less (interest income counts toward gross receipts)
Less than $5 million in gross receipts in the year the credit is elected
Qualifying research activities and expenditures
Payroll-tax liability

Which companies qualify as having gross receipts for five years or less?

Companies aren’t eligible if they generated gross receipts prior to 2013. However, companies that existed prior to 2013 but didn’t receive gross receipts could still qualify.

Although the law is intended to benefit small businesses, larger businesses could potentially still profit. For example, a significant percentage of life-sciences companies have no gross receipts for long periods of time because they’re waiting for their drug to receive approval from the US Food and Drug Administration.

How is $5 million in gross receipts defined?

A company must have less than $5 million in annual gross receipts to be eligible. For new businesses, the gross receipts must fall under the $5 million limit after being annualized for a full 12 months. The gross receipts of businesses that are related or share common ownership need to be calculated on a combined basis for purposes of determining eligibility under this provision.

The IRS issued interim guidance on the definition of gross receipts in March 2017. In the guidance, the IRS confirmed gross receipts include the following:

Total sales—defined as the net of returns and allowances
All amounts received for services
Income from investments, including interest income

Although the gross-receipts limitation helps to define a company’s eligibility for the credit, it’s important to note the R&D credit itself isn’t based on gross receipts. The actual credit is based on the company’s eligible R&D expenses.

What are qualifying activities?

Regardless of industry, companies are potentially eligible for the R&D credit if their activities meet the following requirements, known as the four-part test:

Technical uncertainty. The activity is performed to eliminate technical uncertainty about the development or improvement of a product or process, which includes computer software, techniques, formulas, and inventions.
Process of experimentation. The activities include some process of experimentation undertaken to eliminate or resolve a technical uncertainty. This process involves an evaluation of alternative solutions or approaches and is performed through modeling, simulation, systematic trial and error, or other methods.
Technological in nature. The process of experimentation relies on the hard sciences, such as engineering, physics, chemistry, biology, or computer science.
Qualified purpose. The purpose of the activity must be to create a new or improved product or process, including computer software, that results in increased performance, function, reliability, or quality.

Additional thresholds may apply if a company develops software for internal use. Additionally, activities must be performed in the United States and can’t be funded by another party.

What are eligible R&D expenditures?

Eligible R&D costs include these categories:

Wages. W-2 taxable wages for employees offering direct support and first-level research supervision.
Supplies. Supplies used in research, including so-called extraordinary utilities but not capital items or general administrative supplies.
Contract research. Certain subcontractor expenses if the subcontractor’s tasks would qualify if they were instead being performed by an employee. These can include labor, services, or research, but payment can’t be contingent on results. In addition, the taxpayer must retain substantial rights in the results, whether exclusive or shared.
Rental or lease costs of computers. This could include payments made to cloud service providers for the cost of renting server space, as longs as payments are related to hosting software under development versus payments for hosting a stable software release.

What are some potential benefits of the offset?

Brand-new businesses can potentially claim the credit for up to five years with a maximum of $1.25 million in total credits claimed on their quarterly federal payroll tax returns.

New businesses and start-up companies will see a benefit between 6% and 14% of their eligible R&D costs. For most companies that incur at least $300,000 in eligible R&D costs, the federal credit to offset payroll tax will be equal to 10% of total R&D expenses.

For example, a company with $500,000 of eligible expenses—let’s say engineering costs—could receive a $50,000 credit. On the other hand, a company with over $2.5 million in eligible expenses in 2017 could receive a credit equal to the full $250,000 annual limitation.

If the amount of the credit exceeds a company’s Social Security tax—also known as the OASDI tax—liability in any given quarter, the excess can be carried forward to the next calendar quarter.

Social Security Tax

The payroll-tax offset can only be applied to the Social Security portion of payroll taxes. Companies are required to pay Social Security tax of 6.2% on up to $127,200 of each employee’s salary in 2017. For example, a company that employs 50 employees with an average salary of $75,000 would pay approximately $232,500 in Social Security payroll taxes.

Accordingly, a company would need to have more than $4 million in annual payroll subject to Social Security tax and $2.5 million in eligible R&D costs to offset the maximum $250,000 in payroll taxes each year under the new law.

Most employers are required to deposit their payroll taxes to the federal government on a monthly or semiweekly basis as well as file a quarterly payroll tax return via Form 941. However, the credit will be applied against the Social Security tax on the quarterly return—not when it’s deposited monthly or semiweekly.

The IRS is still formulating a plan for how this process will be formally implemented.

Are there risks to claiming the R&D credit?

Once a company starts using this credit, they receive a much higher level of scrutiny from the IRS. R&D credits are often a high priority for the agency, which assembles industry-specific project teams with technical specialists that assist in reviewing R&D credit claims.

Even at the small business level, it’s common for IRS technical specialists to be involved in R&D credit examinations. In general, however, larger credits receive more scrutiny from the IRS and often require more review and documentation.

Although many companies in the technology industry are likely engaged in activities that would otherwise be eligible for R&D credits, the rules surrounding the credit are complex and always changing. New legislation, regulations, court cases, and IRS guidelines have drastically shifted the landscape of R&D tax law over the past few years and will continue to do so in the future.

Considering these complexities and potential financial penalties, companies can benefit from having their activities analyzed by a CPA, attorney, or enrolled agent familiar with the tax law and accounting rules that govern the R&D credit as well as the IRS examination and appeals process.

To deter companies from claiming credits without the proper level of review and documentation, the IRS can impose penalties greater than 20% of the credit amount claimed. For example, if a taxpayer claims a $250,000 R&D credit and the credit is then audited by the IRS, it’s possible the agency could deny the entire credit and fine the company with accuracy-related penalties exceeding $50,000.

What should companies know about documentation?

It’s important companies have the right documentation in place. It’s also key to know there isn’t a one-size-fits-all approach to documentation. The level of documentation deemed to be adequate varies based on the size and scope of the credit amounts claimed.

Companies should expect a greater time commitment to get set up in the first year of claiming an R&D credit. They’ll also need to put the appropriate measures in place to completely use the credit going forward. Depending on the company, it’s possible any historic R&D spending incurred may need to be evaluated.

Proving Nexus

Taxpayers often will need to provide a nexus between their R&D expenses and qualified research activities. This can be challenging—even for companies that have some level of project tracking in place. This is because time- and expense-tracking systems aren’t generally intended to track eligible R&D expense to business components or R&D activities.

The subjectivity and interpretation of the R&D rules make it difficult to develop the perfect software tool for tracking eligible expenses and documentation, particularly when considering annual updates to tax law, regulations, and IRS guidance. For this reason, it’s important to note project-accounting and time-tracking systems aren’t a prerequisite to claim the R&D credit.

Meeting the Four-Part Test

At minimum, taxpayers’ qualitative documentation should demonstrate how their underlying activities meet the four-part test. Examples of adequate documentation can vary by industry, but it’s possible for companies to leverage documentation they generate in their day-to-day operations. Qualitative documentation may also require review and analysis of any contracts between companies and their customers, partners, or vendors.

Taxpayers who have some level of familiarity with the R&D credit should carefully evaluate their methodology and documentation standards with respect to R&D credits being used under the new rules.

Additional Guidance

Companies in the software and pharmaceutical industries especially are encouraged to review the IRS audit guidelines applicable to their industries. These are available on the IRS website:

The payroll-tax offset is available to eligible new businesses and start-up companies for up to five years. Any unused R&D credits that aren’t elected to offset payroll taxes may be carried forward for up to 20 years and used when the business becomes profitable. This length of time makes thorough documentation even more important.

Can proper documentation assist with my company’s financial-statement reporting per Federal Accounting Standards Board Accounting Standards Codification® Topic 740-10?

All public companies and entities adhering to US generally accepted accounting principles are required to analyze and disclose uncertain tax positions on their financial statements. Many corporations are also required to report those positions on their federal income tax return.

For public companies and companies with audited financial statements, the rules surrounding how R&D credits are recognized on their financial statements can be very complex and subjective. These credits often receive a high level of scrutiny from lenders, investors, and financial statement auditors, especially when a company hasn’t performed an R&D study for management to use in their decision-making processes.

Many unprofitable companies claim R&D credits every year with little support and without fully considering the risk of an audit by taxing authorities. With the help of specialists, these companies can generate more certainty around their credits and assist management with R&D-credit decision-making processes in 2018 and beyond.

Understanding Small Business R&D Tax Credits

R&D
R&D tax credits allow qualified businesses to deduct the cost of qualified research and innovation from their taxable income.
Small businesses can use the R&D credit to offset the FICA portion of payroll taxes.
To find out if your business qualifies, check Section 41 of the Internal Revenue Code and its related regulations.

Growing a business eventually requires developing new products, technologies, systems and sometimes even industries. This growth is vital not only to the success of your individual company but also to the success of the overall economy, which needs innovation to continue growing.
However, innovation requires expensive research and development. In many cases, attempts at innovation fail, with no return on investment, or require multiple stages of development before becoming profitable. These costs can discourage businesses from investing in research and development. This is especially true for small businesses, which do not have the resources and cash flow that large corporations do.
That’s where the R&D tax credit can help your small business.

Key takeaways
The Research and Experimentation Tax Credit is often known as the R&D tax credit.
It benefits businesses by helping them keep more of their profits while also improving their products and technology.
R&D tax credits allow qualified businesses to deduct the cost of qualified research and innovation from their taxable income.
Qualified research must be technological, involve uncertainty and experimentation, and create new products, processes or software.

Qualified research does not have to be successful.
Data analysis allows businesses in a variety of industries to claim the R&D tax credit.
Small businesses can use the R&D credit to offset the FICA portion of payroll taxes.
Keep reading to learn more about each of these topics and how your small business can start benefiting from R&D tax credits.

What is the research and development tax credit program?
The Research & Experimentation Tax Credit is also known as the research and development tax credit or R&D tax credit. As part of the United States tax code, the R&D credit was created to stimulate economic growth by encouraging companies to invest
in research, innovation and new technologies.

It was first introduced in 1981 and regularly renewed in the following decades. In 2015, President Barack Obama signed the PATH Act to permanently extend the Research & Experimentation Tax Credit, along with expanding several of its provisions. Beginning in 2016, the R&D credit could offset the alternative minimum tax (AMT), and startup businesses could utilize the R&D credit against payroll taxes. The Tax Cuts and Jobs Act (TCJA) made further changes to the tax credit, which will go into effect in 2022.
A tax credit allows the taxpayer, in this case your business, to offset the value of that credit against your tax liability. According to the Internal Revenue Service (IRS), the R&D tax credit is for expenses that you incur for “qualified research.”

What are the benefits of the R&D tax credit?
Granting businesses tax credits for research and development is generally thought to help the overall economy by increasing innovation. However, some business groups have said these benefits may be lost under the new amortization rules in the TCJA. Starting in 2022, the TCJA will require that businesses amortize their research and development costs over five years, rather than deducting them immediately. Analysis by the Tax Foundation, an independent tax policy research organization, says canceling the amortization rules will benefit both businesses and workers by increasing economic output and wages.
Businesses that currently claim the R&D credit, however, benefit from reduced tax liability. This makes it a source of cash for many small and midsize businesses. The R&D credit does the following:

Reduces your federal and state taxes for the current year as well as future years
Increases your company’s market value and cash flow
Lowers your business’s effective tax rate
Allows you to keep more of your profits
How do I know if I can claim R&D taxes?
In 2004, the IRS changed language used to decide who could claim tax credits for research and development. Now, most companies that test products, employ engineers, engage in data science and data analysis, or outsource product research can claim the credit.

However, your business must show a component of hard science in the research to claim the credit. If you own a restaurant or are an accountant, for example, you cannot claim the credit, even if you do research or test new products. A business in the “humanities” that tries to claim this tax credit may be more likely to be audited by the IRS.
No matter what type of business you run, if you want to claim a tax credit for research and development, you must keep proper documentation to prove that your expenses qualify.

What documents do I need to claim R&D tax credit?
The IRS does not specify what is “sufficient documentation” to claim a tax credit for research and development. However, the burden of proof is with the taxpayer, which means your business should retain as much documentation relating to your R&D activities as possible in case of an audit. These are some of the documents you should keep on hand:

Payroll information for employees directly involved in R&D and for employees or managers supervising them.
Accounts of which expenses and supplies were related to R&D and those that were not
Copies of contracts with and invoices paid to any contractors who do third-party research for you.
Timekeeping records for work plans, payroll, meetings and any other activities to prove they were related to R&D
Design drawings, test records, blueprints, progress reports, marketing materials, and any other documentation that shows the process and impact of your research
Can my small business’s research tax credits increase?
Small businesses can use the R&D tax credit in multiple ways. Qualified small businesses can claim tax credits for research expenses that increase over time. To claim this credit, you must show that your expenses have increased from your previous year in business.

If your qualified small business doesn’t have an income tax liability, this credit can be used to offset the FICA portion of payroll taxes for up to $250,000. Qualified small businesses are those with annual gross receipts under $5 million and with gross receipts for no more than five years. This allows your small business to claim tax credits for research expenses even if you aren’t yet generating revenue.
Do I qualify for the research and development tax credits?

The rules for the Research & Experimentation Tax Credit are found in Section 41 of the Internal Revenue Code (IRC) and its related regulations. This credit can be applied to any taxpayer who incurs qualified research and development expenses on United States soil.
To qualify for the credit, you must show that your research and development activities meet the following criteria:

They are for the purpose of discovering information that is technological in nature.
They are intended to develop a new or improved business component, such as products, internal-use software, inventions or techniques to be used in your business.
They rely on hard science, such as computer science, engineering, biological sciences or the physical sciences.
They involve uncertainty.

They use experimentation, including testing and alternatives.
If research and development is related to internal-use software for your business, it must meet these criteria:

Be innovative
Result in an economically significant reduction in cost or improvement in speed
Involve economic risk to develop
Not be commercially available
What expenses qualify for research and development tax credits?
These are some expenses related to research and development that qualify for the tax credit:

Wages that you pay to employees involved in qualified research and development, or employees who supervise or support those involved in R&D
Supplies used for researching and developing new technologies other than land, property subject to depreciation or improvements to land.

Costs paid to a third-party contractor to perform qualified activities for your business, regardless of the outcome or success of that research
Research payments to a qualified education institution or scientific research organization for qualified R&D activities
Costs for developing a patent

What expenses are excluded from research and development tax credits?
The R&D tax credit can offset the cost of many areas of research and development. However, some expenses are excluded:
Research conducted after you have begun commercial production
Research to adapt an existing product or process to an individual customer
Duplication of a product or process that already exists
Surveys or studies you conduct, such as market research
Research relating to some kinds of software intended for internal use

Research you conduct outside the United States, Puerto Rico or a U.S. territory
Research in the humanities, arts or social sciences
Research funded by another person, government, grant or organization

The cost of fixed assets necessary to run your business
In some cases, you may also find that expenses which qualify for the R&D tax credit are also eligible for other tax credits, and you will have to choose between them. For example, qualified expenses relating to clinical testing for certain drugs or rare diseases may also qualify for the Orphan Drug Credit. You will need to work with your accountant or a tax preparation expert to decide which credits make the most sense for your business.
The IRS website can provide additional information to help you determine whether your business qualifies for R&D credits and how to claim them.

Is data science research eligible for the R&D tax credit?
In the current economy, businesses that can particularly benefit from R&D tax credits are those that use data science and big data analysis.

With the growth of online data collection and analysis, many organizations, including small and midsize businesses, have dedicated data analysis and data science departments. Employees involved in these departments use complex algorithms, innovative software, and advances in data science to allow them to analyze markets and innovate. The employees responsible for these data science departments are often trained in complex mathematics and computer engineering.

This increases the opportunities for businesses across various industries to claim the R&D tax credit. If your business wants to use data science to understand its market, customers and product innovation, that analysis involves a degree of scientific rigor that almost always qualifies for the R&D tax credit.

The nature of data analysis also involves a high level of documentation, including the development and tests of distinct data sets, that can help your business prove it qualifies for the R&D credit.

How is the R&D tax credit calculated?
In 2007, the IRS introduced an “alternative simplified credit” formula to calculate R&D tax credits. Calculating your tax credit involves five steps:
Calculate qualified research expenses for the preceding three years.
Average these amounts.

Multiply that average by 50%. This number is your credit base.
Subtract the amount of your credit base from your total R&D expenses for the year.
Multiply by 14% to find your R&D tax credit.
As an example, if your business averaged $100,000 in qualified research and development expenses for the past three years, your credit base would be $50,000 (50% of $100,000). If you spent $120,000 on research and development this year, that is $70,000 more than your base. Multiplied by 14%, that means your tax credit is $9,800. This amount can be claimed at once or amortized over 60 months

If your business doesn’t have three years of research and development history to calculate a credit base, then your R&D tax credit can be calculated as a flat 6% of your total R&D expenses for that year. In that case, the credit for $120,000 of qualified expenses would be $7,200.

Though calculating the R&D credit is not complicated, knowing which expenses qualify, and whether you have the correct documentation to back them up, is more difficult for many small businesses. Changes to tax laws, which often go into effect over an extended period of time, can also impact when and how you claim your credits. Before calculating any tax credits, including those for research and development, consult with your accountant or a tax preparation specialist.

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