January 2012 Tax Update - Philadelphia CPA
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January 2012 Tax Update

January 2012 Tax Update

IRS NOW SAYS NO PAYROLL TAXES ON FAMILY EMPLOYMENT IN A SINGLE-MEMBER LLC

Oops!  That’s what the IRS says about its regulation that required corporate payroll tax treatment for single-member LLCs after December 31, 2008.1

In their confessions, the IRS and the Treasury Department admit that they did not intend to eliminate the pre-2009 single-member LLC tax breaks that applied to family employment, such as the favorable avoidance of FICA, Medicare, and unemployment taxes when a parent hires her or her child.

The Family Employment Tax Break

Under the family employment rules, when a parent hires his or her child

Under the age of 21, unemployment taxes do not apply.2
Under the age of 18, unemployment, FICA, and Medicare taxes do not apply.3

For wages paid by a husband to a wife or vice versa, the wages are subject to FICA and Medicare, but exempt from unemployment.4

Example.  Henry Nunn hires his daughter Sally, age 12, to work in his proprietorship.  He pays were $5,000 in wages.  The wages are exempt from FICA, Medicare, and unemployment taxes for both the employer and the employee.

Before the IRS Change of Heart

Before 2009, the IRS allowed the single-member LLC the proprietorship payroll tax exemptions of family employment.

Beginning January 1, 2009, the IRS required the single-member LLC to consider itself a corporation for payroll tax purposes.

Thus, had Mr. Nunn operated as a single-member LLC in 2009, 2010, and 2011, and had the LLC hired Mr. Nunn’s daughter Sally, both the LLC and Sally had to pay FICA and Medicare taxes in each of those years.  But that was before the IRS had a change of heart and issued a temporary fix.

IRS Change of Heart

To fix its unintended payroll tax consequences for the single-member LLC, the IRS allows the single-member LLC to use the proprietorship payroll tax rules when it hires the member’s

Children under the age of 21, and/or
Spouse.
The fix is effective on November 1, 2011, retroactive to January 1, 2009, but it expires on or before October 31, 2014.5

(Yikes—you need to be alert to this most unusual “on or before” expiration date of a regulation.  We are here to help—we are keeping a keen eye on this unusual expiration date for you.)

Retroactive.  The fix is retroactive and you have to like this change.  The single-member LLC may apply the pre-2009 family employment rules retroactively to January 1, 2009.6  Under this rule, you can pretend that the IRS never implemented its unintended consequences regulation.
Do You Need to Amend Your Returns?

To know if you should amend your tax returns for 2009, 2010, and/or 2011, answer the questions below:

Did you operate a business as a single-member LLC?
Did your single-member LLC employ one or more of your children who are under age 18?
Did you pay payroll taxes on the employment of that child?

If you answer “yes” to all three questions, you should consider amending your payroll and income tax returns.

Example.  John Smith operated his business as a single-member LLC.  During 2009 and 2010, his payroll service took payroll taxes from the $15,000 in wages that he paid his two children each year.  By amending his payroll and income tax returns, Mr. Smith and his children will recoup over $6,000 in overpaid payroll taxes—well worth amending.

(The net result has to consider both payroll and income taxes, and that will produce less than $6,000—an amount in the “still well worth amending” category.)

The Way It Is Today

If you operate your business today as a single-member LLC, tax law treats your LLC as a disregarded entity for both income and family employment tax purposes.

Example.  You operate as a single-member LLC.  You have six employees, which include your spouse and two of your children who are under age 18.

For income tax purposes, your LLC is a disregarded entity and you file on a Schedule C as a proprietorship.
For employment tax purposes, your two children and your spouse are treated as if employed by you as the proprietor.  Under the family employment rules, wages paid to the children and your spouse are exempt from unemployment taxes.  Wages paid to the children are exempt from FICA and Medicare taxes, but wages paid to your spouse are not.

On the three third-party employees, payroll taxes apply as if you operated as a corporation which, from a tax standpoint, mirrors payroll taxes on third-party employees by a proprietorship.

1    TD 9554.
2    IRC Section 3306(c)(5).
3    IRC Section 3121(b)(3)(A).
4    IRC Section 3306(c)(5).
5    TD 9554.
6    Ibid.