 Income tax 2021-2022, business expenses, employees pay. Get ready to get refunds to the max, diving into income tax 2021-2022. Most of this information can be found in publication 334, tax guide for small business tax year 2021, looking at the income tax formula line one income, which would have a sub-schedule, basically an income statement, income and expenses, focusing this time on the expenses, expenses basically being deductions, the net then rolling in to line one income of the income tax formula and tax return. As we see here on the tax return, we basically would have a schedule C, bottom line rolling into the schedule one, bottom line of the schedule one, rolling into page one of the form 1040, line number eight, here's the schedule C, profit or loss from business, basically an income statement. So now we're looking at the employees pay. So if we are a sole proprietor, then you'll recall that the bottom line, the net income basically is going to be subject to the self-employment tax, which in a sense is the IRS kind of treating ourselves as if we're the employee of our own business. We are the employer and the employee and have to deal with social security and Medicare. We wanna keep that separate from the concept that if we actually have other employees that we are going to be paying, then we'll have to be dealing with payroll and we will also have social security and Medicare for the employee and employer or portions that we have to deal with in that sense in a similar way as any other kind of business entity or structure for the most part, including like a normal corporation for example. So you can generally deduct on schedule C the pay you give to your employees for the services they perform for your business. The pay may be in cash property or services. So obviously it's similar to any other expense. It would be just as easy as any other expense if it wasn't for all the regulations that are involved with it. In other words, if you just shook someone's hand said you're gonna, when you're working for each other and I'll pay you at the end of the day for the work you've done, you would just be basically recording an employee expense the other side then going to cash. But there's more complexity in that of course because we have to have the W-2's that would have to be in place. We have to have the withholdings. We've got social security and Medicare payroll taxes on top of other kind of human resources on the bookkeeping side of things involved with employees. So to be deductible, your employees pay must be an ordinary and necessary expense. That's the normal rule and you must pay or incur it in the tax year. So that's the general rule. In addition, the pay must meet both the following tests. The pay must be reasonable. The pay must be for services performed. So obviously you would think this would be pretty straightforward is the pay reasonable. It should be unless there's some kind of weird thing going on like it's a family member or something like that. Anytime relatives get involved, then things get funny because you might have payments that are unreasonable pay that people are trying to do funny stuff to get a tax benefit on it. In general, you would think that if you had employees, those two conditions would be met. But in chapter two of publication 535, it explains and defines these requirements in more detail if you wanted to dive into that in more detail. Now you cannot deduct your own salary or any personal withdrawals you make from your business as a sole proprietor, you are not an employee of the business. Now that gets a little bit confusing because like we explained with regards to the self-employment tax, with regards to the self-employment tax calculation, they're kind of treating you as an employee but we're trying to distinguish being an employee that of course has to report like payroll, payroll taxes. And instead of having that, we have the kind of equivalent which is basically the self-employment tax. This also gets confusing because small businesses often might have an incentive to set up their structures in a different setup. So you might set up like a limited liability company which is a flow through type of entity or an S corporation as opposed to a sole proprietorship reported on the Schedule C. Now the S corporation in particular has a bit different structure with regards to how you're gonna be paying your social security and Medicare. In that instance, even if you're the only owner of the Schedule C, you might still be paying yourself because that's how you basically are gonna be subject to the payroll taxes which is the social security and Medicare. So when you compare that entity structure to Schedule C, it could be a little bit confusing on the Schedule C, then you're not gonna be charging your own time as basically wages that you're paying yourself. You're not deducting the wages you're paying yourself. What you're doing is taking the bottom line, the leftover income, that income minus all the expenses and that net income is kind of being treated as basically your income subject to like payroll taxes in the form of social security and Medicare self-employment taxes as opposed to being processed through the wages. And that's really one of the big concerns with this whole thing is the payroll taxes involved because we're gonna be dealing with the federal income taxes but then you also got that payroll tax component, the social security and Medicare. So kinds of pay, some of the ways you may provide pay to your employees are listed below for an explanation of each of these items. You can see chapter two of publication 535. So you might have awards, bonuses, education expenses, fringe benefits, loans or advances. You do not expect the employee to repay if they are for personal services actually performed, property you transferred to an employee as payment for services, reimbursements for employee business expenses, sick pay, vacation. So these are all items that if you have an employee then you can dive into of course all of the benefits that are involved with having an employee. Now the general rule is if you pay the employee typically with some form of cash then they're gonna be subject to the taxes on it and you're gonna have to report it as W2 income which is basically telling the IRS that you gave them the money. You'll also have to be dealing with the withholdings and so on. But you can look into other ways of paying them possibly with like fringe benefits for example which is a form of pay. If you can pay your employees in other words where they're not subject to the tax like if I could pay my employees and they weren't subject to an income tax then of course the money would go further being beneficial to both the employees and ourselves. So you can look into other kind of benefits that you might be able to provide to the employees to see if you can maximize the benefits that you can give them. Part of the way you do that is try to minimize the tax consequences on both the employer and employee side. So fringe benefits, a fringe benefit is a form of pay for the performance of services. The following are examples of fringe benefits. So if you can give your employee money that would qualify under the fringe benefits and not be subject to them being subject to the taxes then that would be beneficial. So benefits under qualified employee benefit programs, meals and lodging, the use of a car, flights on airplanes depends on the industry that you're in as to whether you can give some of these benefits as well. Discounts on property or services which again will be dependent on the industry that you are in. Employee benefit program includes the following, accident and health plans, adoption assistance, cafeteria plans, dependent care assistance, educational assistance, group term life insurance coverage and welfare benefit funds. So again if you were able to give some of these benefits you might be able to have it go a little bit further than the cash and so that can be beneficial to both parties involved. You can generally deduct the cost of fringe benefits you provide on your schedule C in whatever category the cost falls. For example, if you allow an employee to use a car or other property you least deduct the cost of the lease as rent or lease expense. So obviously then you can deduct it in the normal category it would apply to. If you own the property including your deduction for its cost or other basis as a section 179 deduction basically a form of depreciation or depreciation deduction then that's the format that you would be deducting it in. You may be able to exclude all or part of the fringe benefits you provide from your employee's wages. That's the key to putting them into the fringe benefits because you want them to be lowering the tax burden for the employee's which you might think of as the virtuous thing to do of course to help out the employee's but it's also beneficial to you to both parties involved because you're able to pay them higher more money and real money given the fact that the payments you're given to them will not be subject so much to the payroll taxes. So it's beneficial to everybody involved. It's just the regulations make it more difficult so you gotta kind of work out how you can get the most benefit that would be involved. So for more information about fringe benefits and the exclusion of benefits you can see publication 15B and one of the benefits that you could look at one of the big ones obviously would be some type of retirement kind of plan that you can take a look at which could be beneficial for large companies that's usually a 401K something like that for smaller companies you might look into like a simple or possibly a SEP type of plan which are these are gonna be more simplified kind of plans than the traditional 401K which could cause or require a lot of kind of admin type of work involved in those as well. So that's another area that you could dive into if you have the employees for benefits that you might be able to provide as well as possibly benefits for yourself with regards to retirement plans, contributions.