Considering Employment Taxes and Workers' Comp When Choosing a Business Type

Employment Taxes and Workers’ Compensation Insurance

Employment taxes include income tax withholding, Social Security and Medicare taxes and federal and state unemployment insurance taxes. Although workers’ compensation insurance technically is not a tax, coverage is required for most employees. Employment taxes and workers’ compensation insurance are deductible business expenses in determining net income.

Note: The following information on employment taxes and workers’ compensation insurance applies only to businesses that have employees. Sole proprietors and partners that provide services to the business are not considered employees for purposes of paying unemployment taxes or obtaining workers’ compensation insurance coverage for themselves. They may, however, be liable for Social Security and Medicare self employment tax. (See the discussion of the self employment tax below.) Shareholders in a C corporation or an S corporation who perform services for the corporation generally will be considered employees of the corporation and therefore will be subject to employment taxes. In most situations, workers’ compensation coverage for these shareholders also will be required.

Self Employment Tax

Although sole proprietorships and partnerships that do not have employees are not required to pay employment taxes, the sole proprietor or partners may be liable for Social Security and Medicare self employment tax. For 2009 the anticipated Social Security and Medicare self employment tax rate is 15.3 percent. The rate consists of two parts: 12.4 percent for Social Security and 2.9 percent for Medicare. There is no upper limit on payments for self-employed individuals. Social Security and Medicare Tax. Social security and Medicare taxes are paid by both the employer and the employee. The anticipated Social Security tax rate for 2010 for both the employer and the employee is 7.65 percent of the first $106,800. Social Security and Medicare taxes are not required for a sole proprietor’s children under age 18 who work in the sole proprietorship.

Federal Unemployment Taxes

Employers generally are liable for both federal and Minnesota unemployment taxes. The federal unemployment tax rate is 6.2 percent of the first $7,000 in wages paid each employee. A credit of up to 5.4 percent may be allowed for state unemployment taxes paid for a normal net tax of 0.8 percent. Wages paid to a spouse or child under age 21 who works in a sole proprietorship owned by the spouse or parent are not subject to federal unemployment taxes; other exceptions also may apply. (Editors note: changes in state unemployment tax law may change your FUTA liability. Timely payment of state unemployment tax creates an offset credit on FUTA tax liability. Contact a tax advisor for more information.

Minnesota Unemployment Tax

State unemployment tax rates are discussed in the business tax section of this Guide. Different rates apply to new businesses, the construction industry, and businesses which have an established experience rating. The wage base to which the tax applies also depends on the experience rating of the business. Wages paid by a sole proprietor for services performed by a parent, spouse or child under the age of 18 are not subject to Minnesota unemployment taxes. Wages paid to corporate officers or member of an LLC who own 25 percent or more of the corporation or LLC are not subject to Minnesota unemployment tax. Other exceptions also may apply. Workers’ Compensation Insurance. Workers’ compensation insurance rates depend on the nature of the work performed by the employee and the employer’s experience rating. A sole proprietor or partner may elect to obtain workers’ compensation coverage for an employee who is a spouse, parent or child of the owner, but coverage for these family employees is not required. In addition, certain closely held corporations may elect coverage for executive officers who own at least 25 percent of the stock of the corporation.

Workers’ Compensation Insurance

Workers’ compensation insurance rates depend on the nature of the work performed by the employee and the employer’s experience rating. A sole proprietor or partner may elect to obtain workers’ compensation coverage for an employee who is a spouse, parent or child of the owner, but coverage for these family employees is not required. In addition, certain closely held corporations may elect coverage for executive officers who own at least 25 percent of the stock of the corporation.

This is part of a series of articles on How to Pick the Right Business Entity Type. These articles help you select the right business type for your circumstances.

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CREDITS: This is an excerpt from A Guide to Starting a Business in Minnesota, provided by the Minnesota Department of Employment and Economic Development, Small Business Assistance Office, Twenty-eighth Edition, January 2010, written by Charles A. Schaffer, Madeline Harris, and Mark Simmer. Copies are available without charge from the Minnesota Department of Employment and Economic Development, Small Business Assistance Office.