Salon Savvy: Avoiding Tax Pitfalls with Style

As a salon or spa owner, you're a master of transformations – sculpting styles, enhancing beauty and creating confidence with every snip and stroke. But when it comes to taxes, even the most skilled professionals can find themselves tangled in a web of complex rules and regulations. This guide aims to equip you with the knowledge to avoid the six most common industry pitfalls and maintain a seamless tax compliance strategy.

Worker Misclassification

Salon and spa businesses sometimes misclassify workers as independent contractors, rather than employees, which can lead to a myriad of tax collection issues and up to one year in federal prison. A business owner must examine the relationship between the worker and the business and should consider all evidence of the degree of control and independence in this relationship. It is recommended that business owners consult with a tax professional before designating a worker as an independent contractor.

Workers who believe they have been misclassified can file a Form SS-8 with the IRS, which is a formal request to the IRS to determine the workers status for purposes of federal employment taxes and income tax withholding. The Form SS-8 is one of the most common avenues of misclassification discovery utilized by the IRS, as workers are incentivized to report misclassifications to recover the portion of FICA taxes that should have been withheld on their behalf. The misclassification penalties, which are subject to interest, are as follows:

Unintentional Misclassification of Workers

• $50 for each W-2 the employer failed to file;
• Penalties totaling 1.5% of the wages for the failure to withhold income taxes;
• 40% of the FICA taxes that were not withheld from the employee;
• 100% of the matching FICA taxes the employer should have paid; and
• A Failure-to-Pay penalty (up to 25%).

Intentional or Fraudulent Misclassification of Workers

• Up to one year in prison;
• The person(s) responsible for withholding taxes could be held personally liable for any uncollected tax;
• $50 for each W-2 the employer failed to file;
• Penalties totaling 1.5%-3% of the wages for the failure to withhold income taxes;
• 40% of the FICA taxes that were not withheld from the employee;
• 100% of the matching FICA taxes the employer should have paid;
• A Failure-to-Pay penalty (up to 25%);
• Additional fines/penalties from the Department of Labor and IRS are also possible, additional fees can range from $10,000 - $25,000 per employee

The IRS offers the Voluntary Classification Settlement Program, which provides an opportunity for business owners to reclassify their workers as employees for employment tax purposes for future tax periods with partial relief from federal employment taxes. Misclassifying employees as independent contractors is a mistake that could land you in hot water – think hefty penalties, potential jail time, and a whole lot of unwanted stress!

Putting Off Delinquent Tax Liabilities

 Procrastinating on delinquent tax liabilities is like ignoring a split end – it might seem harmless at first, but it can quickly spiral into a tangled mess. Fortunately, the IRS offers collection alternatives for taxpayers unable to pay their full balance. These collection alternatives include:

1. Offer in Compromise: An agreement between the taxpayer and the IRS that settles a taxpayer’s tax liabilities for less than the full amount owed;
2. Installment Agreement: Pay a monthly installment toward the balance due; and
3. Currently Not Collectible Status: Delays collection for 2 years (which can be renewed as needed), based on the IRS’s determination that the taxpayer cannot pay the debt at this time.

Without entering into a collection alternative, taxpayers with unpaid balances risk IRS enforcement action, including, but not limited to, seizure of assets, such as bank accounts, wage garnishments, and passport suspensions/revocations. After all, you wouldn't want the tax authorities to give your bank account an unwanted "trim," would you?

Filing Tax Returns Late or Not at All

Failure-to-File Penalty

 Business owners who are unable to pay their taxes in full, or who just fall behind on their tax preparation in general, often put off filing their returns past the due date, not realizing the additional ramifications of a late return. While it is true that the IRS may assess penalties for failure to pay, failure to deposit, and failure to make estimated tax payments, many business owners overlook the failure-to-file penalty, which can result in a penalty of up to 25% of the taxes that remain unpaid (accruing at 0.5% per month).

Missing Returns Can Preclude Installment Agreement and Offer in Compromise Requests From Consideration Altogether

If a taxpayer is missing any federal tax returns in the past six years, the taxpayer will not be permitted to enter into an Installment Agreement until they come into compliance with their missing returns. The taxpayer will also be unable to have an Offer in Compromise considered if they are missing any federal tax returns in the past six years. Absent financial hardship, a taxpayer with missing returns in the past six years will generally be required to pay in full or be at risk of enforcement action, including, but not limited to, Federal Tax Liens, levying (i.e, seizure) of assets (e.g., bank accounts, real property, etc.), or wage garnishment.

The IRS May File a Substitute-for-Return (SFR) on Your Behalf

It may come as a surprise to many that the IRS is permitted to prepare returns on behalf of nonfilers, utilizing information it has from taxpayers’ banks, employers, and other payers. In the instance of an SFR, the IRS will not claim credits or deductions that would otherwise be claimed, often resulting in a larger tax liability due than if the taxpayer had prepared their own returns.

While an SFR may be corrected, many additional steps will need to be taken, often requiring tax attorney intervention. In the instances of SFRs, the IRS typically will file them within five years of the original due date of the return, however, in certain instances, they may go back further than five years.

So, whether you're a seasoned salon owner or a freshly minted spa entrepreneur, remember – tax compliance is as essential as mastering the latest hair trends. Embrace these tips, seek professional guidance when needed, and you will be well on your way to a tax season that's as stylish and stress-free as your best work. Not sure where to start? Schedule a free consultation online at AzarvandTaxLaw.com or by emailing Info@AzarvandTaxLaw.com.

Stay Tuned for Salon Savvy: Avoiding Tax Pitfalls with Style, Part 2.

About the Author: Tina Azarvand is a Tax Attorney and is the founder of Azarvand Tax Law. She assists businesses with preventing, defending, and resolving tax controversies with the IRS and local taxing authorities. In 2023 and 2024, she was selected to the SuperLawyers: Rising Stars list, a distinction that less than 2% of attorneys receive.