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Have you considered talking to your state's Department of Labor about this? Sounds like a clear misclassification case. I was in a similar situation as a personal trainer and had to file an SS-8 form with the IRS.
Just wondering - how much are you paying in Social Security and Medicare taxes on your W2? As a 1099 contractor, you'd pay both the employer and employee portions (self-employment tax), which is about 15.3%. Make sure you're factoring that in when deciding if you want to push for reclassification.
This is actually a really important point! When I switched from W2 to 1099 for my coaching job, I was excited about the deductions but then got hit with that self-employment tax. Wasn't prepared for it.
I hadn't even thought about that aspect. My last pay stub shows I'm paying about 7.65% for Social Security and Medicare combined. So I'd basically be paying double that as a 1099? That definitely changes the math on whether pushing for reclassification makes sense. I'll need to calculate if the deductions would offset that extra cost.
Have you considered using a "blocker" corporation structure? This is something my business did with our hybrid activities. Essentially, we created a parent holding company that owned both the excluded activities (financial services) and a separate blocker corporation that contained only the qualified business activities (manufacturing in our case). The key is making sure the blocker corporation independently meets all QSBS requirements, including the gross asset test and the active business requirement. Investors then purchase shares directly in the blocker corporation rather than the parent company. Our tax attorney structured it so that profit flows appropriately between entities while maintaining the QSBS qualification.
That's really interesting! I hadn't heard of using a blocker corporation like that. Would this approach work better than simply having two separate subsidiaries under the parent company? And did you have to deal with any step-transaction concerns from the IRS?
The blocker approach works better than two subsidiaries under a parent because when you have subsidiaries, the parent's qualification depends on the aggregate activities of all subsidiaries. With the blocker structure, you're allowing direct investment into the qualified entity. We didn't face step-transaction concerns because we established the structure well before any sale was contemplated (about 3 years prior). The IRS generally respects properly structured entities with legitimate business purposes. The key is having proper governance, separate books, arm's length transactions between entities, and maintaining the structure for a substantial time before any sale. Also make sure your qualified corporation meets the active business requirement independently and isn't just a passive investment vehicle.
Be careful with Section 1202! Our company initially thought we qualified, claimed the QSBS exclusion on a partial sale, and then got audited. The IRS determined that just 15% of our "consulting" business was actually providing training (qualified) while 85% was financial advice (excluded). We had to pay back taxes plus penalties. Make sure whatever structure you set up has a clear operational separation between the activities, with separate accounting, management, and business purposes. And document EVERYTHING! Get your structure reviewed by someone who specializes in QSBS - most regular CPAs don't understand all the nuances.
How much was the penalty? I'm planning to sell shares in our business next year and now I'm worried about claiming QSBS incorrectly!
Something important nobody mentioned - make sure you mail each tax year in separate envelopes! I filed 4 years of back taxes and put them all in one big envelope to save on postage. Big mistake! The IRS lost two of my returns in processing and I had to refile them. Also if you owe money, include separate checks for each year and write the tax year and your SSN on each check. Makes it much less likely for payments to be misapplied.
Thanks for this tip! I hadn't even thought about how to physically submit multiple years. Do they need to be sent to the same address or are there different addresses for back tax returns?
For most people, all prior year returns go to the same IRS processing center based on your state. The addresses are listed in the instructions for each year's 1040 form. But double-check each year's instructions separately because they do occasionally change the processing centers. If you end up owing for any year, I'd recommend sending those returns certified mail with return receipt. It costs a bit more but gives you proof of when you filed, which can be important for penalty calculations.
Don't forget about state taxes too! Most people focus on federal back taxes but forget they need to file state returns too. Some states have shorter statutes of limitations and higher penalties than the IRS.
This! I got caught up on federal but forgot about state taxes. The state came after me with WAY worse penalties than the feds did. They even put a lien on my bank account which the IRS never did.
Another option you might not have considered: check last year's tax return if you claimed the childcare credit then too. The EIN would be listed on Form 2441 that you filed. You can get a transcript of your previous returns on the IRS website pretty easily.
That's really smart! I did claim them on last year's taxes so the EIN should definitely be on my old Form 2441. I'll check my copy of last year's return tonight. If I can't find my copy, is the transcript free to get from the IRS website?
Yes, getting your tax transcript from the IRS website is completely free! Just go to IRS.gov and search for "Get Transcript Online." You'll need to create an account if you don't already have one, and they'll verify your identity with some security questions. Once you're in, you can request a "Tax Return Transcript" for the previous year. It should show up immediately and you can download it as a PDF. Form 2441 will be included, and line 1 should have the provider's name, address, and EIN. Super easy and definitely faster than waiting for the IRS on the phone.
Just a heads up - if you absolutely cannot find the EIN, the IRS does allow you to still claim the credit! You'll need to show you made a "reasonable effort" to get it (document your attempts) and fill out Form W-10. There's a special procedure for this situation specifically because so many small daycares close without providing proper documentation.
Sienna Gomez
Did your preparer have you sign the return before filing? They're required to get your signature on Form 8879 which confirms you've reviewed the return. Always check your return before signing!
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Lydia Santiago
β’They did have me sign, but honestly I just glanced at the refund amount and signed the authorization. I didn't go through all the forms because I trusted them to do it right. Lesson learned - I'll definitely review everything carefully from now on.
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Kirsuktow DarkBlade
Make sure you save all your communication with the preparer about fixing this issue! If the IRS ever questions you about it, having evidence that you took immediate steps to correct the error once you discovered it will help show you weren't trying to claim credits you knew you weren't eligible for.
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