Adding employees to a growing small business is great news, but owners need to be careful to fill out the right paper work and file the proper documentation with the IRS to make sure they don’t run afoul with Uncle Sam.

Last week I covered the tax basics when it comes to payroll, but here are some specific details business owners should know.

Corporations. First of all, if your business is structured as a corporation, you as the owner operator must be on payroll. You cannot take cash draws like sole proprietors or principals in an unincorporated business. If you operate as an S Corporation, you will be allowed to take advances on profit, but this is after paying yourself a reasonable wage.

About five years ago, the IRS frequently audited attorneys structured as S Corporations. Many of these attorneys were taking draws of several hundreds of thousands of dollars and claiming payroll of substantially less. The advantage is the savings on payroll taxes; Sub S corporate earnings are taxed without self-employment tax added on.  But the IRS is watching and it wants to see fair market wages.

There are ways of getting money out of a corporation aside from payroll. You can lease office space, equipment, vehicles, patents and trademarks to the corporation. You can lend the corporation money and receive repayments. Check with your tax pro and attorney to find out ways to pull out money legally and ethically.  You will also want to review the list of assets to determine which should be corporate owned and which should be rented or leased to the corporation.

The IRS wants to make sure you are taking compensation as an employee as well, so don’t overlook this important issue.

Nepotism. Hire your child – no problem. What better way to provide a kid with a real-life education? If you hire your child under the age of 18, you will not be required to withhold FICA and Medicare taxes or kick down the employer share of FICA, Medicare and FUTA. Check with your state to see what it requires.

Unfortunately, if your legal form is corporate or partnership, you must treat your kid as a regular employee and withhold and match these taxes.

The nice thing about paying your kids is that you can funnel their pay into an IRA account. If you start early enough, they may be able to retire before you do.

Be sure to give your child real duties and provide her with a W2 at year end. Deduct her pay on your Schedule C under salaries and wages.

Household Employees. If you have an employee retained for domestic services rather than service in your business, you must withhold and match FICA and Medicare tax for any employee earning more than $1,800 during the calendar year unless the employee is under the age of 18 and the domestic service is not his primary occupation. FUTA tax is also applicable. You needn’t withhold federal income tax.

Employee Business Expenses. If your employees are given an expense account for vehicle, telephone, supplies, meals and entertainment among other expenses, you are not required to withhold and match payroll taxes from these expenses.

Be sure to use a spreadsheet format or have some other reporting method to document these expenses. Receipts for the expenses should be stapled to the report. Then simply cut a check to the employee to reimburse him for the expenses. You may then deduct these expenses on your business’ tax return.

Under the Table. You’re looking for trouble if you decide to just pay someone cash under the table in order to save on the expense and paperwork involved in processing payroll.

First of all, you might save a few bucks on payroll taxes but you will be losing possibly thousands in write-offs for salaries, wages and payroll taxes.

Secondly, if you pay this person on a 1099 and she do not qualify should read she does not qualify. Not only that, but your employee will probably be audited as well. If you don’t provide a 1099, you won’t be allowed the deduction. And think of this, if you don’t get the deduction, why bother? Why should you have to pay this person’s taxes? If you fire this individual, she may file for unemployment. Since you have not paid into the system, the state will come bounding over to your business to perform an audit. If they go back three years and hit you with all the taxes for every “under the table” employee, it can be excruciatingly painful. 

See IRS Publication 15 for more information.

Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all fifty states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, CA and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Follow Bonnie Lee on Twitter at BLTaxpertise and at Facebook.

Bonnie Lee is an enrolled agent admitted to practice and representing taxpayers in all 50 states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, Calif., and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Her new e-book Taxpertise for the Creative Mind Murder, Mayem, Romance, Comedy and Tax Tips for Artists of all Kinds is available at all major booksellers. Follow Bonnie Lee on Twitter and on Facebook.