Why Outsource Your Bookkeeping?Posted on April 26th, 2017
Outsourced Accounting Department, Inc.
So how many of you small business owners out there had the childhood dream depicted in the above picture? Based on this January 2015 article from Entrepreneur Magazine: “What’s the One Task Most Small Business Owners Loathe?,” I suspect not very many of you.
Yet, bookkeeping is an essential task, as is the need to do it accurately, as well as using an accounting method that gives you a true picture of your company’s profitability. So what many small businesses do first is to purchase a small business accounting software such as QuickBooks and attempt to do their books themselves. But they quickly learn that QuickBooks is not as “easy to use” as their name and marketing implies. In fact, I often tell people, “QuickBooks has done a great job of marketing its software as being easy to use, but that’s also what makes it easy to abuse”(and most small business owners I’ve worked with do just that – see my previous article, “Winging It In QuickBooks”).
At some point it becomes more advantageous to the small business owner to outsource this function to someone who better understands accounting, or at the very least, have someone oversee and adjust their work. But it doesn’t take much to completely screw up a set of books, so the sooner you can outsource it completely, the better. Otherwise, you’ll be constantly paying for someone to clean up your books anyway, which is a waste of money. Furthermore, many tax preparers only do this in their own tax software at year-end, not in your books, and then charge you for the extra time to prepare your tax return.
In terms of the cost of outsourcing, don’t get hung up on “hourly rates.” That’s comparing apples and oranges. Keep in mind that you are hiring a person or firm that has its own payroll taxes and overhead just like your business, and you cannot sell your product or service at cost and expect to stay in business very long either. Instead, compare the monthly fee to what it would cost you to hire a full-time bookkeeper on your payroll. Also, compare it to what you could be doing with your own time, such as increasing sales and producing a larger profit, known in the financial world as “opportunity cost.” The timing of course, is a matter of affordability. I’ll have more on this topic in a future article, but in my experience, most small business owners can sense when the time is right to outsource.
Tax Planning for Small Business OwnersPosted on April 15th, 2017
Marianne Kern, CPA
Kern & Associates CPA, P.A.
Tax planning is the process of looking at various tax options to determine when, whether, and how to conduct business transactions to reduce or eliminate tax liability.
Many small business owners ignore tax planning. They don’t even think about their taxes until it’s time to meet with their accountants, but tax planning is an ongoing process and good tax advice is a valuable commodity. It is to your benefit to review your income and expenses monthly and meet with your CPA or tax advisor quarterly to analyze how you can take full advantage of the provisions, credits and deductions that are legally available to you.
Although tax avoidance planning is legal, tax evasion – the reduction of tax through deceit, subterfuge, or concealment – is not. Frequently what sets tax evasion apart from tax avoidance is the IRS’s finding that there was fraudulent intent on the part of the business owner. The following are four of the areas the IRS examiners commonly focus on as pointing to possible fraud:
- Failure to report substantial amounts of income such as a shareholder’s failure to report dividends or a store owner’s failure to report a portion of the daily business receipts.
- Claims for fictitious or improper deductions on a return such as a sales representative’s substantial overstatement of travel expenses or a taxpayer’s claim of a large deduction for charitable contributions when no verification exists.
- Accounting irregularities such as a business’s failure to keep adequate records or a discrepancy between amounts reported on a corporation’s return and amounts reported on its financial statements.
- Improper allocation of income to a related taxpayer who is in a lower tax bracket such as where a corporation makes distributions to the controlling shareholder’s children.
(See also, “Are You at Risk of an IRS Audit.”)
Tax Planning Strategies
In order to plan effectively, you’ll need to estimate your personal and business income for the next few years. This is necessary because many tax planning strategies will save tax dollars at one income level, but will create a larger tax bill at other income levels. You will want to avoid having the “right” tax plan made “wrong” by erroneous income projections. Once you know what your approximate income will be, you can take the next step: estimating your tax bracket.
The effort to come up with crystal-ball estimates may be difficult and by its very nature will be inexact. On the other hand, you should already be projecting your sales revenues, income, and cash flow for general business planning purposes. The better your estimates are, the better the odds that your tax planning efforts will succeed. (See also, “The Most Common Budgeting Errors.”)
Consider Filing Your Business Return as an S-Corporation
In my previous article, “Choosing the Right Business Entity,” I pointed out some major tax advantages to filing your taxes as an S-Corporation, primarily: 1.) Net income is taxed only once at the lower personal tax rate, vs. on both the net income and dividends paid to the owner in the case of a C-Corporation, and 2.) Self-Employment Tax is calculated only on the amount of Officer Salaries (W-2 wages) declared, vs. on the entire net income in the case of sole proprietorships and partnerships. Thus, the S-Corporation tax structure is very popular with small businesses. However, extreme caution must be exercised as the IRS closely monitors these types of business returns for owner abuse, particularly under-declaring Officer Salaries to reduce self-employment taxes.
Choosing the Most Appropriate Method of Accounting for Tax Purposes
For businesses that sell on credit terms and have accounts receivable, and/or a large amount of inventory, using the “Cash Basis” of accounting can provide significant tax savings. This is due to the fact that “accrual” revenues that have not yet been collected are deducted from income for tax purposes, and inventory purchased can be immediately expensed. But the other side of this is if your business also has a large amount of accounts payable, those are also subtracted from Cost of Goods Sold, thus reducing your deductible expenses. Therefore, an analysis should be conducted to determine which way your company is better off reporting its taxes, i.e. between the Accrual and Cash Basis of accounting. (See also, “Profit vs. Taxable Income,” and “The Relationship Between Turnover Ratios and Cash Flow.”)
Maximizing Business Entertainment Expenses
Entertainment expenses are legitimate deductions that can lower your tax bill and save you money, provided you follow certain guidelines.
In order to qualify as a deduction, business must be discussed before, during, or after the meal and the surroundings must be conducive to a business discussion. For instance, a small, quiet restaurant would be an ideal location for a business dinner. A nightclub would not. Be careful of locations that include ongoing floor shows or other distracting events that inhibit business discussions. Prime distractions are theater locations, ski trips, golf courses, sports events, and hunting trips.
The IRS allows up to a 50 percent deduction on entertainment expenses, but you must keep good records and the business meal must be arranged with the purpose of conducting specific business. Bon appetite!
Important Business Automobile Deductions
If you use your car for business such as visiting clients or going to business meetings away from your regular workplace you may be able to take certain deductions for the cost of operating and maintaining your vehicle. You can deduct car expenses by taking either the standard mileage rate or using actual expenses. In 2017, the mileage reimbursement rate is 53.5 cents per business mile (54 cents per mile in 2016).
If you own two cars, another way to increase deductions is to include both cars in your deductions. This works because business miles driven is determined by business use. To figure business use, divide the business miles driven by the total miles driven. This strategy can result in significant deductions.
Whichever method you decide to use to take the deduction, always be sure to keep accurate records such as a mileage log and receipts. (See also, “Deducting Business-Related Car Expenses.”)
Increase Your Bottom Line When You Work At Home
The home office deduction is quite possibly one of the most difficult deductions ever to come around the block. Yet, there are so many tax advantages it becomes worth the navigational trouble. Here are a few tips for home office deductions that can make tax season significantly less traumatic for those of you with a home office.
Try prominently displaying your home business phone number and address on business cards, have business guests sign a guest log book when they visit your office, deduct long-distance phone charges, keep a time and work activity log, retain receipts and paid invoices. Keeping these receipts makes it so much easier to determine percentages of deductions later on in the year.
You can also deduct a percentage of your rent or mortgage interest (unless you itemize and claim it elsewhere on your return), utilities, repairs and maintenance, and other housing expenses. The percentage used to calculate these deductions is the square footage of your home office as a percentage of the total square feet of your home (living area).
Section 179 expensing for tax year 2016 allows you to immediately deduct, rather than depreciate over time, up to $500,000, with a cap of $2,000,000 worth of qualified business property that you purchase during the year. The key word is “purchase.” Equipment can be new or used and includes certain software. All home office depreciable equipment meets the qualification. Some deductions can be taken whether or not you qualify for the home office deduction itself.
As always, seek help from a tax professional to discuss specific tax planning strategies for your business.
Choosing the Right Business EntityPosted on April 10th, 2017
When you decide to start a business, one of the most important decisions you’ll need to make is choosing the right business entity. It’s a decision that impacts many things–from the amount of taxes you pay to how much paperwork you have to deal with and what type of personal liability you face.
Forms of Business
The most common forms of business are Sole Proprietorships, Partnerships, Limited Liability Companies (LLCs), and Corporations (C-Corporations). Federal tax law also recognizes another business form called the S-Corporation. While state law controls the formation of your business, federal tax law controls how your business is taxed.
What to Consider
Businesses fall under one of two federal tax systems:
- Taxation of both the entity itself on the income it earns and the owners on dividends or other profit participation the owners receive from the business. C-Corporations fall under this system of federal taxation.
- “Pass through” taxation. This type of entity (also called a “flow-through” entity) is not taxed, but its owners are each taxed (more or less) on their proportionate shares of the entity’s income. Pass-through entities include:
- Sole Proprietorships
- Partnerships, of various types
- Limited liability companies (LLCs)
- “S-Corporations” (S-Corps), as distinguished from C-corporations (C-Corps)
The first major consideration when choosing a business entity is whether to choose one that has two levels of tax on income or one that is a pass-through entity with only one level directly on the owners.
The second consideration, which has more to do with business considerations rather than tax considerations, is the limitation of liability (protecting your assets from claims of business creditors).
Let’s take a general look at each of the options more closely:
Types of Business Entities
The most common (and easiest) form of business organization is the sole proprietorship. Defined as any unincorporated business owned entirely by one individual, a sole proprietor can operate any kind of business (full or part-time) as long as it is not a hobby or an investment. In general, the owner is also personally liable for all financial obligations and debts of the business.
Note: If you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation.
Types of businesses that operate as sole proprietorships include retail shops, farmers, large companies with employees, home-based businesses and one-person consulting firms.
As a sole proprietor, your net business income or loss is combined with your other income and deductions and taxed at individual rates on your personal tax return. Because sole proprietors do not have taxes withheld from their business income, you may need to make quarterly estimated tax payments if you expect to make a profit. Also, as a sole proprietor, you must also pay self-employment tax on the net income reported.
A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.
There are two types of partnerships: Ordinary partnerships, called “general partnerships,” and limited partnerships that limit liability for some partners but not others. Both general and limited partnerships are treated as pass-through entities under federal tax law, but there are some relatively minor differences in tax treatment between general and limited partners.
For example, general partners must pay self-employment tax on their net earnings from self-employment assigned to them from the partnership. Net earnings from self-employment include an individual’s share, distributed or not, of income or loss from any trade or business carried on by a partnership. Limited partners are subject to self-employment tax only on guaranteed payments, such as professional fees for services rendered.
Partners are not employees of the partnership and do not pay any income tax at the partnership level. Partnerships report income and expenses from its operation and pass the information to the individual partners (hence the pass-through designation).
Because taxes are not withheld from any distributions partners generally need to make quarterly estimated tax payments if they expect to make a profit. Partners must report their share of partnership income even if a distribution is not made. Each partner reports his share of the partnership net profit or loss on his or her personal tax return.
Limited Liability Companies (LLC)
A Limited Liability Company (LLC) is a business structure allowed by state statute. Each state is different, so it’s important to check the regulations in the state you plan to do business in. Owners of an LLC are called members, which may include individuals, corporations, other LLCs and foreign entities. Most states also permit “single member” LLCs, i.e. those having only one owner.
Depending on elections made by the LLC and the number of members, the IRS treats an LLC as either a corporation, partnership, or as part of the LLC’s owner’s tax return. A domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it elects to be treated as a corporation.
An LLC with only one member is treated as an entity disregarded as separate from its owner for income tax purposes (but as a separate entity for purposes of employment tax and certain excise taxes), unless it elects to be treated as a corporation.
In forming a corporation, prospective shareholders exchange money, property, or both, for the corporation’s capital stock. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders.
A corporate structure is more complex than other business structures. When you form a corporation, you create a separate tax-paying entity. The profit of a corporation is taxed to the corporation when earned and then is taxed to the shareholders when distributed as dividends. This creates a double tax.
The corporation does not get a tax deduction when it distributes dividends to shareholders. Earnings distributed to shareholders in the form of dividends are taxed at individual tax rates on their personal tax returns. Shareholders cannot deduct any loss of the corporation.
If you organize your business as a corporation, generally are not personally liable for the debts of the corporation, although there may be exceptions under state law.
An S-corporation has the same corporate structure as a standard corporation; however, its owners have elected to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S-corporations generally have limited liability.
Generally, an S-Corporation is exempt from federal income tax other than tax on certain capital gains and passive income. It is treated in the same way as a partnership, in that generally taxes are not paid at the corporate level. S-Corporations may be taxed under state tax law as regular corporations, or in some other way.
Shareholders must pay tax on their share of corporate income, regardless of whether it is actually distributed. Flow-through of income and losses is reported on their personal tax returns and they are assessed tax at their individual income tax rates, allowing S-Corporations to avoid double taxation on the corporate income.
Another major advantage of S-Corporations is that self-employment tax is based only on the W-2 wages of the owner, versus on the entire amount of income from the business. For this reason, S-Corporations are hugely popular with small business owners. However, this advantage is often abused by many small business owners. Therefore, care must be taken that the amount of income declared as W-2 wages is not too low in the eyes of the IRS, as this can be an audit trigger. And how much salary is considered “reasonable” by the IRS is very subjective. (See IRS article, “Wage Compensation for S-Corporation Officers.”)
To qualify for S-Corporation status, the corporation must meet a number of requirements. Please call if you would like more information about which requirements must be met to form an S-Corporation.
When making a decision about which type of business entity to choose each business owner must decide which one best meets his or her needs. Obtaining the advice of a tax professional is prudent.
IRS Dirty Dozen Tax Scams for 2017Posted on April 2nd, 2017
Compiled annually by the IRS, the “Dirty Dozen” is a list of common scams taxpayers may encounter in the coming months. While many of these scams peak during the tax filing season, they may be encountered at any time during the year. Here is this year’s list:
- Identity Theft
Tax-related identity theft occurs when someone uses your stolen Social Security number to file a tax return claiming a fraudulent refund. Taxpayers should use caution when viewing e-mails, receiving telephone calls or getting advice on tax issues because scams can take on many sophisticated forms, according to IRS Commissioner John Koskinen.
- Phone Scams
Aggressive and threatening phone calls by criminals impersonating IRS agents remain a major threat to taxpayers. In recent weeks, the agency has seen a surge of these phone scams as scam artists threaten police arrest, deportation, license revocation and other things.
Phishing schemes using fake emails or websites are used by criminals to try to steal personal information. Criminals create websites that appear legitimate but contain phony log-in pages, hoping that victims will take the bait so they can steal the victim’s money, passwords, Social Security number and identity. Scam emails and websites also can infect your computer with malware without you even knowing it.
- Tax Return Preparer Fraud
There are some dishonest tax preparers who set up shop each filing season. Well-intentioned taxpayers can be misled by preparers who don’t understand taxes or who mislead people into taking credits or deductions they aren’t entitled to in order to increase their fee. Illegal scams can lead to significant penalties and interest and possible criminal prosecution.
- Hiding Money or Income Offshore
While there are legitimate reasons for maintaining financial accounts abroad, there are reporting requirements that need to be fulfilled. U.S. taxpayers who maintain such accounts and who do not comply with reporting requirements are breaking the law and risk significant penalties and fines, as well as the possibility of criminal prosecution.
- Inflated Refund Claims
Scam artists routinely pose as tax preparers during tax time, luring victims in by promising large federal tax refunds or refunds that people never dreamed they were due in the first place. Because taxpayers are legally responsible for what is on their returns (even if it was prepared by someone else), those who buy into such schemes can end up being penalized for filing false claims or receiving fraudulent refunds.
- Fake Charities
Taxpayers should be aware that phony charities use names or websites that sound or look like those of respected, legitimate organizations. Scam artists use a variety of tactics including contacting people by telephone or email to solicit money or financial information.
- Falsely Padding Deductions on Tax Returns
Falsely claiming deductions, expenses or credits on tax returns is on the “Dirty Dozen” tax scams list for the 2017 filing season. The IRS warns taxpayers that they should think twice before overstating deductions such as charitable contributions, padding their claimed business expenses or including credits that they are not entitled to receive.
- Excessive Claims for Business Credits
Improper claims for business credits such as the fuel tax and the research credit are also on the IRS “Dirty Dozen” list this year. The fuel tax credit is generally limited to off-highway business use or use in farming, and is not available to most taxpayers. Still, the IRS routinely finds unscrupulous tax preparers who erroneously claim the credit to inflate their refunds. The research credit is also an important feature in the tax code to foster research and experimentation by the private sector; however, the IRS does see a significant amount of misuse of the research credit each year.
- Falsifying Income to Claim Credits
This scam involves inflating or including income on a tax return that was never earned, either as wages or as self-employment income, usually in order to maximize refundable credits. Just like falsely claiming an expense or deduction you did not pay, claiming income you did not earn in order to secure larger refundable credits could have serious repercussions.
- Abusive Tax Shelters
Phony tax shelters and structures to avoid paying taxes may use Limited Liability Companies (LLCs), Limited Liability Partnerships (LLPs), International Business Companies (IBCs), foreign financial accounts, offshore credit/debit cards and other similar instruments. Trusts also commonly show up in abusive tax structures. Another abuse involving a legitimate tax structure involves certain small or “micro” captive insurance companies. Taxpayers should steer clear of these types of schemes as they can end up costing taxpayers more in back taxes, penalties, and interest than they saved in the first place
- Frivolous Tax Arguments
Promoters of frivolous schemes encourage taxpayers to make unreasonable and outlandish claims to avoid paying the taxes they owe, such as on religious or moral grounds by invoking the First Amendment. While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law or disregard their responsibility to pay taxes.
Remember: Taxpayers are legally responsible for what’s on their tax return even if it is prepared by someone else.
For more details, read the full article here: IRS Dirty Dozen Tax Scams for 2017.