Small Business Primer for Tax Season

With the passing of the holidays, comes the necessary and dreaded task of preparing yourself and your documentation to report your earnings and deductions to the IRS.  We will go into this a little further next month, but I wanted to give you some preliminary tips to help make the process easier.

• If you paid anyone acting as an independent contractor or compensated a non-employee $600 or more during 2010, you may need to issue a 1099-MISC form to them by the end of January.   This is also true for any rents you paid for real estate or machine rentals.  Generally, payments made to corporations do not require a 1099 form.  Review your income statement to identify all non-employee compensation and rents over $600 and be sure you have a W-9 form on file for each person or entity.  The W-9 form provides the name, address, tax ID number, and type of entity information needed to prepare each 1099 form. 

See specific instructions at this link:  http://www.irs.gov/instructions/i1099msc/ar02.html#d0e624 . 

The W-9 form and instructions can be found here:  http://www.irs.gov/pub/irs-pdf/fw9.pdf?portlet=3 .

 

•  Verify that payroll information agrees with amounts reported on payroll returns and that payroll liabilities agree with year end reports.  Be sure to update any changes to state rates for the upcoming year.  If you do your own payroll, verify employee addresses and social security numbers, and order the necessary number of W-2 and 1099 forms needed (see above).  W-2 forms should be mailed by January 31st.

 

• Get your business bank and credit card accounts reconciled to the institution’s statements.  Review outstanding checks and deposits in transit.  Investigate and eliminate older uncleared transactions, as necessary.

 

• Verify that all of your loan balances and interest paid agrees with the lending institution.  Verify that all interest has been recorded as an expense.

 

• If you have inventory, do a physical count and determine any adjustments to quantity or cost.

 

• Review accounts receivable and determine any amounts that should be written off.  Verify that the allowance for bad debt is a reasonable estimate of potential write-offs.

 

• Review accounts payable for accuracy and evaluate if there are any amounts that you may want to pay in the current year (cash basis).  Enter all invoices received to be paid (accrual basis).  Eliminate any debts on the books that have been forgiven or will not be paid.

 

• Do you have any prepaid items that need to be expensed, i.e., prepaid insurance?

 

• Verify that all major purchases are recorded as assets and that all depreciation and amortization has been recorded for the year.

 

• Are all previous year end accountant adjustments recorded?  Are there any reversing entries that need to be made?

 

• Review all Miscellaneous, Uncategorized, Ask My Accountant, Suspense or other similar types of accounts and reclassify these transactions to the proper accounts.

 

• If you have a home office and do not book any expense until year end or book amounts based on prior year estimates, pull together your year end mortgage interest statements or form 1098, any private mortgage insurance, homeowners insurance, real estate taxes paid, repairs and/or improvements, and utility bills.

 

• If you deduct vehicle expenses, get your mileage log in order and verify that you have the beginning and ending odometer readings for the year.  You will also need any finance charges paid on a business vehicle, business tolls and parking, and the amount of registration or personal property tax expenses paid based on the value of the vehicle.  If you book actual vehicle expenses, be sure that all gas, repairs, tolls and parking, registration, finance charges and depreciation are recorded.

Once all of this is done, I usually review each income statement and balance sheet account for accuracy and consistency in coding, to be sure that monthly transactions have an entry for each month, and that the amounts appear to be reasonable.  It is also helpful to do a prior year comparison, and identify the authenticity of any substantial changes.

So relax and enjoy the holiday, then roll up those sleeves and get to it!  We wish you all a wonderous holiday, and a very prosperous New Year.

Disclaimer: This post is intended to provide general information about the subjects posted.  It should no way be construed as tax or financial advisement.

Seacoast Accountability Takes a Look at Small Business Tax Misconceptions

So you got out from under working for somebody else, and now you own the business.  You are probably very good at what you do, and enjoy doing what you are good at.  Then you begin to think about “the necessary evil” that raises its ugly head-bookkeeping, payroll, taxes and the numerous obligations, deadlines, paperwork and regulations that are in a constant state of flux.  You might be good at making widgets, but you find you are not so good at knowing what to record financially, what paperwork is due when to which taxing authority, or even how much tax you may or may not owe.  Of course, the best thing to do is give Seacoast Accountability a call, but if you are not quite to that step, this article is geared to dispel some of the myths about small business taxes that you may have heard.

A CPA is your best source for tax preparation

This is not always true, and it’s expensive.  Select a tax professional that asks you a ton of questions, better yet, one that has experience in your industry.  CPAs tend to be conservative and may not include deductions that you are legally entitled to get, resulting in the more tax you pay.

The home office deduction will get me audited

Once upon a time, this might have been the case.  With the economy the way it is now, there are an increasing number of home offices, and the IRS simply doesn’t have the resources to audit every one of them.  The key here is to be sure that the majority of your administrative tasks are done from the home office and to have legitimate and realistic deductions. (See my previous blog about the home office deduction)  IRS asks you for a code that identifies your type of business.  They have a database that tells them what the norm is for various expenses in your industry.   It is the ratio of income to expense, or coding a high amount of expense in a particular area that is most likely to trigger the audit.

 If I file an extension, I can wait to pay the tax I owe

Oh, this is a big fat lie!  The only thing that an extension does for you, is give you the extra time to file the return without being hit with a late filing penalty.  Any amount that is due after the due date is assessed with an underpayment penalty and interest begins to accrue from the original date the return was due, typically April 15^th.

If I pay what I owe, I won’t get a penalty

Again, this is false.  Your taxes are calculated quarterly, so if you pay everything you owe when the return is due, you could possibly be hit with an underpayment penalty for not paying taxes in quarterly installments.

I haven’t started operating the business, so I can’t deduct anything

The IRS now allows an immediate deduction of start up costs, or the business expenses you paid out before opening day.  These costs consist of market surveys, wages paid to train employees, travel, and advertising the opening of the business.  You can deduct up to $5,000 in the first year, or the actual start-up costs, whichever is less.  The deduction is reduced by the amount of total start up costs that exceed $50,000.  Any start up costs not deducted in the first year can be deducted over 180 months, starting the month after the business begins.

The only mileage I need to keep track of is my business miles

I run into this every year, especially with new clients.  My returning clients have been trained to know better!  IRS requires that you keep a mileage log of ALL miles.  At least get your beginning odometer reading each year.   (See my vehicle deduction blog)  Not only is this an IRS requirement, but the ratio of total miles to business miles is used to capture other vehicle expenses such as the personal property tax and finance charges paid on the business vehicle, which can be deducted in addition to the standard mileage rate.

I live in New Hampshire, so I don’t have to pay income tax

If you have $50,000 of income, before expenses, you have to file a Business Profits tax return with the state.  You may also be subject to a Business Enterprise Tax.

As a side note, and something to think about, the small business owner is saddled with not only the income tax that every taxpayer is subject to, but the self employment tax, as well.  This is a double-edged sword, because the self employment tax is what you pay into the Social Security system.  The less you pay in, the less you get in your golden years.  I strongly recommend seeking a tax professional to help you get estimated payments set up, review your record keeping and deductions, and advise you about a tax planning strategy.  Now is a great time of year to review what has happened with your company for the first half of the year, and to make any adjustments to avoid surprises at year end.  Give us a call at (603) 834-1271

Seacoast Accountability’s Small Business Tax Tip-The Home Office Deduction

Complete information for taking the Home Office Deduction can be found in IRS Publication 587.  The deduction is calculated on Form 8829, which transfers to Schedule C.  It should be noted that employees who receive a W-2 may also be eligible to claim a home office as an itemized deduction, however this information is not covered here.

Advantages of the Home Office Deduction

The advantages of deducting a home office is that you can take expenses that are not normally deductible, such as homeowners insurance, rent (if you do not own your home), home repairs and maintenance,  utilities, and you are able to depreciate the space, if you own your home.  There is also the advantage of shifting a portion of your mortgage interest and real estate tax from Schedule A to Schedule C, thereby lowering your self employment tax liability.

IRS Criteria to Qualify

The IRS criteria that needs to be met in order to qualify a home office space includes the fact that the space must be used exclusively and regularly as a principal place of business. 

• Exclusively means just that, the space cannot be used sometimes as a spare bedroom, and other times as an office. 
• Regularly means that you use the space on a consistent and regular basis, not casually or coincidentally. 
• Key to defining the space as a principal place of business is supported by the fact that the majority of your administrative and management functions are conducted when using the space, in addition to obvious tasks such as meeting customers or clients. 

Having another space where you conduct business does not automatically disqualify the home office space if you can support that you have met the three qualifications.

The Calculation

The typical basis used to calculate the deduction is square footage.  Another equitable basis could be used in lieu of the actual square footage, but square footage is recommended.  You need to measure the home office space that is used exclusively and regularly, and total square footage of the home.  Expenses are then allocated to the home office space based on its square footage percentage of total space.

The next thing you need to consider is if expenses are direct or indirect.  Direct expenses are amounts spent solely on the home office, and not the total home.  If you painted just the home office, then this expense would not need to be allocated based on square footage, since the cost is attributable soley to the home office.  In contrast, items such as mortgage interest and real estate taxes are attributed to the entire home, and are indirect costs, needing to be allocated to the home office space based on square footage.

Other Considerations

If you began using your home office space for only part of a year, keep track of the costs from the starting date, figure your square footage, and determine your direct and indirect costs from the starting date.  For example, if you began using your home office in July, you would figure your square footage and look at the rent or mortgage interest and real estate taxes, utilities, homeowners insurance, repairs/maintenance, and depreciation (if you own the home), etc. from July 1 through the end of your reporting year.

A home office can be used for more than one business, and your income can be derived from  more than one business location.  If either of these situations pertain to you, seek advice from a qualified tax professional.

Limitation of the Deduction

The deduction is limited by the amount of business income.  Depending on the amount of business loss you are reporting, your deduction will be limited.    If you show a business loss prior to the home office deduction, you may be limited to only the mortgage interest and real estate tax allocated to the home office space.  All other expenses, including depreciation, allocated to the home office, are carried forward to future years.

Depreciation

Be aware that the depreciation you claim on a home office is a factor in calculating the gain or loss on sale of your residence when you dispose of the property.  I get several questions about this, and people seem to have the misconception that if they don’t take the depreciation deduction, they won’t have to factor it into the equation upon selling their home.  This is a myth, and the IRS will calculate the deduction for you, even if you didn’t take it.  So, you  might as well take the deduction if you are going to claim a home office deduction.

If you  have any questions, contact Kathy Foster of Seacoast Accountability at (603) 834-1271, or send an email to info@SeacoastAccountability.com.