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In the July 2015 issue of The General Ledger, a newsletter published by the American Institute of Professional Bookkeepers, they warn that the IRS is now pursuing criminal charges against businesses that fail to pay payroll taxes. This is a new, harder approach than what the IRS had taken in the past.
This is referring to federal withholding tax, social security, medicare, and federal unemployment taxes. Many businesses will try to delay paying these federal payroll taxes to improve cash flow. In the past, the IRS had a more lenient approach to this in which they only sought to collect payment and penalties. This has changed. To quote the AIPB article, “Criminal charges will be sought when unpaid taxes are used to help a business keep going.” Jail time is being sought in certain cases. The IRS considers this an especially egregious offense if the business was generous to employees or others and a substantial amount of money is involved. A case was cited where an employer didn’t pay payroll taxes but gave employees free Starbucks coffee and 100% 401k matching contributions. The IRS won criminal charges against this employer.
To recap our previous discussion of assets, assets are defined as things with current or future economic value. Fixed assets are items your business owns that you actually use in your business. Examples of fixed assets are:
- Office equipment like copiers and fax machines
- Office furniture
Inventory is a different type of asset that is sometimes confused with fixed assets. Inventory is an asset that is specifically purchased for resale. So if you buy a computer to use in the day-to-day running of your business, it is a fixed asset. But if your business is Best Buy or Office Max, you buy some computers specifically to resell them. In this case, the computers bought for resale are inventory. Another example might be a lawn mower. If you are a landscaping business and using the lawn mower in your day-to-day business, it’s a fixed asset. If you are Home Depot and buying lawn mowers to sell, they are inventory.
You’re probably wondering what’s the big deal. They are all assets, right? Yes, they are all assets, but they are handled differently for tax purposes. Fixed assets depreciate over time. This means that you don’t get to deduct the entire cost as an expense in the tax year you purchase a fixed asset. For example, you spend $3,000 on some office furniture today. You can’t deduct the entire $3,000 as an expense this year. Furniture depreciates over 7 years. Using straight-line depreciation, you could deduct 1/7 of the cost each year for 7 years. That means of your $3,000 purchase, you only get to deduct $428.57 as a business expense in the current tax year. Depending on the current year’s tax laws and the depreciation method your CPA uses, this amount may be different.
Inventory is different. Let’s stay with the example of the $3,000 purchase of furniture. You’re not using the office furniture to furnish your own office, you purchased it for resale, so it’s inventory. The amount you get to deduct as a business expense depends on whether or not you sell it in the current tax year. Your tax year is the same as the calendar year. You sold the furniture prior to 12/31 of the year you purchased it. You get to deduct the entire amount as a business expense in the current tax year.
However, if 12/31 has passed and you haven’t sold the furniture you purchased as inventory, you can’t deduct a penny of the cost in the current tax year. That can really hurt come tax time if you have spent lots of money on inventory during the year and haven’t sold it. You essentially have to pay tax on that money (in our example the $3,000) because you can’t deduct it. This is why there are so many year-end sales and retailers lower prices to move inventory before the end of the year. It’s also why you don’t want to keep lots of inventory sitting around.
Assets are things that have current or future economic value.
Cash and money in depository bank accounts (checking, savings, CD’s) are your most liquid assets.
Accounts receivable (A/R) are also assets. Billing a customer and giving them terms to pay like net 30 days creates an account receivable. That customer owes you money. This account receivable has future economic value. These assets are still fairly liquid in that you expect to receive payments within a short period of time.
“Other current assets” is another category of assets. You’ll see this in the type of accounts you can choose if you are a Quick Books user. These are assets that you expect to convert to cash within a year. Examples of this might be an employee advance. You pay an employee ahead of time for work not yet performed, and expect to receive reimbursement from the employee. Another example is if you pre-pay for things like insurance. You may get a bill for an annual insurance premium and pay it all at the start of the coverage period. That becomes an asset to your business. You get future economic value for it during the course of the coverage period.
Inventory is an asset that you specifically buy for retail sale. All of the items on the shelves at Walmart are inventory on Walmart’s books. Inventory does not include items that you buy, use, and then sell. For example, a construction company buys a bulldozer and uses it for construction projects. Eventually, the company decides to sell the bulldozer because it doesn’t need it anymore. The bulldozer is not inventory in this instance. However, if your business is a retail outlet for selling bulldozers (you buy and sell bulldozers as your primary business), then a bulldozer purchase would be inventory. Inventory is less liquid than the previous assets discussed. You expect to sell it, but it might take a while to do so.
Fixed assets are the least liquid type of assets. These are items you buy for use in your business. Examples are buildings, office equipment, furniture, computers, and software. In the example above, the bulldozer purchased for use by the construction company in their regular work is a fixed asset.
We’re beginning a series of posts on bookkeeping basics to help small business owners better understand the principles of bookkeeping.
Automobile expenses are handled differently depending on whether a vehicle is owned by the business or by you personally.
If a vehicle is owned by your small business, most of the expenses associated with it will be deductible. Fuel, maintenance, repairs, insurance, license and registration will all be deductible. When the IRS allows you to deduct all of these expenses, they want to make sure you’re using the car only for business purposes. They will specifically ask if you have a separate vehicle to use for your personal transportation needs. If you use the vehicle predominantly for business, but occasionally for personal transportation, you will have to document what percentage of use is business and what percentage of use is personal. Keep a mileage log to document this. You will be allowed to deduct only that percentage of expenses that matches with what you can prove was the percent of business use of the vehicle. If you use it 90% of the time for business, you are allowed to deduct 90% of the expenses.
If you are a business owner and use your personal vehicle for business purposes, none of the regular expenses of vehicle ownership are deductible. You will pay for fuel, maintenance, repairs, insurance, license and registration from your own personal funds. Then you can reimburse yourself for mileage actually driven for business purposes. It is imperative that you keep a written log to document business miles driven in order to count this as an expense for your business. The IRS sets mileage reimbursement rates. The current rate is $0.575 per mile. So if I drive 10 miles for business, I have essentially contributed $5.75 to my business, and can deduct $5.75 as a business expense. The key here is to keep “contemporaneous” records of the date, odometer readings, and where you are traveling to and from. The IRS prefers “contemporaneous” records meaning you write them down at the time it is happening rather than trying to reconstruct what happened after the fact. I advise clients to keep a pocket size notebook in their car to record this information with every trip.
One other tidbit to keep in mind when you are documenting business mileage is that commuting does not count as business mileage. If you have a home office, and no business location other than your home office, business mileage is easy to understand. Once you have a business location other than a home office, you can only count business travel to and from the business location as business mileage. Traveling from your home to your business location doesn’t count: it’s commuting. Traveling from your home to a client’s office similarly doesn’t count. The IRS considers that commuting, too. If you travel from your home, to your office, then to the client’s office, you can count only the travel from your office to the client’s office as business mileage. Travel from one business location to another is OK to count as business travel. For example, traveling from one client’s office to another client’s office counts as business travel.
The main take-away for business owners is that automobile deductions are vastly different depending on who owns the vehicle.
Intuit, the parent company of Quick Books, published a primer on fraud protection. In it, they cite the 2014 Association for Financial Professionals Payments Fraud and Control Survey. According to this survey, 60% of businesses experienced actual or attempted payments fraud in 2013. Only 10% of businesses recovered the full amount they were defrauded, and 30% of businesses recovered nothing.
Clearly fraud prevention is important and Quick Books offers some tips you might not have considered.
Reconcile all of your bank statements regularly. This includes checking and savings accounts, credit card accounts, and loans. Anything that gets a statement, reconcile it. Quick Books point out that waiting too long to discover and report fraud to your bank makes it easier for the bank to claim that you are responsible for the financial consequences of the fraud. It’s also easier to remember which transactions were legitimate if you review them sooner than later.
They also point out that making sure your bookkeeping firm has liability insurance is good fraud protection. Most people don’t think of running a business without carrying liability insurance. It is a sound practice. Rest assured that Provision Business Services LLC carries professional liability insurance. Beware that many freelance bookkeepers have never run a business and don’t realize they need to carry insurance. Always ask.
Finally, they point to the importance of keeping organized stating that if a bank can prove you didn’t keep a responsible, organized routine for your finances, you can be liable for the fraud. Your bookkeeper can be a great partner in keeping your finances organized.
In the February 2015 issue of The General Ledger, a publication of the American Institute of Professional Bookkeepers, a case of the IRS denying travel expenses is detailed. According to IRS §274, Disallowance of certain entertainment, etc., expenses, a higher level of documentation is required to prove travel and entertainment expenses. Worksheets prepared after the fact are not considered good proof of expenses. You cannot rely simply on bank and credit card statements or invoices. The IRS wants to see receipts that document the date, amount of payment, payee, a description of what was purchased, and the business purpose of the expenses.
In today’s age of “paperless” offices, many business owners falsely believe that bank and credit card statements are enough to document business expenses. Please keep your receipts with contemporaneous notes to document the relevant information listed above. This is the best way to insure you are allowed all of your tax deductions.
We encourage clients to keep a very simple filing system to keep their receipts. Use an envelope for each month of the year to keep your receipts organized chronologically. Write on the receipts other relevant information. For example, to document a business meal, write the name and business name of who joined you for the meal as well as the nature of the business matters discussed.
The Albuquerque Journal published an article on 4/1/15, page B1, about our state being rated near the bottom of all US states in terms of financial literacy. It considered the following variables:
% of people with a “rainy day fund” – we ranked 49th
% of “unbanked” households – we ranked 43rd
% of people who pay the minimum on credit card bills – we ranked 46th
And % of people who compare credit cards before applying – we ranked 41st
The most financially literate states were New Hampshire, Utah, and Massachusetts, while Louisiana, Arkansas, nevada, and Mississippi ranked below us.
Also according to the Wallet Hub study cited, only 2 in 5 adults have a budget.
Your business can’t be healthy without a budget. We can help you evaluate your expenses with profit and loss reports and balance sheets. Once you have this data, you can make better decisions about how to spend your business’s money.
Cash flow and profit & loss are two terms that can be confused. If you end up talking with a banker, you’ll want a clear understanding of both terms.
Let’s start with profit and loss, which is the easier concept.
Income – Expenses = Profit (or Loss).
If your income is greater than your expenses, you have a profit. If your income is less than your expenses, you have a loss. Pretty straight forward.
The confusion comes when you have “expenses” that accountants and bankers don’t categorize as “expenses”. For example, loan or credit card payments. When you make charges on your credit card, those are expenses. For example, $25 at Chevron for gas, $50 at Office Max for office supplies, $100 to Verizon for your cell phone. Each of these is an expense and fits into the “expenses” part of the profit and loss equation above.
What happens when you write a check to the credit card to pay for your charges? When you write a check for $175 to Capital One to pay your credit card bill, it is NOT an expense. It doesn’t fit into the profit and loss equation at all. You are actually paying off a liability. This affects your cash flow, but not your profit and loss.
All deposits – all withdrawals = Positive (or negative) cash flow
If your deposits are greater than your withdrawals, you have positive cash flow. If your deposits are less than your withdrawals, you have negative cash flow.
You can be making a profit and have a positive cash flow at the same time, which is kind of intuitive. You can have a loss and a negative cash flow – also kind of intuitive. However, what happens if you’re making some profit, but you have too much debt to pay off? A profit with a negative cash flow.
Let’s say you make $5,000 profit, but between your credit card payments due, not due on cars you are financing, the mortgage due on the office building, payroll taxes due, sales taxes due, and income taxes due, you can have a very negative cash flow.
Before a bank will loan your business money, they will look at both y our profit and loss and at your cash flow. Having a good understanding of these concepts will make you a better business owner, and a more responsible borrower.
One of the worst surprises a business owner can face is to find out they’ve taken out more money from their business as a distribution or draw than what they thought they took out. One of the hidden ways this number creeps up is from meal expenses. Only 50% of the cost of business meals is deductible for tax purposes. So you spend $50 at a restaurant with a potential customer, and $25 of that ticket gets categorized as money you took out of the business over the year. Do this often enough and it really adds up. Even if you take 10 people out to dinner, it’s still only 50% of the bill that is expensible and you get taxed on the remaining portion.
A point of frequent confusion is that many people try to expense their own lunches or other meals as business expenses. Here’s an example: part of your business involves making deliveries. So while you’re out driving the delivery van, you get hungry and swing through the McDonald’s drive through for lunch for yourself. This is not a business expense. Buying the $1.39 drink at the gas station while you fill up is not a meal expense.
Of course, there are exceptions. If you are travelling out of town for business purposes, your meals will be deductible (with certain limits) on travel days and on days you are conducting business. If instead of buying the $1.39 drink at the gas station, you buy a case of drinks and take them back to the office to share with your staff, the case of drinks is deductible.
The main point here is to be aware that you are probably taking money out of your business when you expense business meals, and will end up getting taxed on it.