Why Bank Reconciliations are Absolutely Necessary for Your Small Business

Great Depression Bank Runs

 

Why doesn’t my QuickBooks balance match my bank balance?

Whenever you issue checks to vendors, there is no saying how long it will take the vendor to deposit the check into their bank account.  This represents a “timing difference”.  For instance, if you issue a check on March 29th, and the vendor doesn’t deposit the check until June 29th (For whatever reason) there is a significant timing difference between when this check was entered into your accounting software and when it effectively hits the bank statement.  Timing differences are the main reason why your QuickBooks balance doesn’t match your actual bank balance and they happen quite frequently.

 

Your QuickBooks balance, assuming you are on top of your data entry duties, is a more accurate picture of your bank balance alone as it takes into account the floating checks and already subtracts that cash from the bank account balance. It also accounts for deposits in transit (deposits that have not yet hit the bank statement).  Timing differences won’t exist however, if your checks and deposits clear within the final days of the month.

 

The goal of a reconciliation is not to find the discrepancy between your accounting software balance and your bank balance because of timing differences.  These are normal discrepancies.  The goal is see if this discrepancy is a result of error from the accounting system or error from the bank (Yes-sometimes the banks screw up too!)

 

Think of it as a way to verify that your cash from your company books is consistent with your bank statement records.  Since the ability to acquire and obtain cash is the beating heart to any business, small or large, the cash account, or multiple cash accounts deserve specific attention.  The phrase “Cash is King” has been merited all these years with great reason.

 

The Bank Statement Formula

Consistent with any bank statement is the formula used to determine how we get to the ending balance from the beginning balance.  The formula is stated below:

= Beginning Balance
+ Deposits and other Credits
–  Withdrawals and other Debits
–  Checks
–  Service charges
= Ending Balance

This is the formula that is being used to determine the reconciliation difference.

 

Reasons to do bank reconciliations

  1. Internal control – tracking the inflows and outflows of cash is crucial in determining if someone with check writing authority is abusing their power.
  2. Determining if there are missing transactions—the bank reconciliation helps determine that all of your cash transactions are in your accounting system.
  3. To see if companies are taking advantage of you—Sometimes humans make mistakes and might run your card twice on accident but sometimes it’s no accident.
  4. Discovering bank errors or accounting software data entry errors
  5. To give a true accurate depiction of the money in your bank account.  For example, take a property management company.  They may manage properties in Florida, California, Missouri, and Illinois.  With hundreds of checks being written and mailed, it is absolutely crucial to know what checks are still outstanding because these vendors can deposit the check at any time.  Some vendors take months to deposit checks (I’ve seen it before and I’ll see it again.)

So there you have it.  Now that you know why you should do a bank reconciliation, read my next post about how to do a bank reconciliation.

Does This Make My Files Look Fat (Part 2)?

Photo by xeeliz at Flickr.com

What Documentation Do I Need To Support My Tax Return?

 

I recently got an e—mail from my friend Steve who was concerned that he was keeping his records for too long.  He was looking to purge some of his files and he also wanted to know if he was overdoing it on his documentation.  Steve owns a small business.   This is part 2 of a series—http://robergtaxsolutions.com/2013/11/does-this-make-my-files-look-fat/.

 

In my last post I talked about the IRS rules for record keeping.  The problem I find with the IRS post is they tell you to keep records for your tax returns, but they don’t tell you what records to keep.  I’m going to go over those here.  Part of my job as an Enrolled Agent is to assist people who are getting audited.  So, based upon my audit experience I think you should keep the records that the IRS will ask for in the event of an audit.

 

Bank Statements—if you own a small business, you should have a separate bank account for the business.  In an audit, the IRS will always ask for copies of the bank statements.

 

Deposit tickets—Granted, your deposits should all be reflected on your bank statement, but they always ask to see those so hang onto them as well.

 

Receipts for expenses— always good to have.

 

Mileage logs—if you claim mileage you should have a log.  Hold onto these—they are like gold.

 

Your QuickBooks or other accounting software records.

 

Now for space purposes—you can have all of these things scanned and saved on disc or on the cloud.  I like to keep the paper around for at least three years, but after that, as long as you can access the scanned documents you should be good.

 

Here’s the funny thing—the better you are at keeping records, the more stuff you can throw away.  Counterintuitive, right?  Let me explain, let’s say you use QuickBooks, and you purchase a few cases of paper and other stuff from your local office supply company.  They deliver the paper and goods and send you a bill.  You write them a check and log into QuickBooks something like Check #1241 to Office Supply Solutions for $162.47 paid on October 31, 2013 from Bank of America checking account and expensed as office supplies.  It’s all right there in your QuickBooks transaction.

 

Now, for the three years, I would still hang on to the Office Supply Solutions receipt, I’d keep my bank statement, and my checking account register.  But after five years, I’d let those receipts find their way to the shredder.  (Yes, the IRS says three, but I’m paranoid.)

 

If your records are good, you don’t need to hang on to stuff for as long because you documented everything and it will tie to your bank statement.  Three years from now when you’re getting audited, you’ll have no clue what check number 1241 was for—you don’t have to, it’s in your QuickBooks.

 

But if your records are bad—that’s when you really need them.  Let me explain—

 

Let’s say I don’t use accounting software, I don’t maintain a separate bank account for my business, and I don’t keep a ledger of my expenses.  One day the IRS decides that I’ve over claimed my expenses (meaning that my income is actually higher.)  Remember my last post?  If the IRS believes that you underreported your income by 25% or more, the statute of limitations on an audit is 6 years instead of three.  (If they think it’s fraud, it’s open season on your forever.)

 

Well, the person with good records still has his QuickBooks account and matching bank statements.  Everything ties.  Easy audit—in, out and outta there.

 

The person with the bad records is going to have to dig and find that office supply receipt, find cancelled checks (who still get cancelled checks anyway?) or somehow prove the expense.  Can you pick up a random bank statement from three years ago and look at a check number without copies of the cancelled checks and tell what that check was written for?  Even if you can, the IRS auditor isn’t going to believe you without a receipt to back it up.

 

So keep good records now, so you can thin out your files later.

Does This Make My Files Look Fat?

Photo by Julep67 at Flickr.com

Can You Have Too Much Documentation?

 

I recently got an e-mail from my friend Steve who was concerned that he was keeping his records for too long.  He was looking to purge some of his files and he also wanted to know if he was overdoing it on his documentation.  Steve owns a small business.

 

Personally, as an accountant, when Steve told me about his recordkeeping–I was just so excited!  He kept such good books.  But at what point do you not need all those records?

 

I’m posting what the IRS says on its official website in red.  My comments are in black.

 

Note: Keep copies of your filed tax returns. They help in preparing future tax returns and making computations if you file an amended return.   I would also add that you should keep the official tax documents that go with the return, especially things like 1099s and W2s if you are an employee.  Keep anything that shows a tax payment.

 

According to the IRS, your need to hang onto records depends upon your situation.  The situations are as follows:

 

You owe additional tax and situations (2), (3), and (4), below, do not apply to you; keep records for 3 years.  What they mean is that if you don’t have any tax problems, you only need to hold on to your tax returns for three years.  That’s how long the IRS has to go after you for a simple mistake like leaving an interest statement off your return.   So here’s my issue with this–what if you don’t know you have a tax problem?  Like what comes next—

 

You do not report income that you should report, and it is more than 25% of the gross income shown on your return; keep records for 6 years.   Bingo!  This is why I don’t approve of tossing documents after only three years.  Here’s a good example–let’s say you’re a senior citizen with some social security, a pension, and some stocks.  You sell $10,000 worth of your mutual fund for your living expenses but you had a loss so you don’t think to even put it on your tax return.  (That’s a very common mistake.)  So even though the missing item on your tax return was a loss, to the IRS, its $10,000 and hit’s the over 25% mark.

 

You file a fraudulent return; keep records indefinitely.   Okay, so if you’re filing fraudulent returns, keep your records forever.  Ahem…people who intentionally file fraudulent returns–well that’s just not my specialty.  But normal people who screw up their returns–that is.  The IRS has a hard time telling the difference between criminals and good people who do stupid things.

 

You do not file a return; keep records indefinitely.  Okay, I say file a tax return every year whether you are required to or not.  It helps protect you from identity theft and it protects you from the IRS coming after you to taxes later because you missed a document.

 

You file a claim for credit or refund* after you file your return; keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later.  That means if you filed an amended return to get back more money, hold on to your records for even longer.

 

You file a claim for a loss from worthless securities or bad debt deduction; keep records for 7 years.   That makes sense.

 

Keep all employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.  The IRS is very touchy about employment taxes.  These are really important.

 

Of course, records relating to assets that you own should be kept for at least as long as the asset is in the business.  For example:  You buy a computer and you’re depreciating it for 5 years.  You must keep the receipt for that for the whole five years.  You buy a business building–you hang onto that document for the whole 39 years or until you sell the building.

 

So here’s my “Jan Rule” on keeping tax records.  If you own a small business, keep your actual tax returns and back up for at least 10 years.  In my next post, we’ll talk about what back up you’re going to want to keep.

IRS Letters – the CP 2000: Common Errors and How to Fix Them

Photo by 401(K) 2012 at Flickr.com

 

Have you gotten a letter from the IRS that says something like this?

 

“The income and payment information we have on file from sources such as employers or financial institutions doesn’t match the information you reported on your tax return.  If our information is correct, you will owe…”


That letter is called a CP2000—it’s from the Individual Automated Under Reporter Unit of the IRS.   In 2012, they issued 4.5 million notices with an average of $1,572 in additional taxes owed.  That’s over $7 billion dollars!

 

Just because you receive one of these CP2000 letters, doesn’t necessarily mean that you owe the IRS any money.  So before you go writing the IRS a check, you need to take a look at your tax return and the CP2000 letter very carefully to make sure you owe before you pay.  Let’s take a look at some of the most common things the IRS is asking about.

 

Missing W2:  You’d be surprised how many people forget a W2 off of their tax return.  It’s easier than you’d think.   You could have a Christmas season sales job at Macy’s in 2011 but get a pay check for one day in January 2012.   When you file that 2012 tax return in 2013, you’ve forgotten about that one paycheck.  If you moved during the year, you might never get your W2.  If you forgot a W2 on your tax return, usually it’s just best to sign the letter and pay the tax.

 

Missing stock trades:  This is probably the most common type of CP2000 letter that I see and they fall into two categories.  The first is employee stock options.  If you work for a company that issues employee stock options, when you exercise those options, you pay the tax through your payroll withholding.   Even though the stock options are accounted for in your paycheck, you still have to do additional paperwork on your taxes. If you don’t also report the employee stock options on a Schedule D, you’ll get an IRS notice.  Usually, if this is what happened, you won’t owe any additional tax, you just need to submit the missing paperwork.

 

The other category of missing stock options consists of trades that just weren’t reported.   Many people who made the election to receive their brokerage notices online didn’t realize that their 1099B notices were online also.  I think that’s one of the most common reasons I’ve heard for people not reporting their trades.  If you fall into this category, remember that the IRS doesn’t always include stock basis when they figure your tax.   If you have stock trades on your CP2000, you’ll need to prepare an amended return and be sure to include the basis of all our stock trades.  You may still owe the IRS money, but I’ve never seen one of these cases where the person owed the IRS the full amount that the IRS stated.

 

Mismatched documents:  This happens all the time.  For example, let’s say that you have three accounts at Bank of America.  One earned $10 interest, another earned $15, and the other earned $20 of interest.  You put $45 of interest down on your tax return.  And that’s right.  But the IRS may get the documents as 10; 15; and 20 and since it’s a computer and not a human that does the matching, you could get a notice saying you didn’t report your interest properly.  You can usually solve issues like that with a simple phone call.

 

These are just a few of the more common and easy ways to solve CP2000 issues.  If you receive a CP2000 letter and it doesn’t make any sense, or you just need some help, please call us.  That’s what we do.

 

Check out the IRS link as well: http://www.irs.gov/Individuals/Understanding-Your-CP2000-Notice

Tax Refund for Christmas 2013

82/365 - my christmas eve buddy.

Photo by B Rosen at Flickr.com

 

If you normally use your income tax refund to pay for your Christmas presents, listen up.  You’ve got a problem.

 

First, nobody is doing Christmas loans.  Remember when H&R Block and Jackson Hewitt used to provide loans against your refund?  Then the IRS changed the “debt indicator” which made it almost impossible for anyone to offer those loans.  A few companies provided Refund Anticipation Loans, (the loans where you got your refund in 1 or 2 days instead of two weeks) but they were few and far between.  Most people had to wait for two to three weeks to get their refund.

 

Now the IRS has announced that tax filing will be delayed—meaning that instead of accepting tax returns on January 21st like they had previously announced—they won’t accept returns until January 28th, and maybe not until February 4th.

 

What does this have to do with Christmas?  Well, if you’re putting holiday gifts on your credit card in the hopes of paying it off with your tax refund—you’re not getting your refund until mid to late February at the earliest.  If you can’t afford to pay your credit cards without your tax refund—you’ve got a problem.

 

So what other options do you have?   For some people, if you know that you’re going to have a refund on your taxes, you can change your withholding now so that you get more money in your paycheck.  If you’re reading this in October or early November, you’ve got a chance to put away some extra cash for presents.  If it’s already December by the time you see this—it’s probably too late.

 

Here’s something else you need to know.  If you have your taxes done by one of those corner shop tax companies, they will gladly take your money and tell you that they’re filing your return.  You might think that you’re filing on January 3 or 4th, but you’re not.  What they’re doing is “stockpiling” your return.  They hit a button, it gets sent to a big corporate server, but it just sits there until the IRS says they’re accepting returns.

 

Why is that important to know?  Because people think that they need to file early to get their refunds.  But those early returns are often wrong.  They’re missing information, or the software’s not fully functional yet.  The IRS needs time to work out the glitches and if the IRS is having glitches, so are all the other tax companies.  If you have the big green tax company send your tax return to their server and then you discover a problem with it, you can’t take your tax return back.   It’s too late.  And if your tax return is sent in with a mistake it could delay your refund for weeks, or even months.

 

There aren’t a lot of options out there for using your upcoming tax refund to pay for this year’s holiday gifts.  But you know what?  Christmas comes every year.  Every year!  Once you do receive your refund, it might be the only time in the whole year that you’ve got extra cash.  Take some of your refund money and stick it in the bank so you’ve got cash to pay for your 2014 Christmas.    Seriously, you never want to be dependent upon the IRS for you to have a Merry Christmas.