Why Bank Reconciliations are Absolutely Necessary for Your Small Business

November 26, 2013 by Michael Siebert · 1 Comment
Filed under: Bookkeeping 

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.

Understanding Your Small Business Balance Sheet

September 17, 2013 by Jan Roberg · 2 Comments
Filed under: Accounting 

(Balance Sheets for Dummies)

 

Snowy Playground

Photo by elycefeliz at Flickr.com

 

I learned how to do balance sheets from an ex-Israeli special ops soldier turned CPA.  (Go ahead, take a minute and morph Judd Hirsch and Arnold Schwartzenegger, it’s more fun than math.)  Although my balance sheet training was a little “intense,” this is just a brief overview to help you understand your balance sheet.

 

The basic accounting equation (there I go with the math, don’t get scared off yet)  for a balance sheet is:

 

Assets = Liabilities + Owner’s Equity

 

Assets are the good things like cash and equipment.  A more politically correct accounting definition is “Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.”

 

Liabilities are the stuff you owe like credit card bills and loans.  You could also say liabilities are “probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.

 

Owner’s Equity is what’s left over (assets minus the liabilities).  On your tax return, owner’s equity is referred to as “Retained Earnings.”  Another technical definition is “the residual interest in the assets of any entity that remains after deducting liabilities.

 

So let’s take a simple balance sheet.  A small business runs on a cash basis.  It has no equipment and no debt.  There’s $2,000 in the bank account.

Assets                   =             $2,000 cash in the bank

Liabilities              =             $0

Owner’s Equity                 =             $2,000

 

In this simple example, as cash comes into the company, the owner’s equity goes up.  As cash goes out, the owner’s equity goes down.

 

Here’s the important part: When the owner takes the money out of his company for his own use (which he does because it’s his money) the owner equity in the business goes down because he took the cash out of the company.

 

For example:  Sarah and Peggy have a Partnership.  They started the year with $2,000 in their checking account.  After expenses, they netted $100,000.  Now if they kept all of that money in the company, their balance sheet balances would read:

Cash:                     $102,000

Owners Equity:                 $102,000

 

But Peggy and Sarah like to eat and pay their rent so they each took $45,000 out of the company (that’s $90,000 altogether) so at the end of the year, the balance sheet balances would have looked like this:

Cash:                     $12,000

Owner’s Equity:                $12,000

 

This is important to know because many software programs will just plug a number into owners equity to make it tie out.  Sometimes the plug goes into cash.  If Sarah and Peggy didn’t check their balance sheet, in a few years it could look like they have half a million dollars of equity sitting in their company that’s just not there.   I’m not joking about that.

 

I once had to amend ten years worth of tax returns for a business owner trying to sell his company.  His balance sheet had $2 million dollars worth of equity but the figure should have been closer to $200,000.  For ten years his tax preparer had let the program “adjust” his balance sheet.  The taxpayer didn’t know any better (and clearly that preparer didn’t either.)  Sadly, the owner had quite a bit of a “smack down” when he tried selling his $2 million dollar company that was really only worth $200,000.

 

That’s why it’s so important to be able to read your balance sheet.  If you own a business, you need to know what’s on there and why it’s there.

 

My next post will add some common balance sheet items so you can see a more complete picture.   The bottom line is—your balance sheet should tell you what your company is worth.  If the “owners’ equity” doesn’t jive with what you think your company is worth—then it’s time to start asking questions.

Top 5 Reasons Your Tiny Business May Not Be Doing As Well As It Could Be

August 20, 2013 by Jan Roberg · 2 Comments
Filed under: Small Business 
Throwing Money Away

Photo by Tax Credits at Flickr.com

 

The government defines small businesses as companies making less than $7 million a year or having fewer than 500 employees.  The companies I work with generally have three or fewer employees and only dream about seven million dollar revenues.  I call these “tiny” businesses.

 

As tiny businesses, we’re generally ignored by the government.  When you hear something in the news about Congress passing legislation to “help” small business owners—they don’t mean us.  That’s okay with me.  We tiny businesses can get into enough trouble all by ourselves.  Here are my top 5 picks for tiny business problems.

 

1.  Not working around Roadblocks.   Every tiny business has roadblocks; you need a license, or special training or there’s a law change.  No matter what type of business you have, there will be roadblocks.   The successful tiny business finds a way to work through or around them.

 

True story:  There was a small business owner who was basically ready with her business; the only thing left was to get her web-site up.   She had asked me for some help.   Mind you, the only thing stopping her business from getting off the ground (at least as she explained it to me) was her website.  I gave her names of people who could make her website for a fee and  I also gave her free website resources as budget was an issue for her.

 

Six months later we met again.  She still didn’t have a website.  The work was stalled because she couldn’t find the “right” art for it.  She wanted a picture of a compass.   She had hired a high school kid to draw it for her for free.  He wasn’t done yet.  Okay—go to Google images, type in compass and you get hundreds of pictures.  Granted, she’d probably have to pay to use one of those pictures but her “free artist” hadn’t gotten the work done in six months.

 

And letting a high school kid that you’re not even paying be the reason your business hasn’t gotten off the ground?  That’s ridiculous.  Now in fairness, the compass idea was a cool idea and it tied to her business theme.  But—it wasn’t necessary to her business.  She could have already been up and running for 6 months while waiting for this art that she wanted so badly.

 

Sometimes, we’re our own worst enemies.  If you’ve got a roadblock that’s holding your business back get a second opinion.  There’s usually more than one way to skin a cat.

 

2.  Not knowing who your customers are. If you own a business you’re selling something.   The tough question is who’s going to buy it?

 

I once knew a woman who had started a business making bows.  She had made hundreds of bows, invested in a bow making machine and lots of expensive ribbons.  She hadn’t sold a single one.  She really liked making bows so that was what she was doing with her time, but she hadn’t figured out who would buy them.  At that point, that wasn’t really a business it was just a hobby. You have to have customers, someone willing to pay for what you’re selling to be a real business.

 

3.  Partner problems.  Recently I was asked, “Why do you hate partnerships?”  It was a fair question, I was being pretty negative.  The truth is, I don’t hate partnerships, I’ve just had to dissolve too many of them.  Partnerships get started because two or more friends decide they want to go into business together.  Good friends (or spouses) do not always make good business partners.  If there is a disagreement—how do you settle it?

 

I recently sat down with a couple that had a pretty good business plan and they seemed to be a good choice for a partnership.  But I was asking a lot of questions and I’m glad I did.  It seemed that Adam and Eve each had two income streams that they were thinking about for the partnership—sales of widgets and sales of thingamajigs.  Adam was going to cut back on his widget sales to pursue the thingamajig sales full time in the partnership.  Eve couldn’t sell thingamajigs she was just going to help Adam with that and in the meantime she would still sell widgets.  It all sounded like a good plan.

 

Except:  Widget sales was technically another job.  The money Eve earned selling widgets was outside the partnership—just as Adam’s widget sales were outside the partnership.  Adam was counting on Eve’s widget income to help support him because he knew that the thingamajig income wouldn’t be enough to support him during the first year.  Eve was hoping the thingamajig income would supplement her widget income; she wasn’t planning on turning over half of her widget income to Adam.

 

The bright side to this scenario is that they were thinking and talking before they made the partnership.  They hit a roadblock, yes, but they’re smart and will work around it somehow.  Too often I see partners who went into business together and later wind up fighting because they didn’t spell out their expectations up front.

 

4.  You gotta work at your business—I can’t tell you how many times people have come to me because they bought a business or invested in a business that required no work—and they lost their money.  If it sounds too good to be true, it probably is.  And if you’re picking a business, do something you love to do—because you’re going to be at it a lot.

 

5.  Not planning for your taxes—This wouldn’t really be a tax blog if I didn’t mention taxes now would it?  The whole idea about owning a business is that you want to be profitable.  If you’re making a profit, then there are going to be taxes.  If your small business is making enough money to support you and your family then you know you’ve got self-employment taxes to pay.

 

Screwing up one year—that happens.  Screwing up two years—you need to be more careful.  But if you screw up and don’t make your estimated tax payments after you’ve been profitable and owed tax money for three years in a row—you’re asking for trouble.  Our business cards say, “If you don’t have a strategy for your taxes, you’re probably paying too much.”  Taxes take a huge chunk out of your earnings.  Don’t let IRS penalties and interest make matters worse.

Small Business Owners: Are You Claiming Too Many Deductions?

November 13, 2012 by Jan Roberg · Leave a Comment
Filed under: Small Business 

Photo by Herkie at Flickr.com

The short answer:  probably not!

 

This is a sentence I hear at my tax desk every year, “I bought this for my business or I did that for my business but I’m not going to claim it because I have too many deductions!”   Seriously?  No you don’t.

 

I guess I should back track a little on this—if you’re claiming stuff you shouldn’t be claiming—that’s another story.  But if you own a business and you have a legitimate business expense—then claim it.

 

Often times, small businesses, especially in the beginning, have losses.  On your tax return it’s called a net operating loss or NOL.  If you have an NOL, you carry that back two years and use it to offset income that you had two years ago.  If you still have a loss, you can carry it forward for another 20 years!

 

Now sometimes you have an expense that gets limited if your business doesn’t have enough income—like a section 179 deduction or a home office expense.  That doesn’t mean that you can’t claim these things, they just get carried forward to be used to offset your future income.

 

Don’t skip your deductions!  I can’t stress this enough.  Often, at the “big box” stores, they’ll skip your home office deduction because they’re “saving you money by not claiming it” since they charge you for each form.  But it’s like that old expression, “pennywise and pound foolish.”  Sure, you save a few bucks by not filing the 8829 form, but you just lost the carry-forward of a few hundred dollar deduction.  This is especially important this year with taxes most likely going up next year.  Even if your deductions won’t help your tax return right now—do not just leave them off.  Otherwise, you would have to amend your prior returns to carryforward the deductions which will cost even more money in the end!

 

It’s still November, you have plenty of time to round up your receipts, review your mileage log, and make sure that you’re doing everything you need to be doing to maximize all of your deductions.  Obviously you can’t claim stuff that’s not a real business expense.  But you can claim everything that is a legitimate expense for your business.  Not only can you claim it—it’s the right thing to do.

________________________________________________________________________

For those of you who do not have a home office, these posts will help get you started:
http://robergtaxsolutions.com/tag/home-office-deduction/
http://robergtaxsolutions.com/2011/07/how-to-boost-your-home-office-deduction/

Small Business: Proving You Have Income Without a 1099-MISC

For some small businesses, a simple wire bound receipt book is the key to substantiating your income.

Now some people may be wondering, “Why would I want to prove I have more income than I have to?”   But for many small business owners, that’s exactly the problem—you have income, you want to report it to the IRS, and you’re having a hard time proving it.  This post is for you.

The number two reason for reporting your non-1099 income  (number one of course being basic honesty) is qualifying for the Earned Income Tax Credit.  2011 sort of hit small business owners who normally qualify for EIC with a one-two punch.  We had the new 1099 reporting requirements that upped the ante for so many businesses, and we had the new EIC tax preparer due diligence rules with one of the questions being “Do you have forms 1099-MISC to support the income?” With the next  question being, “If not, is it reasonable that the business type would not receive Form 1099-MISC?”  Here’s a clue:  if you answered NO to the first one, you have to answer YES to the second.

So what types of businesses wouldn’t normally receive a 1099?  Bunches of them!  Face it, if you’re reading this—I’m guessing that your business doesn’t receive 1099s.  Generally, it’s reasonable to expect that anybody who works for other people, as opposed to other businesses, would not receive a 1099.  House cleaners, dog walkers, handymen, lawn mowing services, daycare  providers, interior decorators, and even income tax preparers are all types of business that could easily never see a 1099.   (Yeah, me too!  Although I’m now getting 1099k forms because I take credit cards, I don’t get 1099-MISC for preparing personal tax returns.  Maybe I’ll see some 1099-MISC forms from some of my business clients this year, but I never used to get them in the past.)

So, how does a small time personal service provider prove his or her income to the IRS?  There are a couple of things you can do.  I’m going to start with my favorite:  the business bank account.  This is what I do and several of my clients do it too.   (Okay, because I’m their accountant and this is what I tell them to do.)   Get an Employer Identification Number (EIN) for your business and set up a separate bank account for your business in your business name.  Only business income goes in, only business expenses go out.  You may have to put some of your own money in for a start up, and once you’re making money you’ll take out a draw, but you’ll label those as such.  Other than those two items, your business checking account is pretty much your profit and loss statement as well.  Now for a bigger company that would be over simplifying things, but for us little folks–I’m spot on.  See this post for more information about getting an EIN number:  Free EIN

Why does this make good proof?  Because you’ve got a monthly record of your income and expenses.  I also have deposit slips to back it up:  Mary Jones paid me $200, Fred Smith paid $250.   It’s a good solid audit trail.  Here’s another post about bookkeeping and your business bank account:  Banking and Bookkeeping

But what if you don’t have a separate account?   Maybe your business is just too small to bother with the expense of an extra account.  What if you’ve just got something really simple like watching the little neighbor kid for a couple of hours after school every day.  There’s no contract, no business cards, no advertising.   You get $100 a week from your neighbor friend.  She pays you in cash—it never sees the inside of a bank because that’s your grocery money.   It’s not much but it supplements your child support.  How do you prove that kind of income?

The easiest way to prove your income if you provided child care is to have the person you provided it for claim your services on their tax return.  You make them a daycare receipt, just like the ones regular day cares do showing the name of the child, how much they paid you and your EIN number.  (You can use your social security number but I never recommend that.  You can get an EIN number for free.  Protect yourself.)  This is doubly good because the IRS will get confirmation of your income from an outside source.  You prove income, your customer gets a tax deduction, it’s a win/win situation.
But what if your business isn’t day care?  What if you did something like mow lawns around the neighborhood and shoveled snow in the winter?  Nobody’s going to be claiming you on their tax return, what can you do?  In your case, I like receipt books.  You can find different kinds at Office Max or any office supply store.  I like the ones with a carbon copy—one for you, one for your customer.

Now if you have just one customer and you’re always going to the same place—you can just use the little one that just has a couple of lines and the amount on it.  You might write, “Mowing, Mr. Jones, $30, 5/15/2012” on it.  You know what you did, who you did it for, how much you got paid, and when.  If you have multiple customers you’ll want the larger receipt books that include the address and phone number of the customer.  If you do different types of jobs for different people, you might need the bigger ones so you can write down the type of work that you did for them as well.

You don’t have to have a 1099-MISC to prove your income to the IRS.  You just need to have a system in place to document your income and you’ll be fine.

Tiny Business Owners: When You Don’t Want to Reduce Your Income for Tax Purposes

December 13, 2011 by Jan Roberg · Leave a Comment
Filed under: Small Business 
Small restaurant in Forks

Photo by Derrick Coetzee on flickr.com

I know what you’re thinking: “Come again? You must be out of your head! Don’t I always want to reduce my income for tax purposes?” Sometimes, the answer is no. Actually, I got the idea for this post from Howard, one of my readers with an accounting background and an owner of a struggling restaurant.

I’m walking on a tight rope here so I want to make sure that I explain this carefully. Under tax law, a small business owner is required to report all of his income and expenses accurately. I’m always telling people “don’t make stuff up” – that’s my rule and I stand by it. That said, there’s some leeway, like prepaying expenses at the end of the year to reduce your business income and stuff like that.

Where I’m going with this is there are some people who don’t want to reduce their business income for the tax year. One category is people who are applying for a home loan—you want your net income to be as high as possible, even if you’re paying self-employment taxes because the bank will be looking at your net income. The other category of folks who might not want to reduce their business income is people who may qualify for an Earned Income Credit (EIC).

Since leaving the big box tax company, I haven’t filed a lot of EIC returns; most of my clients are small businesses owners and have incomes that are too high to qualify. But last year, I had 5 EIC returns for people who had never even heard of EIC before, basically small businesses that had hit a rough spot with this economy. (I do lots of returns for people who don’t own businesses too. But I’m on a business roll right now.)

So here’s the thing: as a small business owner, you’re taxed 13.3% for your self-employment tax for 2011. If you make a net profit of $10,000 your self-employment tax is about $1,330. (Not exactly, it’s a funky equation, but that’s pretty close.) If you’re single with no children, the Earned Income Credit would be about $278, so it would make sense for you to lower your net income if you can so that you reduced the self-employment tax. But, let’s say you’re filing as head of household with 2 children – in that case your Earned Income Credit would be around $4,010 so reducing your net might not be such a good idea.

Bottom line: the tax strategies for a business owner who is a parent may be different than the strategies of a business owner with no children.

The IRS website has an Earned Income Tax Credit Calculator to help you determine how much of an Earned Income Credit you can receive if you qualify for one. Here’s the website: http://apps.irs.gov/app/eitc2010/SetLanguage.do?lang=en.

Remember, that’s just the EIC and it is an estimate. Remember that for your-self employment income, there’s also self-employment tax – the quick and dirty calculation for that is 13.3%. It will help you figure out where you stand with the EIC compared to self-employment taxes.

If you’re married and your spouse has income, that income will be included in the overall calculations, so EIC may not be a factor for you.

There are so many things to think about when you own your own business. It’s a good idea to get some professional help at least once every three years to make sure you’re on track and getting every deduction and tax credit you deserve. If you have made mistakes in the past, a professional can amend your prior year returns and get you refunds for what you’ve missed as long as you’re within that three year time limit.

Year End Tax Tips for Tiny Business Owners

December 6, 2011 by Jan Roberg · Leave a Comment
Filed under: Small Business 

Countdown clock Updated for 2013!

Tiny business owners, you know who you are: you’re a single member LLC or sole proprietor, or maybe you’re in business with your spouse. You might even have an employee or two, but that’s about it. When Congress passes laws to help “small business” they don’t mean us. This post is for you. If you are a Sub-chapter S corporation, I’ve got tips here:  http://robergtaxsolutions.com/2011/12/2011-year-end-tax-tips-for-your-single-owner-sub-chapter-s-corporation/

Number 1: If you’re going to be in the red for this year, you don’t really need to worry about reducing your business tax, right? Your negative business income will help offset your other income (if you’re lucky enough to have some). You can devote your energy to being profitable next year.

Number 2: If your business is in the black, congratulations! You’re going to want to look at cash flow and make sure you’re got enough cash to pay your upcoming expenses (like payroll and payroll tax if you’ve got it), but let’s look at some ways to reduce your excess income before the year is out.

Hire your kids: If you’ve got kids under the age of 18, you can hire then without having to pay FICA.  It used to be if you had an LLC, you paid FICA for your kids but that changed in 2011 so even if you have an LLC, you don’t pay FICA on your children’s wages.     There are rules that have to be followed, but if you could use a little help at work this time of year you’d at least be keeping the money in the family. For more information check this: http://robergtaxsolutions.com/2010/12/last-minute-tax-tip-hire-your-kids/

Pre-pay business expenses: Most tiny business owners use something called “cash basis accounting”, basically, you’re taxed on what comes in versus what goes out. If you are cash heavy, you can pre-pay some of your business expenses for up to twelve months. For example: I lease my office space, I’ve got a one year contract so I know that I’m going to have that monthly expense for the rest of the year. If I were cash heavy (in my dreams) I could prepay my rent for the entire 2012 year and write it off on my 2011 taxes. But you see how you can play with that? While I won’t be paying a full year of rent in advance, I did pay a few January bills early.

Delay invoices: Remember, this only works if you’re cash flush. Let’s say you did a job and a client owes you $1000 and you normally would send out the bill with a due date of December 30th. Change to due date to January 15th—you’re pushing that income ahead to next year. Besides, your client might just appreciate the break at Christmastime. I set up a billing schedule for a client that didn’t start until January and I used “I thought you could use a little Christmas break.” She was thrilled and I delayed the income—talk about a perfect win/win situation.

Credit card purchases:     According to IRS rules, if you buy something with a credit card, you’ve bought it now. So, let’s say you’re a little cash poor right now but you’ll have the revenues next month to cover your expenses. Pay expenses with your credit card and it will count as having been paid when charged.  I always like to be cautious about credit card spending–hate those bills, but it’s a good solution for some businesses.

This one I don’t like to say, but buy equipment: If you need it. I almost hate to list this as advice because it’s the standard that everybody says every year. One of my clients fired his old accountant for saying it. Like he said, “I know what I do need and don’t need to run my business and I don’t need any more equipment. What other ideas you got?” In this same category is the buy a new SUV that weighs over 6,000 pounds so you can use 100% bonus depreciation to write off the whole thing. Here’s my advice, “Don’t buy crap you don’t need.” If you do need equipment, and you’re profit heavy, it’s better to buy in December than in January. But buy what makes sense for the business.

Get your retirement plan in place: If you’re just investing in an IRA, you don’t need to worry about that yet, you’ve got until April. If you’ve been wanting to set up a SEP or a 401(k), you need to get that done by December 31st. Contact your financial advisor about setting up your retirement plan.

Last, because this isn’t really business: charitable contributions. If you’re a sole proprietor, your charitable contributions do not count as business expenses. So if you give money to the Salvation Army, that’s a personal deduction, not a business deduction. Every year, I see a lot of people trying to claim their charitable contributions as business expenses and it won’t fly with the IRS. Even if you pay a charity from your business bank account, it’s not allowed as a business expense. Charitable contributions won’t help reduce your self-employment taxes. Please give to charities and give generously, but know that it’s a personal deduction, not a business one.

Estimated Taxes for Small Businesses

September 6, 2011 by Jan Roberg · Leave a Comment
Filed under: Small Business 
Income Tax

Photo by Shayne Kaye on Flickr.com

I’ve gotten this question twice in the past week so I thought I’d post it on my blog:

I pay my estimated taxes out of my personal account, but really I’m paying estimated taxes for my small business, shouldn’t I take the money out of my business account?

That’s a really good question, and the answer is “It depends.” If you own a C corporation, then the answer is yes. But most of the small businesses I deal with are Sole Proprietors and Sub S Corporations; if you have one of those, the answer is NO!

Here’s why Sole Proprietors and Sub S Corporation Owners should not pay their estimated taxes out of their business accounts: All of the profits from these kinds of companies are taxable to the individual that owns them. The companies themselves pay no tax, the individual owner does. Because the owner, not the company, owes the tax, the owner must pay from his personal account.

Let’s do an example: Daisy Duke owns Daisy’s Delightful Doggie Daycare (D4). It’s basically a pet-sitting business she runs out of her home. Daisy’s pretty savvy about accounting, so she maintains a separate bank account for her business and she claims every legal deduction she’s entitled to. She runs all of her business expenses through her business account.

For the quarter, Daisy has $10,000 of income and $6,000 of business expenses. She wants to make an estimated payment on the remaining $4,000 of income. Daisy determined that she spends 40% of her net income on federal taxes so she’s going to send $1600 to the IRS. This check is not written on the D4 checking account, but instead on Daisy’s personal account.

Note that Daisy runs all of the business expenses through the business account, but because the taxes are not considered to be a business expense, they can’t go in there. If Daisy were to take her kids to Chuck E. Cheese’s for pizza, she would not pay for that out of her D4 account either. Now it’s sounds crazy equating estimated tax payments with Chuck E. Cheese’s Pizza but to the IRS’s eyes, they’re the same thing—a personal expense.

So here’s the next question that people always ask: What if Daisy doesn’t have enough money in her personal checking account to pay the taxes? That’s another good question. Remember, though, that the reason Daisy has to pay estimated taxes is because she’s making a profit. She’s got that $4,000 of profit sitting in her business bank account. She can make a payment to herself because she owns the company. She’s paying herself a draw (or maybe with an S Corp a salary), but when you own the business and you have a separate business account, you are allowed to pay yourself from the account.

Next question: But isn’t it a waste of time? Aren’t you writing two checks-one to Daisy and then one to the IRS, when writing one check directly to the IRS would solve the problem? No, it’s not a waste of time because it’s worth the extra five minutes to keep your books straight.

If you keep your business books strictly for business, with no personal expenses running through there at all, the IRS is going to think you’re pretty boring and not worth wasting much time on trying to audit you. This is one of those times where boring is good! Remember, paying your estimated taxes out of your business account is seen to be the same as taking your kids to Chuck E. Cheese’s Pizza. It’s a cheesy expense! (Sorry, that pun flew out of the keyboard, I couldn’t stop it.)

Many small business owners get into tax trouble because they wind up using their business accounts for personal spending. While your estimated tax payment seems like it would be a business expense, it’s not and you have to keep it separate.

See also: http://robergtaxsolutions.com/2011/04/how-do-i-keep-from-owing-so-much-tax-next-year-estimated-tax-payments/

ATMs and the IRS: Why Your Business Shouldn’t Take Cash Out of the ATM

September 2, 2011 by Jan Roberg · 8 Comments
Filed under: IRS, Small Business 
P4250062.JPG

Photo by Jenny Brown on Flickr.com

You should never take cash out of the ATM using your business bank account. Never.

If you never have and never will take ATM cash out of your business account, you’re done here. Go read a different post, I’m not worried about you. If you still think it’s okay to make a cash ATM withdrawal from your business account, keep reading. Imagine you’re routinely getting whacked upside the head with a rolled up newspaper about every two minutes until you learn this lesson.

Why not use the business account for the ATM?

1. It’s a blazing red flag to the IRS that you’re doing something naughty. Even if everything you do related to your ATM withdrawals is 100% legitimate, to the IRS it says, “I’ve been a scumbag! Make me pay more taxes!” It’s really not a message you want to convey.

2. It’s bad bookkeeping practice. You have income and expenses. You take money in and you spend it. You need to account for how you spend it. An ATM cash withdrawal doesn’t give you the paper trail you need for your expenses. Even if you’re good about keeping those receipts (and believe me, you’d be the exception) you’re still stuck with issue number 1 – blazing red flag to the IRS.

But I own the business and it’s my money, why can’t I just make a withdrawal? Good question. Let’s say you’re just a plain sole proprietor, nothing fancy. You’re absolutely right; that’s your money and you’re entitled to use it as you see fit. If you’re keeping a separate bank account for your business, then you should write a check from your business to you for your “draw”. That’s legit and it gives you a paper trail. Whenever you take money from your ATM, it is considered as going to you and you’ll be taxed as that being your profit.

Here’s an example: Fred takes $200 a month out of his business account to pay some contract laborers. He occasionally hires some kids from the local football team to help him with his moving company. He pays the boys in cash and has never paid any one boy more than $600 so he hasn’t had to issue a 1099 (1099s must be issued if you pay $600 or more.) Fred gets audited by the IRS. He’s claimed $2400 in expenses for contract labor. That’s the $200 a month cash he’s paid to the boys on the football team to help him with some moving projects. What the IRS sees is $2400 in ATM cash paid directly to Fred and they charge him $1200 in taxes and penalties for under-reported income. Fred will have a very difficult time fighting this. It’s possible that he can fight and win, but why be in that position in the first place?

Let’s move it up a notch, what if Fred has an LLC-a limited liability company? Let’s say Fred takes an ATM withdrawal from his business account so he can take his wife out to dinner. Once again, its Fred’s money and he has that right. But now Fred is treating his business account as a personal account. This messes up his “limited liability” status. If you don’t keep a strict line between your business account and your personal account, you risk losing your limited liability protection. This makes it even more important for Fred not to use his business ATM card for cash if he has an LLC.

How’s your head? Been smacked enough times? Bottom line: never make an ATM cash withdrawal from your business bank account. If you want to pay yourself, write yourself a check. If your business needs to use cash, set up a petty cash account and fund it by writing a check for petty cash. A clean paper trail will keep the IRS off your back and that means money in your pocket.

Five Things You Can Do to Reduce Your Self-Employment Taxes

August 2, 2011 by Jan Roberg · 1 Comment
Filed under: Small Business 
My home office (early Dec 2009)

Photo by Phil Brookes on Flickr.com

A fellow business owner told me that he was really surprised last year at tax time. His business had done well and he didn’t have many expenses to offset his income. You want to have income—it’s sort of necessary if you like to do things like eat, wear clothes, and have a roof over your head, but the more income you have, the more you pay in taxes. These tips are things that you might be spending money on anyway that can help reduce your “business income” and reduce your self-employment tax.
Claim a home office. If you are working for yourself, you should have a home office. I actually have two offices: one in an office building where I meet clients, and my home office where I perform administrative duties like paying my company’s bills. If you have more than one office, your home office should be your administrative office—doing so makes your commute to the other office a deductible expense (normally, commuting is not deductible).
If you’re already claiming a home office, make sure that you’re maximizing your deduction. Did you know that hallways, stairways, crawl spaces, and bathrooms don’t count towards your total square footage? And don’t forget to claim the depreciation on your home. I’m always amazed at the number of folks who don’t claim it. If your business has a loss, the deduction carries forward to next year.
Hire your kids. If you have children under the age of 18, you can pay them to work for you and you aren’t required to pay FICA, and you don’t have to pay Federal Unemployment tax on them either. The work has to be real and the wages have to be commensurate to what you’d pay someone who is not your child. They also have to do work for the company, not things like clean up the kitchen for this to count. Have them keep a time sheet so that you have documentation of the work in case the IRS checks on it. For this you must be a sole proprietor, you can’t be an LLC or Sub S corporation.
Hire your spouse and set up a Section 105 Health Plan. Sure you can deduct your health insurance on the front of your tax return, but it doesn’t affect what you pay in self-employment taxes and it only covers your health insurance. With a Section 105 Health Plan, you hire your spouse as an employee and the compensation package includes 100% health coverage for him (or her) and his family (which includes you). This has the effect of putting all of your family’s health care expenses as a deductible business expense. Just like with hiring your kids, your spouse will have to perform a real job for the company, keeping a time sheet, etc. (Must be a sole proprietor, LLC is okay. Cannot be Sub S Corporation.)
Maximize your auto deduction. The majority of people claim auto mileage for their business because it’s easier (I’m talking about claiming real mileage and not the folks who go around claiming 40,000 business miles a year on a car that’s only been driven 12,000. I like to stick with honest deductions). For a lot of folks, it’s worth it to claim your actual expenses, especially now with the price of gas so high. Take the time to really keep track of your actual auto expenses for one year. This will vary a lot depending upon your auto usage, but for some people it’s a big savings.

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