What You Need to Know about Capital Gains

No one likes to pay taxes, especially on an appreciated investment.

With careful planning, you could avoid or minimize capital-gains taxes. Here are three tips.

Hold investments for at least 366 days

How long you keep investments in your portfolio before selling them determines the taxes you pay on your gains. Short-term capital gains are taxed as ordinary income. Long-term capital gains are taxed at rates of 0%, 15%, or 20%, depending on your tax bracket.

Invest in a low-turnover fund

Mutual funds realize capital gains just as individual investors do. Any time your fund sells a security at a gain, that gain is taxable. Since the law requires mutual funds to pass most of their net gains on to investors, you realize a capital gain. This is either long-term or short-term, depending on how long the mutual fund held the securities. You can avoid these types of gains by investing in a low-turnover mutual fund.

Use capital losses to offset capital gains

Do you have a losing investment in your portfolio? You might want to sell it and use the loss to offset gains. For example, if you have $4,000 in capital gains, and you take a $4,000 capital loss, the two will negate each other, and your tax liability on the gains will be eliminated.

Plus, if your investment losses for the year exceed your gains, you can use the balance to offset your ordinary income, up to a $3,000 limit.

Business Expenses: Get Reimbursement Right

If a business owner is the main or only employee of the company, it’s important to implement a judicious policy of expense reimbursement that’s similar to that of major organizations. Solo enterprises are, in fact, the most likely operations to incur business expenses paid with personal funds. This often occurs when the owner uses a personal credit card for company purchases.

The business should treat reimbursed expenses as if it had paid for them directly. The reimbursement is recorded in an expense category of the company’s accounting system that describes the type of expenditure. Creating nebulous categories with such names as “Reimbursements” or “Credit Card Payments” obscures the actual business purpose. Instead, use an expense account that classifies the cost exactly as you would for nonreimbursed, directly paid expenditures.

A sound reimbursement policy ensures that you don’t miss claiming valuable tax deductions, improperly classify business expenses, or suffer cash drains of uncertain origin.

Limit the Episodes

It’s best to limit the occurrences of expense reimbursement. The easiest solution is to have a single credit card devoted entirely to business purchases. Bookkeeping accounts for each credit card charge as it occurs. Since all the charges are company costs, the credit card bill is simply paid by the company. The bill payment is allocated to the credit card liability account on the balance sheet to which the charges were applied.

A credit card provider that supports a business account will issue secondary cards if you have employees. This allows tracking of charges by each worker.

In an era where almost anything may be purchased with a credit card, cash advances are generally unnecessary. Company policy should prohibit cash advances – even to the owner. If you must spend cash for a small item, place the receipt in the business records and collect a reimbursement. This is the same procedure you would utilize with an employee. In these cases, bookkeeping should record the expense in the same category it would have if the expense had been directly paid by the business.

Avoid Complications

Personal expenditures inadvertently charged on a company credit card are not business expenses. An owner may easily make the mistake of charging something like a personal dry-cleaning bill on the company credit card. Account for these charges as owner distributions. With all credit card charges recorded on the books – even these owner distributions – the liability balance in the bookkeeping system will match the eventual credit card bill.

Setting a standard of recording every charge exactly as it will appear on the credit card bill ensures easy reconciliation of the books to the credit card statement. Avoid the temptation to make a bookkeeping entry for a group of charges. This technique is suitable only when reimbursing multiple expenses paid with cash or a credit card not dedicated exclusively to business. A single charge may be divided into multiple expense categories. For instance, meals while traveling for business must be distinguished in the company’s accounting from lodging and transportation. Additionally, personal entertainment during a business trip is not tax-deductible, despite the allowable deduction of travel costs.

What You Need to Know about Capital Gains

No one likes to pay taxes, especially on an appreciated investment.

With careful planning, you could avoid or minimize capital-gains taxes. Here are three tips.

Hold investments for at least 366 days

How long you keep investments in your portfolio before selling them determines the taxes you pay on your gains. Short-term capital gains are taxed as ordinary income. Long-term capital gains are taxed at rates of 0%, 15%, or 20%, depending on your tax bracket.

Invest in a low-turnover fund

Mutual funds realize capital gains just as individual investors do. Any time your fund sells a security at a gain, that gain is taxable. Since the law requires mutual funds to pass most of their net gains on to investors, you realize a capital gain. This is either long-term or short-term, depending on how long the mutual fund held the securities. You can avoid these types of gains by investing in a low-turnover mutual fund.

Use capital losses to offset capital gains

Do you have a losing investment in your portfolio? You might want to sell it and use the loss to offset gains. For example, if you have $4,000 in capital gains, and you take a $4,000 capital loss, the two will negate each other, and your tax liability on the gains will be eliminated.

Plus, if your investment losses for the year exceed your gains, you can use the balance to offset your ordinary income, up to a $3,000 limit.

Business Expenses: Get Reimbursement Right

If a business owner is the main or only employee of the company, it’s important to implement a judicious policy of expense reimbursement that’s similar to that of major organizations. Solo enterprises are, in fact, the most likely operations to incur business expenses paid with personal funds. This often occurs when the owner uses a personal credit card for company purchases.

The business should treat reimbursed expenses as if it had paid for them directly. The reimbursement is recorded in an expense category of the company’s accounting system that describes the type of expenditure. Creating nebulous categories with such names as “Reimbursements” or “Credit Card Payments” obscures the actual business purpose. Instead, use an expense account that classifies the cost exactly as you would for nonreimbursed, directly paid expenditures.

A sound reimbursement policy ensures that you don’t miss claiming valuable tax deductions, improperly classify business expenses, or suffer cash drains of uncertain origin.

Limit the Episodes

It’s best to limit the occurrences of expense reimbursement. The easiest solution is to have a single credit card devoted entirely to business purchases. Bookkeeping accounts for each credit card charge as it occurs. Since all the charges are company costs, the credit card bill is simply paid by the company. The bill payment is allocated to the credit card liability account on the balance sheet to which the charges were applied.

A credit card provider that supports a business account will issue secondary cards if you have employees. This allows tracking of charges by each worker.

In an era where almost anything may be purchased with a credit card, cash advances are generally unnecessary. Company policy should prohibit cash advances – even to the owner. If you must spend cash for a small item, place the receipt in the business records and collect a reimbursement. This is the same procedure you would utilize with an employee. In these cases, bookkeeping should record the expense in the same category it would have if the expense had been directly paid by the business.

Avoid Complications

Personal expenditures inadvertently charged on a company credit card are not business expenses. An owner may easily make the mistake of charging something like a personal dry-cleaning bill on the company credit card. Account for these charges as owner distributions. With all credit card charges recorded on the books – even these owner distributions – the liability balance in the bookkeeping system will match the eventual credit card bill.

Setting a standard of recording every charge exactly as it will appear on the credit card bill ensures easy reconciliation of the books to the credit card statement. Avoid the temptation to make a bookkeeping entry for a group of charges. This technique is suitable only when reimbursing multiple expenses paid with cash or a credit card not dedicated exclusively to business. A single charge may be divided into multiple expense categories. For instance, meals while traveling for business must be distinguished in the company’s accounting from lodging and transportation. Additionally, personal entertainment during a business trip is not tax-deductible, despite the allowable deduction of travel costs.

Automation Requires More – Not Less – Outside Support

Business owners know that to stay on top of conditions impacting their companies, they need to become one with their financial reports. However, this isn’t easy; wringing useful information from financial reports needs to be the result of tireless bookkeeping work.

In the start-up phase, pieced-together data in a spreadsheet may deliver adequate information. But a business owner expecting to thrive over the long haul needs better numbers. Fortunately, there is accounting software to automate the process. Unfortunately, automation is also the bane of small-business owners with limited bookkeeping knowledge.

Why? Because not everything in an automated system is automatic. Individuals lacking experience with double-entry bookkeeping commonly make data entry mistakes. Some events, such as purchases and sales of capital assets, depreciation expense, and borrowing arrangements, pose real problems.

If you enter data yourself, you may make mistakes – which can slow you down or throw you off track. If you expect a family member or college intern to handle the function, well, more of same.

Truth is, there’s no substitute for an expert. Whether you’re a do-it-yourselfer or you opt to hire someone for data entry, you still need professional assistance to check for errors and record complex transactions. Skilled accountants and experienced bookkeeping services deliver crucial value. In return for the cost, you have the security of reliable financial statements to aid in managing your business.

The takeaway: Automating your accounting doesn’t relieve you of the need for outside assistance tailored to your needs and budget. In fact, it may make it even more crucial.

How to Limit Those Nasty Financial Surprises

We all know people who are quick to respond. But thought leaders, entrepreneurs, and mega-successful business owners don’t wait to respond. They’re proactive. And it pays off for them – big time.

Some people are born with a “proactive personality.” But research shows that no matter where you are in your life cycle, you can develop a proactive mind-set. Even if you weren’t born with this trait, you too can improve your chances of success by choosing to look – and act – ahead.

The list below comes from an Inc.com article written by David Van Rooy, Walmart Canada’s vice president of talent and organizational capability. In it, Van Rooy outlines seven tips to help you become more proactive. They are:

  • Focus more on the future. Learn from the past, but look toward the future.
  • Take personal responsibility for your success. Don’t wait for others to lead you.
  • Think big picture. Consider your ultimate goals and determine how to achieve them.
  • Focus on what you can control; let go of the stressors you can’t.
  • Prioritize. Not everything is important. Choose what is and focus on it.
  • Think through scenarios. Anticipate what could happen in your industry and stay ahead of your competitors.
  • Make things happen.

Reactive people respond to events after the fact, and, as we all know, sometimes that just needs to happen. But those who look ahead, anticipate what may happen, and take steps to capitalize on opportunities create their own reality.

What kind of business owner do you want to be? It’s your choice.

Find the Narrative in Your Financial Statements

Reliable financial statements are essential for every business. Small companies included. To fulfill your vision for your company, you need to use, and understand, your financial statements, with the help of your team: your accountant and your bookkeeper.

The narrative: By design, financial statements summarize past events. They’re only relevant to future action when accompanied by explanations. Simply recording transactions and not studying the resulting financial reports accomplishes little. Similarly, don’t let complacency take over when you receive financial information from a professional bookkeeper. Instead, examine and learn from it.

Understanding all the elements in financial statements is often challenging. For instance, a business may have a profit but insufficient cash. The income statement doesn’t indicate cash paid for unsold inventory, loan payments, new equipment, owner distributions, or income tax payments. Therefore, along with the balance sheet and income statement, a cash flow statement is an important component of financial reports.

Cash in the bank is like insurance against uncontrollable events. For any business, shifts in the market can arise suddenly. Be prepared with enough cash to survive events like reduced customer orders or the need to replace equipment.

If you check the financial statements of a large organization, whose securities are listed on a public stock exchange, you’ll find an analysis and discussion by management. Your bookkeeper can give you access to similar types of information on your company; he or she can highlight major trends, identify recent issues, and point out any red flags in your financial statements.

The significance of financial statements comes in knowing what they convey. Wise business owners, with support from their bookkeepers, are always aware of year-to-date sales, profit margins, changes to primary expenses, debt ratios, payroll hours, and the collection of receivables. They recognize when inventory on the balance sheet isn’t worth the stated cost and when receivables should be written off, as well as the tax implications of selling particular capital assets.

Own the numbers: If an accountant issues a compilation of your financial statements, a cover page will accompany this report. Read the language describing the accountant’s responsibilities. The accountant assumes no responsibility for any of the numbers. Rather, the compilation report clearly states that the figures are the responsibility of the company’s management. Even with fully audited financial statements – which are uncommon for almost any small enterprise, because they’re costly and usually unnecessary – an accountant only provides reasonable assurance that the statements are free of material misstatements.

The takeaway is that company management is responsible for the financials. Hence, you must take ownership of the financial data and understand every line on the statements.

Your business tax return: Be aware that the internally prepared financial statements of a small business are commonly adjusted for tax reporting purposes. Tax returns treat assets differently, don’t allow deduction of some expenses, and distinguish certain incoming cash from ordinary sales income. Ask your accountant to explain how your tax return reconciles to your financial statements. Your financial team members are available to explain the complexities. So use them!

The Easy Way to Monitor Your Financial Health

Money problems can be avoided by monitoring a few key financial areas. The good news: you don’t have to be a wizard at financial statement analysis; you just have to be vigilant.

Cash on hand: Monitoring cash balances is a simple process. It just requires a regular glance at your company’s balance sheet. Bank accounts appear at the top of this report, and you should frequently compare account balances over time.

Determining whether you have enough cash on hand involves some quick math. Cash, plus the receivables you expect will become cash within a month, should exceed the near-term debts you owe – called “current liabilities” on the balance sheet. Current liabilities include credit card balances, payroll taxes, sales tax, and other upcoming amounts you expect to pay.

Spending: A significant number of business errors are the result of not knowing where the money is going. Money should be spent for things that simplify your business and make you more productive. The income statement (also called the profit and loss statement) will help you evaluate your spending habits.

Here you’ll find the percentages of each expense category relative to revenue. By comparing this report over multiple periods, you’ll discover how your expenditures may have changed as percentages of revenue.

When business is going well, you’ll want to keep spending the same percentages of revenue for the expense categories that are variable. With fixed expenses, such as rent and telephone, what will hopefully be an increase in sales will cause the percentages of revenue for these categories to favorably decline.

Tax-Deductible or Not? Ask Your Expert

As business owners prepare to file tax returns, many find they have to reconstruct some of last year’s expenses. This is usually a result of paying business expenditures by personal means instead of through a checking account or credit card used exclusively for business. Delays and frustration result when there isn’t sufficient information, or you can’t remember the details required for some write-off claims.

By hiring an accounting professional, you can be sure every expense deduction your business is entitled to will be captured in a timely manner. Bookkeeping experts know how to record expenses regardless of the payment method. And they understand the conditions that make certain types of expenses tax-deductible.

Double-entry systems

With a double-entry bookkeeping system, every transaction records a balanced combination of debits and credits. Unlike spreadsheet entries, double-entry accounting will debit an expense category and simultaneously record the offsetting credit to an account that shows how the expense was paid.

Using accounting software for do-it-yourself bookkeeping is not a complete solution because it leaves you with the burden of learning about account categories and tax classifications. But when a skilled bookkeeper sees checking account outflow or credit card use, he or she will immediately seek information about the balancing expenditures. Even when your personal funds are spent for business purposes, your accounting professional will know the account that offsets the expenditure.

Normal expenses

A deductible business expense must be necessary and normal for your type of enterprise; personal expenses are never tax-deductible just because they’re paid by your business or have a loose connection to business operations. These types of transactions are considered owner draws.

For example, an accounting professional knows that business owners are prohibited from claiming tax deductions for wardrobe items or personal grooming. Expenditures such as haircuts and gym memberships are strictly personal, regardless of the intangible benefit derived from maintaining a good appearance.

Businesses also cannot deduct costs for the owner’s residence. However, if you meet home office requirements, the business may reimburse you for a percentage of your home expenses. This is based on the portion of your home used regularly and exclusively for business; in most cases, the home office space also must be the primary business location.

Special rules

There are special tax rules that allow deductions for business education and travel. General business education is deductible, but seminars and conferences must maintain or improve skills required in your current line of business.

Business travel is generally associated with overnight stays away from home. A deduction for all the travel cost is allowed when the primary purpose of the trip is to conduct business. When the trip is primarily for pleasure, only expenses directly related to business are tax-deductible. In this case, deductions for transportation and lodging costs are based on the percentage of days during the trip that business is conducted.

Obviously, caution must be exercised when claiming certain tax deductions. Your accounting professional is a valuable source of knowledge about what can – and can’t – be claimed.

Tax Implications of Business Losses

Business profits will always incur income tax, but a business loss does not necessarily provide a tax benefit. Typically, individuals may use business losses to offset income from other sources when determining their adjusted taxable income. But there are limitations.

A business owner with a loss can determine if the loss is tax-deductible by applying at-risk rules. The at-risk amount generally comprises money or property contributed to the activity in question plus the amount borrowed that, legally, the owner must repay personally.

Individuals in partnership businesses are also subject to the at-risk limitation; plus, they must satisfy the requirement for a sufficient tax basis. A partner’s basis is generally the amount of money and property contributed to the partnership, plus the partner’s allocation of undistributed profits that have accumulated over all past periods. A tax basis, therefore, decreases as a consequence of distributions received along with nondeductible expenses.

The income tax consequence for a partnership’s profit or loss is assessed on the individual tax returns of the partners. But deduction of a loss is limited when a partner has no tax basis or at-risk amount. Here, a capital contribution or a personal guarantee of partnership debt is required so the partnership’s pass-through of loss can be deducted from each partner’s personal return.

This presents a complication for limited partners, who avoid liability for the entire enterprise because their exposure to a business is limited to their contributions of cash. That said, having less money at risk may also restrict a limited partner’s ability to deduct a partnership loss.