Business Finance Articles

Many companies hold petty cash as a convenient means for making small purchases. The money is also used to reimburse employees for office items they buy. Unfortunately, petty cash is prone to accounting errors.
One of the problems is failure to accurately record expenses paid with petty cash. The money is an asset just like a bank account. Businesses should therefore subject petty cash to the same controls as funds in a bank. A policy is needed that establishes who approves petty cash disbursements as well as who reconciles the cash drawer.
Money removed from petty cash is replaced with receipts for a business expense attached to a supervisory approval for the purchase. The custodian of petty cash periodically totals the receipts and determines the amount of petty cash spent for each business expense category. The sum of the receipts and the remaining cash always equals the same original petty cash amount. After the petty cash fund is nearly depleted, the custodian turns in the receipts and obtains replacement cash. This returns the petty cash amount to its original balance.
Businesses must conduct reimbursements to employees under the rules of an accountable plan. Doing so means that reimbursements are not considered income for employees and are therefore exempt from payroll taxes. Businesses with accountable plans treat reimbursements as if they had paid the expenses directly. Accountable plans require reasonable accounting of expenses with a business purpose. Disbursements in advance require the employee to return with a receipt for the business purchase and the change.

There’s more to the financial operations of a business than tracking revenue and expenses. The balance sheet shows what happened to the profit or loss and reveals the overall condition of a business.

By examining the balance sheet you see the assets acquired with your profits as well as debt you incurred to buy those assets or to cover an operating loss. You already know to monitor your available cash. The balance sheet permits you to also supervise the levels of what’s owed to you and how much you owe.

The most useful function of the balance sheet is that it permits you to locate any accounting mistakes. As the name implies, this financial report must balance, so any incorrectly reported expenses or unreported revenue must create an equally erroneous amount in an offsetting account on the balance sheet.

Some incorrect amounts are obviously too large or too small in relation to known facts. For example, you generally know about how much you paid for your inventory on hand. So a glance at the amount indicated for inventory on the balance sheet confirms some general accuracy.

In addition, the balance sheet provides an opportunity for specific accuracy of your accounting. That is, most of the figures on the balance sheet are verifiable against independent sources.

For example, cash asset balances should reconcile to bank statements, the inventory asset balance should reconcile to a physical inventory count, loan balances should reconcile to reporting by lenders and credit card balances should reconcile to monthly statements.

An S corporation is taxed differently than an unincorporated proprietorship because the S corporation doesn’t incur self-employment tax. This is the tax on a proprietor’s profit that substitutes for payroll taxes covering Social Security and Medicare.

Shareholders of an S corporation pay only regular income tax on their respective shares of business profit – regardless of whether the corporation distributes any profit. This regular income tax assessment is identical to a proprietorship. However, there are no payroll taxes on S corporation profits. S corporation employees – including shareholders who operate the business – incur payroll taxes on their wage compensation.

Wage Requirements

These circumstances result in an incentive for S corporation shareholders to minimize their own wages. This increases the corporate profit that’s not subject to payroll taxes. The Internal Revenue Service (IRS) is increasingly interested in these situations. After all, someone must operate the corporation. This person is therefore an employee who should receive wages. The IRS expects payroll taxes on some amount of wages for the operating shareholder.

The general IRS rule is that an operating shareholder of a profitable S corporation must receive “reasonable” wages for services. S corporations that pay less than “reasonable” wages to shareholders have drawn IRS attention.

Determining What’s Reasonable

The IRS has authority to adjust S corporation tax reporting to reflect reasonable wages. Doing so causes an assessment of back payroll taxes – along with penalties and interest – on shareholder wages disguised as non-payroll distributions.

This doesn’t mean that S corporations are not a viable opportunity to reduce taxes on a business. However, it does indicate that those forming S corporations should obtain competent advice about compensation to operating shareholders. Distributions of profit to shareholders should not substitute for reasonable wages.

The tax code doesn’t contain a definition of “reasonable” wages, but the IRS suggests it is determined by such things as hours worked, duties performed, and the complexity and size of the business.

S corporations making distributions to shareholders that exceed their wages commonly draw IRS scrutiny.
In addition, wages to operating shareholders that are far below the market wage garner attention.

The trade-off for escaping self-employment tax on S corporation profit is incurring payroll taxes on wages that are fairly related to the value of services rendered.

In some circumstances, lower-than-market wages are justifiable. For example, a high level of debt service might impact wages. When debt includes loans from shareholders, it must involve documentation and include interest.

Another factor related to operating shareholder wages is the effect on retirement plans.

Because the profit of S corporations is not self-employment income, the IRS has ruled that such profit is not considered for determining contributions to qualified retirement plans.

The only basis for retirement plan funding is wage compensation.

Businesses can avoid trouble with mileage expenses by following a few simple rules.

For starters, businesses can deduct mileage expenses only when certain standards are followed. The same requirements apply to self-employed individuals deducting business mileage, and companies that reimburse employees for business miles.

Adequate records are required for business mileage deduction. They must document the date, place and business nature of the vehicle use. Employees who obtain reimbursement for business miles must provide this record to you. A single record is permitted for several business stops on an uninterrupted trip. Minimal personal use is considered an uninterrupted trip.

The Internal Revenue Service (IRS) establishes a standard mileage rate at least annually. The tax deduction for mileage cannot exceed this rate. Because the rate is announced in advance, you can obtain it from the IRS website or your accountant.

Your employees must return any reimbursements that exceed the standard mileage rate or that aren’t substantiated by records provided to you. In addition, employees must provide their business mileage records within a reasonable amount of time. The IRS considers 60 days after incurring the business miles as reasonable.

Mileage reimbursements are not taxable income to employees who provide the required records and receive no more than the standard IRS rate. When these conditions are not met, the excess reimbursement is added to employee compensation and reported on the annual Form W-2.

Correspondence from the Internal Revenue Service (IRS) can produce a fright in the recipient, but there’s usually no cause for alarm.

The most frequent letter sent by the IRS is the CP2000 notice. Its purpose is simply to convey proposed changes to a tax return.

A typical trigger for this is math errors on your tax return or the apparent omission on your return of income that was reported to the IRS by parties that paid you.

How to Read the Notice

Every CP2000 notice itemizes the details for a proposed change and states the tax liability impact. Sometimes, no additional tax is owed. Many notices do not require a response to the IRS. Even when a payment is required, you need to return only the signature page along with a check if you agree with the changes.

You should read the notice carefully before forwarding it to your accountant.

If the notice indicates that some income was omitted from your return, you must determine if you really received the income and whether you conveyed it for preparation of your return. If you disagree with the IRS notice, your accountant can help you prepare a response. You might disagree with some, or all, of the proposed changes described in a CP2000 notice. You need documentation to support any dispute.

Types of Responses

A common cause for a CP2000 notice occurs when a payer of money to you reported that amount on a Form 1099 to the IRS.

When your tax return doesn’t appear to include that figure, the IRS proposes the change to your tax return by issuing the CP2000.

Additional tax is assessed on omitted income. For example, you might receive a notice for omitting some of your interest income. In that case, the notice proposes extra tax owed.

If the notice is correct, all that’s required is signing and returning it with a payment.

However, depending upon the nature of the income, you may have certain expenses to deduct against the amount paid to you and reported on Form 1099.

In that case, your accountant can help you prepare an amended tax return that reports the originally omitted income as well as the ordinary and necessary expenses that are deductible before making the tax calculation.

Act Quickly but Carefully

The IRS reviews responses to a CP2000 and issues a new notice if there’s a correction in the tax assessment.

When the IRS does not approve any changes to the original CP2000, a notice of tax owed is sent. After that, there’s no recourse other than paying the tax or petitioning the United States Tax Court.

A taxpayer is normally given 30 days to reply to a CP2000 notice. An extension for more time is customarily granted when you are preparing documentation for a response or an amended tax return.

Before final resolution, an outstanding CP2000 notice simply means that you’ve been notified of proposed changes to your tax return.

If you sign and return the notice, you have agreed to the changes and are no longer entitled to dispute the assertions.

Efficiently organizing the information needed to prepare your income tax return is more than just a courtesy to your accountant.

Better organization permits your accountant to prepare the tax return faster and minimizes your cost.

More important, anyone involved in preparing your tax return is required by law to understand information you supply about income and deductions.

Rules of the Internal Revenue Service require tax professionals to conduct reasonable inquiries into taxpayer information to assure that income is not understated.

Categorize Deductions

Your accountant has to spend time clarifying details when your tax deductions are not organized.

Tax deductions should be partitioned among the associated income-producing activities.

In addition, provide totals for each category of tax-deductible expense. Don’t simply list expenses chronologically.

List expenses for a rental property with the rent received.

Be sure to list each property separately. Don’t combine landlord expenses for all properties.

Know What to Provide

Your accountant can help you determine which incurred costs are tax-deductible.

A tax organizer is available each year that shows you the different types of income and associated expenses from your prior year tax return.

Give particular attention to detail about various deductions.

For example, do you have a business home office? If so, you provide your home utilities. This includes only costs to maintain normal use of the home – which is heating and cooling the house, not home telephone and cable television.

Mortgage interest is reported by your lender on Form 1098, so provide that form to your accountant.

Property taxes are an income tax deduction in the year they are paid, not the year assessed. If you paid a 2010 property tax assessment in January of 2011, it’s not deductible until you prepare the 2011 tax return another year from now.

If you started a new business in 2010, list the income along with the ordinary and necessary expenses you incurred.

If you purchased or sold a rental property, provide the settlement statement from the closing. Then list the rental income you received and categorize expenses you paid.

If you received money for any reason that was not a gift, it is probably taxable income. List the amount and the nature of the income.

Provide every Form 1099 you receive.

Don’t Perform Calculations

Don’t attempt to perform calculations for your tax return.

For example, if your business has a home office, just provide the total square feet for your home and for your office space. Then list your housing expenses for utilities, repairs, insurance, maintenance, homeowner association dues and other expenses of maintaining your home.

Proper management of bookkeeping information not only improves accuracy but also saves time and money. This is true if you perform your own business bookkeeping or hire a bookkeeper.

Don’t expect all the responsibility for efficiency to rest completely with your bookkeeper. If you do your own bookkeeping, you already know that a stop-and-go process is costly. It involves having to cease a smooth workflow in order to locate details required to proceed.

Whenever a bookkeeper has to stop a work session, an entire process is interrupted. Think about how much time is spent just getting started with bookkeeping procedures – starting a computer, launching the accounting software, using the password login and reviewing tasks for this session. Stopping the process in order to search for details requires logging out, listing missing data and tracking down information.

Because of the fixed steps, batching work for each session is critical. Resolve this year to always have complete information ready for each bookkeeping session. Don’t let any session become interrupted by large documentation gaps.

Have a method for your bookkeeper to convey minor issues requiring further clarification after each session. Then make sure you provide complete answers for the bookkeeper to act upon in the next session.

Develop a consistent process of providing your bookkeeper with your non-urgent questions. Let your bookkeeper answer in the subsequent bookkeeping session. These habits permit you to maximize bookkeeping efficiency.

Using petty cash is a convenient way to make small purchases or reimbursements, but it is prone to accounting errors.

Rules for the Cash

Establishing a petty cash fund does not mean that the money in the pot is an expense. Rather, the cash is an asset just like a bank account and thus must be subject to similar controls.

Accounting for Petty Cash

The petty cash custodian should periodically total the receipts and determine the amount of petty cash spent on each category of expense. Someone other than the petty cash custodian should occasionally verify this.

Reimbursement Rules

Providing reimbursement to employees requires you to have an accountable plan under rules of the Internal Revenue Service (IRS). Reimbursements under an accountable plan are not considered income to employees. As a result, they are not subject to payroll taxes. Instead, the expenses are simply recorded as if the business had paid them directly instead of reimbursing employees for them.

The requirements for an accountable plan with the IRS are that the expense reimbursed must be reasonable and have a business connection, that there must be reasonable accounting for the expenses and that employees must return any advances in excess of their actual expense amounts within a reasonable time.

Employers that fail to account for reimbursements risk having all reimbursements considered wages.

Did you know that you may be able to deduct a portion of your home for business use – even if your business has a different primary location?

To claim a business deduction for your home there must be an area used exclusively and regularly for business. When the area is not your principal place of business, it must be a part of your home used only to meet or deal with clients, customers or patients in the normal course of business. It may also be a separate structure not attached to your home with an exclusive and regular connection to your business. For storage uses, you are required only to use the location regularly but not necessarily exclusively.

Terms Defined

“Exclusive use” means a specific area of the home is used only for trade or business. “Regular use” means the area is used regularly for trade or business. Incidental or occasional business use is not regular use.

Corporations

If your business is a corporation – including an S corporation – you may be able to claim a home office deduction under the rules that apply to employees. For an employee to deduct home office expenses, the regular and exclusive business use must be for the convenience of the employer. When a home office is merely helpful, you cannot deduct expenses for the business use of your home.

The convenience requirement is often met when the principal business location is a manufacturing facility without office space. In that case, office functions done at home by the company president may qualify as meeting the convenience condition.

It seems that many business owners could be wasting money because of bookkeeping errors relating to payroll.

The thing is that taxes you pay that are associated with payroll are not your payroll tax expense, and if your bookkeeping records show that they are, your accountant has to fix the error. That’s not an easy task, considering how many pay periods there are in an entire year. This inevitably leads accountants to make a “reasonable” determination about your actual payroll expenses in order to prepare your income tax return. This results in higher costs and missed tax deductions.

Payroll Tax Explained

Your payroll tax expense does not include the taxes withheld from employee pay. That is wages expense. The employees pay the deducted taxes. You simply withhold them and remit them to the Internal Revenue Service (IRS) for the employees.

Your quarterly payroll reports reflect this. Remember, the IRS receives a quarterly payroll tax report with this information. It also obtains your annual income tax return. The IRS compares details from both sources. The wages stated on the quarterly reports must match your income tax return. If they do not match, you are likely to receive a notice from the IRS requesting an explanation. A reply requires time and is costly.

Your quarterly payroll reports to the IRS should also match your annual filing of employee W-2s. If you decide to pay some bonuses at year-end, they must be reported on both the W-2s and the fourth-quarter payroll report to the IRS.

How Your Accountant Can Save You Money

Your accountant helps you by ensuring that deductible wages on your tax return equal wages on the W-2s. If your bookkeeping does not show the exact total on the W-2s as your deductible wages, your accountant does an important exercise. The amount your books show as wages is added to the amount indicated as payroll taxes. The accurate amount of wages – known from the W-2s or quarterly payroll reports – is then subtracted. The remainder must be the payroll taxes. If that figure is not reasonable, more time and cost are involved to determine the error.

To avoid the time delay and cost for locating errors, minor inaccuracies are often ignored. This is a disadvantage to businesses with inaccurate records, because discrepancies are simply lost tax deductions. The cause is normally failure to record in the bookkeeping payroll those taxes that have accrued at year-end. Cash basis accounting records expenses, except for payroll taxes,  when they are paid. The taxes are deductible expenses for the year that the wages are paid. So the payroll taxes you incur for payroll dates this year are tax-deductible this year – even if the taxes are remitted next January. Likewise, the payroll taxes remitted in January of this year relating to wages paid last year should not be recorded in your bookkeeping as current year expenses. Those are last year’s expenses.

You cannot rely on your accounting software to eliminate the possibility of error. Your accountant should help you correctly set up the automated system. Have your payroll accounting reviewed by your accountant at least one other time during the year in addition to tax preparation season. Make sure your payroll reports match your bookkeeping to avoid costly problems and missed tax deductions.