That Expense Was Business-Related – Can I Deduct It?

Business owners share the common goals of maximizing sales and minimizing expenses. But when it comes time to prepare income tax returns, their focus shifts to maximizing expenses in order to make the most of write-offs. Entrepreneurs typically look for opportunities for deductions in every area of the business. This can prove beneficial to boosting their bottom line.

Unfortunately, not all business purchases are tax-deductible. An entrepreneur is confronted with limitations on deducting several types of expenditures that may seem like legitimate costs of doing business. Keep in mind, simply having your business pay for these things does not make them tax-deductible.

Customer Relations

Tax-deductible business meals are arrangements where the primary purpose is conducting business. Buying lunch for a customer so that business matters may be discussed is a deductible business expense. Dining solo is not. Stopping for lunch alone between business appointments is not tax-deductible. This holds true even if you would have avoided the restaurant cost were it not for your appointment schedule outside the office. The exception is meals you consume while traveling overnight away from home for business purposes. Additionally, only half of the cost for business meals is tax-deductible.

Giving gifts to customers is a common business practice. It builds goodwill and aims to garner referrals. But the IRS limits the tax deduction of a business gift to $25 per person for each gift. So if you give a gift of $100 to a customer, your deduction is limited to $25.

Appearances at Meetings

Getting to business meetings using your personal vehicle triggers a tax deduction based on the miles driven. Don’t count the miles commuting from home to your principal place of business. Going to a meeting before going to your office necessitates a little arithmetic. To determine the business miles, subtract the home-to-office commuting distance from the miles driven between home and the meeting location.

Looking sharp for a business meeting is certainly beneficial. Maybe you always prefer casual clothing, except when seeing customers. Nevertheless, clothing adaptable to other situations is not a tax-deductible business expense. Only uniforms, including clothing with a company name or logo, are deductible. Nothing else you buy that is common attire for occasions other than business is eligible for tax deduction.

Protection from Trouble

Life insurance on a business owner is definitely prudent, especially when the company is expected to survive the current owner. Tax deduction of the premiums is not allowed if the business is the policy beneficiary. If the owner’s heirs are the beneficiaries, the business may deduct the premiums, but doing so could be unwise as it jeopardizes the future income tax exclusion of life insurance death benefits.

Keeping out of trouble with the law is clearly a crucial business matter. But fines and penalties levied on an enterprise are not tax-deductible. A penalty for late payment of a tax assessment must be accounted for separately from the tax itself. You cannot deduct the penalty. Likewise, no deduction is allowed for parking tickets or traffic citations issued when traveling for business, such as making deliveries or attending meetings.

To ensure appropriate accounting, consult with your financial professional regarding deductions for your particular circumstances.

Self-Employment Taxes: Watch Out for the Double Whammy

Freelancers and small-business owners alike are required to make quarterly estimated tax payments. If you’re in this boat, you’ve probably noticed that Q1 estimated payments have the same deadline as the tax return for the previous year. If you owe more tax for the previous year, plus an estimate for the current year, this date can loom large on the calendar.

Fortunately, you can take steps to make these tax payments go smoothly. A good tax accountant can prepare your quarterly forms to send with estimated tax payments. Additionally, he or she can help complete tax returns on time so your estimated tax forms are ready when the first payment is due.

To estimate your tax for this year, your accountant can use the prior year as a guideline. In fact, the IRS permits you to avoid an underpayment penalty by paying estimated tax payments the current year that are equivalent to your tax from the prior year.

A byproduct of this “safe harbor” method is that you might eventually owe more tax (without penalty) if profit is higher in the current year than it was in the previous year.

To avoid this additional payment in Q1, your accountant can use an alternative process of estimating this year’s tax by projecting current-year profit. This makes accurate current-year records essential, so an optimal forecast of this year’s profit can be made. This includes up-to-date tracking of business revenue and expenses. In other words, don’t wait to identify your profit for this year until the tax return is due next year. Remain in regular contact with your accountant in order to manage these numbers and avoid surprises at the end of Q1.

Selling Your Equipment? How to Account for Asset Sales

As you operate a business, you’ll accumulate assets. These might include equipment, machinery, computers, furniture, vehicles, and buildings. These are not garden-variety expenses. They belong in a category for items with extended periods of use and more than nominal cost.

These assets are in contrast to minor expenditures, such as computer keyboards, staplers, or small chairs. While these items may last a long time, their costs are too low to count as assets. They are expensed in the same way as disposable items that you purchase. These minor expenditures are found on the statement of income and expenses, while asset costs are found on the balance sheet.

For many entrepreneurs, this accounting gets tricky when it comes time to disposing assets. The process is shrouded in mystery, and unraveling it is essential to achieving accurate bookkeeping and tax filing. Here are the basics.

Fixed Asset Facts

Knowing the value of an asset is of course essential when selling it. But the market value price tag you place on the asset is not the same as the value your company’s accounting has for the asset. Your business bookkeeping reports the original cost of the asset and the amount by which it has depreciated in value since it was acquired. That depreciation was a tax-deductible expense over the time your business owned the asset.

When you sell a business asset, the price you receive gives back the past amount of depreciation you’ve deducted. For example, let’s say you paid $10,000 for a piece of equipment two years ago, and you have depreciated it by $7,000.

If the useful life of the asset is about 10 years, it still has a market value of $8,000. The balance sheet for your business, however, only has a remaining value of $3,000 (the $10,000 cost less the $7,000 of depreciation). If you sell it for $8,000, that is $5,000 more than the remaining value on your balance sheet. So, you have $5,000 of income, but you sold the equipment for $2,000 less than your original cost, which seems like a loss.

The solution to this problem is two distinct steps in the transaction, which must be appropriately accounted for in your tax records.

Asset Sale Steps

First, you have income from getting back the depreciation previously deducted. In our example, the $8,000 selling price for the equipment returns to you $7,000 of past depreciation.

Second, you received $8,000 for equipment that originally cost $10,000, causing a $2,000 loss.

These separate elements offset to render a $5,000 profit. However, you have two components: the recaptured depreciation of $7,000 and the loss of $2,000. The $5,000 of income from recaptured depreciation is taxed differently than is the $2,000 loss.

Clearly, sound records of cost are crucial. Don’t forget to include the sales tax, shipping, and installation fees.

Also keep in mind that disposing of assets doesn’t only occur when selling them. If an asset wears out and you scrap it, that’s the same as selling it for zero dollars.

Your bookkeeping and tax return should report both sold and scrapped assets. The key is communicating with your bookkeeper and tax accountant to correctly record asset disposal and identify tax consequences.

Business Assets: Accounting for ‘Goodwill’

When you buy a business, whether to expand your current enterprise or to venture into new entrepreneurship, you will encounter an element of accounting known as goodwill. The simplest definition of goodwill is a premium paid above the market value for tangible assets such as equipment.

For example, buying a business might result in obtaining equipment worth $20,000, plus office supplies valued at $400, as well as a $600 computer and a truck with a $30,000 market value. Based on face value, if you acquired these items separately, they would cost you a total of $51,000. If you pay $60,000 to buy the business, the extra $9,000 is a cost for goodwill. It covers the intangible value that is above and beyond the tangible assets you acquire.

Each of the types of items you purchase must be accounted for separately in your books, so identifying the fair market value for each tangible asset is crucial. A business buyer and a seller always agree on the fair market value for tangible assets, and the buyer designates the premium paid as goodwill. The seller also needs to know how much goodwill you’re buying, since that’s the amount of goodwill he’s selling. A seller’s tax calculations depend on the cost for each item sold, including the goodwill.

Keep in mind, goodwill is another asset on your business balance sheet. It is not an expense that you deduct. Your bookkeeping should record distinctive amounts for inventory, supplies, various categories of equipment, and goodwill. Additionally, different tax treatment applies to each type of asset. Consult with your financial professional to ensure goodwill is accounted for correctly when paying taxes.

Unraveling the Mystery of Profit Margin Analysis

Why do entrepreneurs own and operate businesses? To make money. But the amount a company makes is not measured by revenue alone.

A business also has expenses. Looking solely at the profit amount doesn’t reveal the whole truth. True earnings are what remain after the owner pays for expenses. The foundation for proper income assessment is an examination of the percentage of revenue you retain as profit. This is your profit margin.

Calculating Profit Margin

Profit margin is the ratio of profit to sales, expressed as a percentage. Wise small-business owners maintain judicious scrutiny over both gross profit margin and operating profit margin.

Gross margin is your profit after paying all the direct costs for completing sales, which is typically called cost of goods sold. Numerous factors may be considered in identifying cost of goods sold. A retail operation has costs for the merchandise it sells. A service organization has costs for labor and perhaps some materials or parts. Regardless of the nature of your business, it has some cost of goods sold.

Still, even a sole proprietor with no employees or inventory may determine a gross margin. This is accomplished by subtracting reasonable compensation as an “employee” of the business from the amount of revenue, then dividing the result by the revenue. For example, a bookkeeper may want to earn $35 per hour for work performed because that’s the cost for hiring someone with the necessary skills to provide the effort. If the business receives revenue of $50 for a one-hour project, the gross margin is 30% because only $15 of gross profit remains (15/50 = 0.3 or 30%).

Of course, business owners are responsible for paying general operating expenses, too. The profit remaining after all these overhead expenses are paid is divided by revenue to calculate the operating profit margin.

Analyzing Profit Margin

These calculations should guide business owners in operational decisions. An examination of gross profit margin can lead to smart reforms in pricing and costs. The most knowledge can be gained by calculating gross margins for various types of sales.

Attaining this degree of detailed information requires a bookkeeping system that tracks revenue and direct costs for each product line or type of business. Some companies identify gross margin by territory or for each sales representative. As long as revenue is paired with its associated costs, the data present a straightforward determination of profit margin.

Low gross margins are improved by raising prices, finding lower cost inputs, or even discontinuing an entire line of business. Operating profit margins are stabilized or increased by effectively controlling expenses. Conversely, a fall in operating profit margin is an indication of unsound expense management.

Businesses with strong profit margins maximize the available cash to grow the company by hiring more staff, increasing space, or expanding marketing efforts. Alternatively, operations may use funds from higher profit margins to reduce debt or pay larger distributions to owners.

By contrast, falling profit margins impose burdens on the business. Slashing expenses and downsizing become the byproduct of lower profit margins…along with reduced compensation to ownership.

Ultimately, profit margin is foundational to business success. Close monitoring of this indicator is a key strategy for business owners to optimize resources for a prosperous future.

Not All Surprises Are Good: Know What to Expect on Your Tax Bill

It’s virtually unavoidable. When your business makes a profit, you pay income tax.

Some of your business earnings automatically belong to the government, which means you get to hold on to that money only for a limited period before handing it over to the tax collection authority. But you don’t have to be surprised by this bill. Plan ahead and use careful accounting to avoid unexpected tax bills.

Examine your business balance sheet regularly. This statement should have a liability account for accrued taxes. Consequently, the true amount of funds available for spending in your bank balance is the total minus the tax liability you must eventually pay.

Since most small businesses operate with cash-basis accounting, accrued liabilities on the balance sheet are not technically correct. Cash-basis expenses are counted only when they’re paid, not when they accrue. To keep your books in order, move the reserves for income tax into an entirely separate bank account. In your bookkeeping, you will transfer funds from one asset bank account to another.

This provides the advantage of having government cash out of the business operating account. Instead of an accrued liability for taxes appearing on the balance sheet, the funds available for business functions are simply the bank operating account on the balance sheet. Tax payments are remitted from the tax account.

The optimal amount of money to save for taxes is a subject to discuss with your tax accountant at the end of every year so you can appropriately plan the next year’s reserves.

Buying Out Your Corporation Co-owner

You may think of your joint shareholder as a business partner, but an incorporated business is a tax entity that is different from a partnership. This arrangement comes with specific tax consequences if you decide to buy out your corporation co-owner.

First, it’s important to understand that buying the company’s shares of stock from someone does not impact the corporation. Rather, this is an arrangement between you and the other shareholder. You are buying his shares. The number of shares issued by the company doesn’t change.

If the departing shareholder merely takes some money from the corporation, that is not a payment from you for your stock purchase. It’s simply a taxable dividend to the other shareholder. Or, if the business has a tax classification as an S corporation, the departing shareholder is taking a distribution, which is likely not taxable.

The fulfillment of your stock purchase agreement occurs with payment of your personal money to the departing shareholder. If your source for this cash is the company, then you have the tax consequence of receiving a dividend (or distributions, in the case of an S corporation). Again, this process has no tax impact on the company.

The tax consequences of the buyout fall entirely on the individual shareholders. As the buyer, you have a cost for the stock shares you’re acquiring. The selling shareholder has a gain or loss that’s the difference between what you pay him and his cost basis in the shares he’s selling.

If you’re unsure about this money flow, consult with your business accountant, who can guide you through the process.

How to Create a Useful Budget for the New Year

Entrepreneurs rarely find anything enjoyable about devising a budget for the year ahead. Consequently, the budgeting exercise is commonly neglected. Yet budgets offer advantages by facilitating planning, guiding cash management, and providing comparison to actual results.

Of course, professionals reap these benefits only if the budget is useful. Giving attention to a forecast that results in gross inaccuracies and misjudgments is even worse than no budget at all. The key to making the budget process easy and accurate is to focus on six basic factors.

Expense Limits, Revenue Timing, and Capital Goods

Always begin your budget with projections of expenses. Fixed expenses are the simplest to address. These are recurring items such as telephone and internet service, office rent, professional liability insurance, and licensing or certification fees.

Next, examine variable costs, which fluctuate with revenue. After paying fixed expenses, you have limited cash available for variable costs, such as inventory, materials, and staff needed to complete sales. Your revenue is then based on your markup of these variable costs.

An additional factor to consider is how long it takes to get paid for sales. This could happen immediately, as in the case of a retailer, or a few months after project completion, if you provide billed services. Be sure to place your revenue collections in the appropriate periods of your forecast. You might need to pay another month of expenses before receiving the income from sales a month prior. And the initial months in next year’s budget may have incoming funds from jobs in your pipeline that you complete this year.

Don’t forget to include expenditures for capital goods such as machinery, equipment, and computers. For example, rising sales may at some point necessitate adding both a new worker and a new piece of equipment.

Substantiating, Duplicating, and Assessing

Verify your budget accuracy by comparing the numbers to the facts. These are crucial elements such as the number of potential customers in your market and how likely you are to connect with them based on your marketing costs. Identify how many potential customers turn into buyers. Determine the average purchase size. Overall, your aim is to ensure that your sales goal is realistic.

Turning optimism into pragmatism is achieved by forecasting multiple growth scenarios. The numerous factors at play are easily manipulated in a spreadsheet application on your computer. One scenario might modify the overall growth rate for next year. Another could change the pace at which your business grows. That is, you might end the future year at your optimistic sales level but get there more slowly.

Constant reassessment of your budget is vital. Maintain your forecast in a spreadsheet that allows you to recalculate upcoming projections as you enter each month’s actual results. Follow up each entry with a re-evaluation of the approaching period. Modify the forecast with a revised projected growth rate to match your recent activity. Change variable expenses and capital goods costs accordingly.

Lastly, review whether sales are rising faster or slower than expected. Based on this trend, consider whether you should expand or slash the fixed costs over which you have control. These adjustments will help keep your budget balanced and keep your business on track for success.

Make Financial Spreadsheets More Meaningful

The explosive proliferation of spreadsheets has brought with it an unfortunate byproduct: complexity. This quality is not bad in and of itself. However, some financial analysis reports have increased in complexity to the point where they are indecipherable. In some cases, creators fail to incorporate appropriate information, rendering the report useless.

If developed and used properly, forecast spreadsheets can facilitate projections for in-house use and allow lenders or investors to better comprehend the future expectations of your business. With this in mind, use the following principles to craft your data.

Make assumptions. In other areas of life, you’re told never to assume. When it comes to financial spreadsheets, however, assumptions are a good thing. In fact, spreadsheets are worthless without them. Your spreadsheet must have a listing of assumptions. These reflect how much you can deliver with the given level of personnel, equipment, and working capital. You must correlate projected revenue with the time, people, and tools available to complete the work, and with the cash on hand for marketing and sales.

Place your assumptions right in the spreadsheet. Use color-coding to distinguish assumption constants from formula financial results. Assumptions should appear in front of dollar figures – on top or to the left of the money numbers – for easy access and instant adjustments.

Crack your code. If you use any abbreviations, define them. If, for example, you operate a fleet of trucks delivering construction materials, make sure to convey the unit of measurement – like square yards or board feet. Or, if you sell items through a website, make it clear whether your measurement of daily active users reflects site visitors or purchasers.

Learn from the past. Sensible financial projections are bridged to past results. The initial month in a forecast should indicate where the business already stands. Projected outcomes then flow from this historical base.

Cover all the bases. For each period, a financial forecast summary should show the beginning cash, the addition of revenue collected, the subtraction of every expense category, and the ending cash. Don’t forget to subtract the costs for new capital goods like machinery and equipment.

You must also remember to consider any lag time between selling and getting paid. Reduce incoming revenue by a reasonable percentage of sales that are not paid upon delivery; add that revenue to a future period in the forecast, when those customers will pay.

Tab it. Organize spreadsheet tabs in a logical order from left to right. For instance, the first tab is typically a summary sheet that tallies the results from subsequent sheets of projected revenue, variable expenses, fixed costs, and asset purchases.

Separating these elements on distinctive sheets is often necessary for comprehending detailed connections. You may also need to apply different sets of assumptions to various sheets.

Keep it neat. Cosmetic factors on spreadsheets matter. Make your spreadsheets readable with numbers that have commas and a consistent number of digits after the decimal point. Align all column headings over the numbers. And give your eyes a break: use at least 10-point font.

Business Growth: Are Your Projections Realistic?

Entrepreneurs with unrealistic business growth projections are like sprinters in a marathon. They’re in the wrong race, because their objective doesn’t correspond with ability. Don’t make the same mistake. To avoid depleting all of your business oxygen, set reasonable goals that you can strategically achieve.

An especially common error in growth forecasts is a hockey stick pattern. This predicts rapid growth after initiating a marketing strategy, followed by a steady upward trajectory thereafter. But growth doesn’t magically continue simply from momentum. Projecting a fixed percentage of rising revenue masks the actions and costs associated with expansion.

The foundation for a genuinely realistic growth projection is a focus on inputs. Inputs are what you actually control. Time, capital, and equipment are inputs that result in output. These elements dictate growth in the near future. Tie the sales forecast to assumptions about these available resources. Let the output – and its rate of growth – simply fall into place as your input plan unfolds.

Keep in mind, the rate of growth will not be constant. It will rise as your business scales and then reach a ceiling where revenue is capped. To break through this ceiling, you must continue to increase inputs. Hiring more people, automating more tasks, and outsourcing administrative duties are common steps. Of course, these measures require money, which is generated by growth. Consequently, your projections should reflect periodic dips in cash flow to fund renewed expansion, allowing the healthy cycle of growth to continue.