20 Frequently Asked Tax Questions, Part Five!
Many of our clients and readers send us questions they would like answered.
This final installment discusses deducting bad debt expenses, how to save estate
and self-employment taxes, and how to reduce audit risks.
Q. My brother and his wife own a multi-million-dollar paving business. Two of his sons work in the business as well. Would switching the business to a family limited partnership (FLP) on paper save them estate taxes, down the road?
A. If your brother plans far enough ahead, putting the paving operation into an FLP can reduce the size of his taxable estate as well as cut probate time and costs. This way, he can also transfer the business to his sons gradually over time through yearly tax-free gifts.
Q. I’m a sole proprietor, but I have a huge self-employment tax bill. Is there any way to lower this?
A. Yes. Switching over to “S” corporation status and becoming an employee of the corporation would save you some money by changing your self-employment taxes to “payroll” taxes. However, there are some costs and legal fees involved in maintaining a corporation, as well as fees for corporate tax return filings. For a small business, these costs are pretty low—and tax deductible. Consult with your local tax professional to see if this move is right for you.
Q. Will incorporating my one-man accounting operation reduce my audit risks?
A. Most likely yes. The audit rate for incorporated small businesses with under $1,000,000 gross receipts has been less than half of similar unincorporated businesses. Still, you’ll want to look into the costs and expenses that come along with the incorporation process. Incorporating comes along with some complexities that you may not want to deal with, and procedures vary state by state.
Q. What is bad debt expense and when is it deductible?
A. If your business is selling goods and you can’t collect payment from credit provided to a client, you can usually deduct your loss. However, this is unfortunately not true for service businesses. Let’s say you’re a doctor, and you’ve had some patients who didn’t pay their medical bills. You can’t deduct the “bad debt,” but you can still deduct any money spent in connection with providing these services (e.g. medications, supplies).
Q. My brother and his wife own a multi-million-dollar paving business. Two of his sons work in the business as well. Would switching the business to a family limited partnership (FLP) on paper save them estate taxes, down the road?
A. If your brother plans far enough ahead, putting the paving operation into an FLP can reduce the size of his taxable estate as well as cut probate time and costs. This way, he can also transfer the business to his sons gradually over time through yearly tax-free gifts.
Q. I’m a sole proprietor, but I have a huge self-employment tax bill. Is there any way to lower this?
A. Yes. Switching over to “S” corporation status and becoming an employee of the corporation would save you some money by changing your self-employment taxes to “payroll” taxes. However, there are some costs and legal fees involved in maintaining a corporation, as well as fees for corporate tax return filings. For a small business, these costs are pretty low—and tax deductible. Consult with your local tax professional to see if this move is right for you.
Q. Will incorporating my one-man accounting operation reduce my audit risks?
A. Most likely yes. The audit rate for incorporated small businesses with under $1,000,000 gross receipts has been less than half of similar unincorporated businesses. Still, you’ll want to look into the costs and expenses that come along with the incorporation process. Incorporating comes along with some complexities that you may not want to deal with, and procedures vary state by state.
Q. What is bad debt expense and when is it deductible?
A. If your business is selling goods and you can’t collect payment from credit provided to a client, you can usually deduct your loss. However, this is unfortunately not true for service businesses. Let’s say you’re a doctor, and you’ve had some patients who didn’t pay their medical bills. You can’t deduct the “bad debt,” but you can still deduct any money spent in connection with providing these services (e.g. medications, supplies).
Ted Lanzaro is the
founder of Lanzaro CPA, LLC, a boutique tax consulting firm specializing in
small businesses and the real estate and construction industries. For more
information about CPA Ted Lanzaro, check out his website at www.lanzarocpa.com and www.taxcpact.com.
20 Frequently Asked Tax Questions, Part Four!
Many of our clients and readers send us questions they would like answered.
Here are more of the 20 most frequently asked.
Q. What are the advantages to having IRA, SEP, 401(k) or other retirement plans if I’m self-employed?
A. Retirement plans offer immediate tax breaks to small business owners. With the exception of the Roth IRA, you’ll save on taxes every year, and the money you invest will accumulate interest, dividends, and capital gains. The tax is deferred until you withdraw it.
Q. I give my employees little bonuses and gift certificates to help keep them loyal. Can I deduct the cost of these things?
A. Yes, you can deduct all of the costs of gifts to employees; but the employee will have to report anything totaling more than $25 per year as additional income. However, if you have a service business, services that wouldn’t be used anyway can be given away tax-free. There are also special tax codes denoting bonuses of up to $1,600 per year. Check with a tax pro such as myself for more information.
Q. I hire a lot of independent contractors for my small business instead of employees—which saves me a lot on taxes. Are there any risks involved in this?
A. All those tax savings are safe as long as the workers are legally independent contractors. But if you’re providing them with a workplace on your premises, controlling the hours they work and directing them—then to the IRS, they look like employees. Getting caught would mean big trouble for you, and be cause for fines and penalties from your state tax agency as well.
Q. If I take my wife to a trade show in New York and we spend an extra few days after the show, can I still deduct the trip expenses?
A. Unless your wife is an employee of your business—and on the trip with you for business reasons—you won’t be able to deduct any expenses (e.g. food) that are solely attributable to her. However, your airfare, your shared hotel room, the rental car for the business days, etc. are all deductible.
Q. What are the advantages to having IRA, SEP, 401(k) or other retirement plans if I’m self-employed?
A. Retirement plans offer immediate tax breaks to small business owners. With the exception of the Roth IRA, you’ll save on taxes every year, and the money you invest will accumulate interest, dividends, and capital gains. The tax is deferred until you withdraw it.
Q. I give my employees little bonuses and gift certificates to help keep them loyal. Can I deduct the cost of these things?
A. Yes, you can deduct all of the costs of gifts to employees; but the employee will have to report anything totaling more than $25 per year as additional income. However, if you have a service business, services that wouldn’t be used anyway can be given away tax-free. There are also special tax codes denoting bonuses of up to $1,600 per year. Check with a tax pro such as myself for more information.
Q. I hire a lot of independent contractors for my small business instead of employees—which saves me a lot on taxes. Are there any risks involved in this?
A. All those tax savings are safe as long as the workers are legally independent contractors. But if you’re providing them with a workplace on your premises, controlling the hours they work and directing them—then to the IRS, they look like employees. Getting caught would mean big trouble for you, and be cause for fines and penalties from your state tax agency as well.
Q. If I take my wife to a trade show in New York and we spend an extra few days after the show, can I still deduct the trip expenses?
A. Unless your wife is an employee of your business—and on the trip with you for business reasons—you won’t be able to deduct any expenses (e.g. food) that are solely attributable to her. However, your airfare, your shared hotel room, the rental car for the business days, etc. are all deductible.
Ted Lanzaro is the
founder of Lanzaro CPA, LLC, a boutique tax consulting firm specializing in
small businesses and the real estate and construction industries. For more
information about CPA Ted Lanzaro, check out his website at www.lanzarocpa.com and www.taxcpact.com.
20 Frequently Asked Tax Questions (FATQ), Part Three!
Many of our clients and readers send us questions they would like answered.
Here are more of the 20 most frequently asked.
Q: I had some bad luck with my business venture last year. Now I’m behind in payroll taxes for $110,000 and I owe suppliers and others even more. Will the payroll taxes disappear if I file bankruptcy?
A: Unfortunately, Congress decided that payroll taxes cannot be wiped out in bankruptcy. My advice to you is to use your business assets to make the payroll tax payments. You’ll probably be able to discharge the suppliers’ bills in bankruptcy, but it’s important to pay the IRS first. Setting up a payment plan with them is the easiest thing to do.
Q: Since some states don’t have personal income AND corporate taxes, will incorporating my business out of state save on costs and taxes?
A: It can be tempting, but it’s actually the opposite of a moneysaver. It can be expensive to form and maintain an out-of-state corporation, and you’ll still have to file both corporate and personal tax returns for the state in which you’re actually doing business. It may therefore only result in higher overall costs and taxes. People usually choose to incorporate out of state for more favorable liability laws.
Q: Help! I’m being audited by the IRS, and the auditor told me that a number of my business expenses will be “disallowed” in his report. What should I do?
A: You can appeal an auditor’s decision to the IRS Appeals Office, which is a completely separate division of the IRS. Basically, their job is to make sure you don’t take the IRS to Tax Court. You probably won’t be let off the hook completely in terms of your business expenses, but they should at least compromise with you. If you are still unhappy after trying to compromise, you could always take the IRS to Tax Court.
Q: I make model trains in my spare time and have been able to sell a few items at craft fairs. I love doing this, but overall I lose money every year. Are these losses tax deductible?
Q: I had some bad luck with my business venture last year. Now I’m behind in payroll taxes for $110,000 and I owe suppliers and others even more. Will the payroll taxes disappear if I file bankruptcy?
A: Unfortunately, Congress decided that payroll taxes cannot be wiped out in bankruptcy. My advice to you is to use your business assets to make the payroll tax payments. You’ll probably be able to discharge the suppliers’ bills in bankruptcy, but it’s important to pay the IRS first. Setting up a payment plan with them is the easiest thing to do.
Q: Since some states don’t have personal income AND corporate taxes, will incorporating my business out of state save on costs and taxes?
A: It can be tempting, but it’s actually the opposite of a moneysaver. It can be expensive to form and maintain an out-of-state corporation, and you’ll still have to file both corporate and personal tax returns for the state in which you’re actually doing business. It may therefore only result in higher overall costs and taxes. People usually choose to incorporate out of state for more favorable liability laws.
Q: Help! I’m being audited by the IRS, and the auditor told me that a number of my business expenses will be “disallowed” in his report. What should I do?
A: You can appeal an auditor’s decision to the IRS Appeals Office, which is a completely separate division of the IRS. Basically, their job is to make sure you don’t take the IRS to Tax Court. You probably won’t be let off the hook completely in terms of your business expenses, but they should at least compromise with you. If you are still unhappy after trying to compromise, you could always take the IRS to Tax Court.
Q: I make model trains in my spare time and have been able to sell a few items at craft fairs. I love doing this, but overall I lose money every year. Are these losses tax deductible?
A: If you can prove a
“profit motive,” it is possible the IRS could give you a break. Keep good
records that show your effort to turn a profit, and do some advertising just
like any business would. This will help you out if you ever get audited.
Remember, it doesn’t matter if you actually make a profit, you just need to
prove that you tried. For more information on this, see my blog article, Is it a
Hobby, or is it a Business?
Ted Lanzaro is the
founder of Lanzaro CPA, LLC, a boutique tax consulting firm specializing in
small businesses and the real estate and construction industries. For more
information about CPA Ted Lanzaro, check out his website at www.lanzarocpa.com and www.taxcpact.com.
20 Frequently Asked Tax Questions (FATQ), Part 2!
Many of our clients and readers send us questions they would like answered.
Here are a few more of the 20 most frequently asked.
Q: How long should I keep my business records?
A: According to the IRS statute of limitations on audits, the minimum is three years from the date you file your tax return. However, you probably want to keep your records stored for at least twice that long. The IRS is allowed to go beyond three years if serious cases of underreporting have occurred, and some state tax agencies have more time to audit as well.
Q: If I hire my 12-year-old to sweep floors and answer the phone for about $50 a week, will I get in trouble with the IRS?
Q: If I have to use my car to call on customers and make deliveries, am I better off leasing a vehicle or buying one?
A: If you need a car worth at least $16,000, leasing will give you a bigger tax deduction. However, if your business needs a big truck or an SUV, the tax deductions will be much more favorable if you own the car. Plus, IRC 179 might even allow you to write 100% of a large vehicle off in the year of purchase.
Q: A couple of friends and I want to go into business building and fixing furniture. What’s the easiest way to do this in terms of taxes?
A: For this kind of venture, your best bet would probably be to form a Limited Liability Company (LLC). Forming a partnership or a corporation are also options, but could be more complicated tax-wise. The three of you should sit down with a business lawyer or tax pro before opening the business, just to be on the safe side.
Q: How long should I keep my business records?
A: According to the IRS statute of limitations on audits, the minimum is three years from the date you file your tax return. However, you probably want to keep your records stored for at least twice that long. The IRS is allowed to go beyond three years if serious cases of underreporting have occurred, and some state tax agencies have more time to audit as well.
Q: If I hire my 12-year-old to sweep floors and answer the phone for about $50 a week, will I get in trouble with the IRS?
A: Nope, it’s totally
fine to hire your kids – and it can even save your family some taxes by
transferring some income from your tax bracket to the child’s lower bracket.
Just don’t try to disguise their tax-deductible salaries as weekly allowances.
For more information see my blog article: Can You Hire Your
Kids?
Q: If I have to use my car to call on customers and make deliveries, am I better off leasing a vehicle or buying one?
A: If you need a car worth at least $16,000, leasing will give you a bigger tax deduction. However, if your business needs a big truck or an SUV, the tax deductions will be much more favorable if you own the car. Plus, IRC 179 might even allow you to write 100% of a large vehicle off in the year of purchase.
Q: A couple of friends and I want to go into business building and fixing furniture. What’s the easiest way to do this in terms of taxes?
A: For this kind of venture, your best bet would probably be to form a Limited Liability Company (LLC). Forming a partnership or a corporation are also options, but could be more complicated tax-wise. The three of you should sit down with a business lawyer or tax pro before opening the business, just to be on the safe side.
Ted Lanzaro is the
founder of Lanzaro CPA, LLC, a boutique tax consulting firm specializing in
small businesses and the real estate and construction industries. For more
information about CPA Ted Lanzaro, check out his website at www.lanzarocpa.com and www.taxcpact.com.
20 Frequently Asked Tax Questions (FATQ)
Many of our clients and readers send us questions they would like answered.
Over the next few weeks, we will answer the 20 most frequently asked.
Part I.
Q: Will I be audited for claiming a home office deduction for my home-based business?
A: If the deduction is large – say, 50% or more – in relation to your business income, then it’s possible. If not, a home office will only slightly increase your chances of audit.
Q: Do I still have to file a federal income tax return for my business if I lost money?
A: If your business is incorporated, yes. If your business is not incorporated, filing the federal return isn’t required, but it’s still a good idea. Your loss might actually be to your tax advantage, because it could reduce your other taxable income in that year or in future years. Simply fill out and attach IRS Form 3621.
Q: What is “depreciation”?
A: When a business asset has a useful life of more than year, the IRS will give you a tax break corresponding to its loss in value as the asset wears out over time. The amount of the deduction and the length of time you must take them depends on how the property is classified within the tax code.
Q: Do I need prior IRS approval/registration before starting my own business?
A: If you’re a sole proprietor without employees, no. You can use your own Social Security number when filing taxes. However, if you have one or more employees, OR if you’re starting a business entity (partnership, LLC, corporation, etc.) you must get a federal Employer Identification Number (EIN) at the beginning of your operation. This can be obtained by filing IRS Form SS-4.
Part I.
Q: Will I be audited for claiming a home office deduction for my home-based business?
A: If the deduction is large – say, 50% or more – in relation to your business income, then it’s possible. If not, a home office will only slightly increase your chances of audit.
Q: Do I still have to file a federal income tax return for my business if I lost money?
A: If your business is incorporated, yes. If your business is not incorporated, filing the federal return isn’t required, but it’s still a good idea. Your loss might actually be to your tax advantage, because it could reduce your other taxable income in that year or in future years. Simply fill out and attach IRS Form 3621.
Q: What is “depreciation”?
A: When a business asset has a useful life of more than year, the IRS will give you a tax break corresponding to its loss in value as the asset wears out over time. The amount of the deduction and the length of time you must take them depends on how the property is classified within the tax code.
Q: Do I need prior IRS approval/registration before starting my own business?
A: If you’re a sole proprietor without employees, no. You can use your own Social Security number when filing taxes. However, if you have one or more employees, OR if you’re starting a business entity (partnership, LLC, corporation, etc.) you must get a federal Employer Identification Number (EIN) at the beginning of your operation. This can be obtained by filing IRS Form SS-4.
Ted Lanzaro is the
founder of Lanzaro CPA, LLC, a boutique tax consulting firm specializing in
small businesses and the real estate and construction industries. For more
information about CPA Ted Lanzaro, check out his website at www.lanzarocpa.com and www.taxcpact.com.
What Should I Investigate When Buying A Business?
Due Diligence
When purchasing a business, it’s certainly best for both parties if things go as smoothly as possible. As the buyer, it’s your job to do “due diligence,” which means reviewing certain documentation from the seller to verify income and expenses and make sure no liabilities from the previous owner will become your responsibility.
Here’s what you’ll want to look into:
When purchasing a business, it’s certainly best for both parties if things go as smoothly as possible. As the buyer, it’s your job to do “due diligence,” which means reviewing certain documentation from the seller to verify income and expenses and make sure no liabilities from the previous owner will become your responsibility.
Here’s what you’ll want to look into:
- Tax returns. Get copies of all business income and employment tax returns for the last three years. You must be sure that the seller has paid all his or her taxes.
- Personal credit reports. Be on the lookout for tax liens filed against individual shareholders. You want to get personal credit reports from all selling shareholders.
- Public, UCC and state records. The IRS doesn’t always file lien notices on tax debtors, but it’s always good to check public records before buying. Look for federal and state tax liens. You can get state info by sending Form UCC-3 to your Secretary of State’s office (there may be a fee).
- A signed Tax Information Authorization (Form 8821) for the individual shareholders as well as the business. Sure, they may seem nice, but not everyone is going to be square with you about all their personal documentation. Make sure your purchase agreement requires the seller to give you a signed copy of Form 8821 for the business and the individual shareholder(s). This way you can access the seller’s IRS tax records and know without a doubt that they’re not trying to hide anything.
Ted Lanzaro is the
founder of Lanzaro CPA, LLC, a boutique tax consulting firm specializing in
small businesses and the real estate and construction industries. For more
information about CPA Ted Lanzaro, check out his website at www.lanzarocpa.com and www.taxcpact.com.
Buying the Assets of a Business – Unincorporated vs. Small Business Corporations
When buying a business, it’s important to know the tax implications that
purchase contract might have. Maybe you’ve been eyeing up that restaurant on a
popular corner of the street because you think it would be the prime location
for your florist shop. But what happens to all of the restaurant’s assets during
the business transfer?
Most businesses are just a conglomeration of assets. However, depending on the type of venture –incorporated vs. unincorporated, for example – there will be different tax consequences to your purchasing contract.
Unincorporated Business Debts
Most contracts don’t include any business-related liabilities. The seller is usually required to pay all debts before closing the deal. However, if any of the individual assets of the business (e.g. equipment) have debts attached to them, the new owner could be responsible.
Tax debts, on the other hand, are never transferred with the business. The only way a buyer would need to worry about a seller’s tax debts is if the IRS or state agency files a tax lien before the business transfer. Typically, a lien release would be required prior to the closing of the business purchase or sale.
Small Business Corporation Debts
If you’re planning to buy an incorporated business, you’ll need to watch out for tax liability. Keep in mind:
Overall, there are usually tax consequences attached to a business sale. Whether it’s a sole proprietorship or an incorporated business, it’s never a bad idea to talk to a tax professional before starting the buying process.
Most businesses are just a conglomeration of assets. However, depending on the type of venture –incorporated vs. unincorporated, for example – there will be different tax consequences to your purchasing contract.
Unincorporated Business Debts
Most contracts don’t include any business-related liabilities. The seller is usually required to pay all debts before closing the deal. However, if any of the individual assets of the business (e.g. equipment) have debts attached to them, the new owner could be responsible.
Tax debts, on the other hand, are never transferred with the business. The only way a buyer would need to worry about a seller’s tax debts is if the IRS or state agency files a tax lien before the business transfer. Typically, a lien release would be required prior to the closing of the business purchase or sale.
Small Business Corporation Debts
If you’re planning to buy an incorporated business, you’ll need to watch out for tax liability. Keep in mind:
- You won’t automatically assume a corporation’s liabilities if you buy only their assets.
- If you buy the corporation’s stock, you may be responsible for all assets and liabilities including unknown taxes.
Overall, there are usually tax consequences attached to a business sale. Whether it’s a sole proprietorship or an incorporated business, it’s never a bad idea to talk to a tax professional before starting the buying process.
Ted Lanzaro is the
founder of Lanzaro CPA, LLC, a boutique tax consulting firm specializing in
small businesses and the real estate and construction industries. For more
information about CPA Ted Lanzaro, check out his website at www.lanzarocpa.com and www.taxcpact.com.
Can Incorporating Fringe Benefits Offer Tax Relief?
If you’ve ever worked a salaried position, you’ve probably enjoyed “fringe
benefits” that came with the job. However, that term is generally pretty vague,
and for the new business owner, it’s one that’s definitely worth exploring.
Essentially, fringe benefits are the things that a business can offer to its employees above and beyond their salaries and bonuses. Medical insurance, dependent care assistance, or 401(k) plans, for example.
Fringes can be beneficial to both the employee and the employer. For the business owner, fringe benefit expenses are usually tax-deductible. For the employee, they’re often untaxable, or at least taxable at an advantageous rate.
However, they may be any of the following:
The best range of fringe benefits (tax breaks thereof) is available to C-corporations, assuming the business is profitable. However, there are numerous benefits that are valuable to small businesses as well. The most popular by far are health and retirement plans, but other fringes such as business meals and travel can also serve as benefits to a small-business agenda.
Essentially, fringe benefits are the things that a business can offer to its employees above and beyond their salaries and bonuses. Medical insurance, dependent care assistance, or 401(k) plans, for example.
Fringes can be beneficial to both the employee and the employer. For the business owner, fringe benefit expenses are usually tax-deductible. For the employee, they’re often untaxable, or at least taxable at an advantageous rate.
However, they may be any of the following:
- Tax-free
- Partially tax-free
- Tax-deferred
- Fully taxable in the year provided
The best range of fringe benefits (tax breaks thereof) is available to C-corporations, assuming the business is profitable. However, there are numerous benefits that are valuable to small businesses as well. The most popular by far are health and retirement plans, but other fringes such as business meals and travel can also serve as benefits to a small-business agenda.
For more information on
what kind of fringe benefits would be most tax-advantageous to your small
business, contact Ted Lanzaro at 203-922-1742 or ted@lanzarocpa.com.
Ted Lanzaro is the
founder of Lanzaro CPA, LLC, a boutique tax consulting firm specializing in
small businesses and the real estate and construction industries. For more
information about CPA Ted Lanzaro, check out his website at www.lanzarocpa.com and www.taxcpact.com.
Can Incorporating Fringe Benefits Offer Tax Relief?
If you’ve ever worked a salaried position, you’ve probably enjoyed “fringe
benefits” that came with the job. However, that term is generally pretty vague,
and for the new business owner, it’s one that’s definitely worth exploring.
Essentially, fringe benefits are the things that a business can offer to its employees above and beyond their salaries and bonuses. Medical insurance, dependent care assistance, or 401(k) plans, for example.
Fringes can be beneficial to both the employee and the employer. For the business owner, fringe benefit expenses are usually tax-deductible. For the employee, they’re often untaxable, or at least taxable at an advantageous rate.
However, they may be any of the following:
The best range of fringe benefits (tax breaks thereof) is available to C-corporations, assuming the business is profitable. However, there are numerous benefits that are valuable to small businesses as well. The most popular by far are health and retirement plans, but other fringes such as business meals and travel can also serve as benefits to a small-business agenda.
Essentially, fringe benefits are the things that a business can offer to its employees above and beyond their salaries and bonuses. Medical insurance, dependent care assistance, or 401(k) plans, for example.
Fringes can be beneficial to both the employee and the employer. For the business owner, fringe benefit expenses are usually tax-deductible. For the employee, they’re often untaxable, or at least taxable at an advantageous rate.
However, they may be any of the following:
- Tax-free
- Partially tax-free
- Tax-deferred
- Fully taxable in the year provided
The best range of fringe benefits (tax breaks thereof) is available to C-corporations, assuming the business is profitable. However, there are numerous benefits that are valuable to small businesses as well. The most popular by far are health and retirement plans, but other fringes such as business meals and travel can also serve as benefits to a small-business agenda.
For more information on
what kind of fringe benefits would be most tax-advantageous to your small
business, contact Ted Lanzaro at 203-922-1742 or ted@lanzarocpa.com.
Ted Lanzaro is the
founder of Lanzaro CPA, LLC, a boutique tax consulting firm specializing in
small businesses and the real estate and construction industries. For more
information about CPA Ted Lanzaro, check out his website at www.lanzarocpa.com and www.taxcpact.com.
Cash vs. Accrual Basis Accounting
When you start a business venture, you’ll have to choose an accounting method
for recording income and expenses. Generally, your method is elected in the
first year of business as either the cash or the accrual
method.
The Cash Method
This system is used mostly by businesses that sell services rather than goods, and refers to any kind of payment – checks, credit card, etc. – not just literal cash.
It’s pretty simple: income and expenses are recorded when they are paid. You can prepay an expense, as long as it’s not more than 30 days in advance. For example, if you pay your building’s January 2014 rent on December 23, 2013, you’ll get the deduction for 2013.
There are some tax rules to the cash method that you should look out for, particularly one called constructive receipt:
The accrual method is a bit more complex. In order to stay organized and out of trouble, I would suggest that you consult a tax professional that is familiar with your industry before setting up an accounting system for your business.
The basis of the accrual system is this:
Hybrid Methods
Perhaps your business sells both goods and services. For this type of venture, it makes sense to use a combination of the cash and accrual systems.
Overall, it is important to study up on the rules laid down by the IRS when keeping the books for your business. Once you choose an accounting method on your tax return, you must check the same box in all subsequent returns unless the IRS grants you permission to switch to a different system. (Note: IRS permission is not required if there is a fundamental change in the way your business operates – i.e. If you currently stock inventory but switch to a repair company, or vice versa.)
The Cash Method
This system is used mostly by businesses that sell services rather than goods, and refers to any kind of payment – checks, credit card, etc. – not just literal cash.
It’s pretty simple: income and expenses are recorded when they are paid. You can prepay an expense, as long as it’s not more than 30 days in advance. For example, if you pay your building’s January 2014 rent on December 23, 2013, you’ll get the deduction for 2013.
There are some tax rules to the cash method that you should look out for, particularly one called constructive receipt:
- Items must be counted as income as soon as they are available or credited to you, even if you don’t take them. For example, you can’t wait to deposit a check from a client until the next fiscal year if the funds are available to you at the time they gave you the check.
- A deduction can’t always be taken in the year the item was paid for if it is not yet received. You may buy a two-year magazine subscription, but the expense will be prorated over those two years rather than at the time you bought the subscription.
The accrual method is a bit more complex. In order to stay organized and out of trouble, I would suggest that you consult a tax professional that is familiar with your industry before setting up an accounting system for your business.
The basis of the accrual system is this:
- Income is considered received when it is earned, regardless of when it was actually received.
- Expense is recorded and deducted at the time the obligation or contract was made, even if it isn’t paid until later.
Hybrid Methods
Perhaps your business sells both goods and services. For this type of venture, it makes sense to use a combination of the cash and accrual systems.
Overall, it is important to study up on the rules laid down by the IRS when keeping the books for your business. Once you choose an accounting method on your tax return, you must check the same box in all subsequent returns unless the IRS grants you permission to switch to a different system. (Note: IRS permission is not required if there is a fundamental change in the way your business operates – i.e. If you currently stock inventory but switch to a repair company, or vice versa.)
Ted Lanzaro is the
founder of Lanzaro CPA, LLC, a boutique tax consulting firm specializing in
small businesses and the real estate and construction industries. For more
information about CPA Ted Lanzaro, check out his website at www.lanzarocpa.com and www.taxcpact.com.
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