3 MIN READ
With 2020 officially in the rearview mirror (see ya never!) and our sights set on 2021, it's time to start thinking about fresh starts, new beginnings, and, of course, taxes 😉. I recently sat down with XY Tax Solutions Senior Tax Manager, Michael Law, to get an insider's perspective on how to ensure your books are ready for tax preparation. Together, we've answered some of the most frequently asked questions on the topic.
What would you suggest clients do for year-end tax planning?Do a year-end review by printing off your income statement and balance sheet. Add any income you still expect to receive and subtract any expenses you expect to pay to arrive at potential taxable income. Now is also a good time to consider things you may want to do for tax purposes. Is it a good time to buy assets to deduct and shelter income? Or would those deductions be a better tax benefit next year? As an RIA consider your retirement plan contributions; if you have an S corp, consider if you have paid yourself an adequate salary.
What is the most important thing a financial planner can do to prepare their books for you?Make sure all entries are made when providing the books. There is nothing more frustrating to a tax preparer than getting several revisions to the books while trying to prepare the returns. Look through the accounts. You don’t need to be an expert bookkeeper to recognize errors. If it doesn't feel right, then it probably isn’t.
In small businesses, it is too common to use personal accounts for business deductions and business accounts for personal deductions. It's incredibly helpful to go through the entries to remove the personal deductions and make sure the business deductions paid from personal accounts are recorded. Finally, check that new vendors get deducted correctly. Sometimes a new vendor is treated as a personal expense when it should be deductible because it was not recognized as a business vendor. Review the personal draws/distributions account to make sure no business deductions were treated as draws.Oh, and just because a payment was made from a business account does not make it a business deduction.
When preparing taxes, what are the common mistakes you see that could easily be avoided? What do you normally do to fix them?
Most common mistake: going too fast to get the return done and not doing a complete job. Forgetting income or deductions because they were not captured in the accounting records. Not keeping up with the tax law and treating something a way that was acceptable in the past but isn't acceptable now. Bartering and other non-cash transactions are hard to record in the books but may still be taxable events. Forgetting changes that occur from a prior year (which means addresses or dependents may change). The list goes on...
Changes in ownership are not usually reflected in the books, so a return would miss that unless the preparer was tipped off somehow.
For S corps with multiple owners, the requirements for cash distributions to be based on share ownership need to be carefully monitored. This is not just the cash paid to the owners, but expenses paid as draws that are personal in nature and not deductible by the S corp. A corrective distribution is needed to balance the shareholders.When the taxpayer has several businesses, make sure the deduction is recorded on the right entity. This is cleaned up by recording due to and due from the related entities to move a deduction to the right place.
If the changes are not identified during preparation of the return and an insufficient review of the return was done, then the return will be filed with errors and may need to be amended.
What do you suggest when a client has personal and business expenses combined in their books?
The client needs to identify them as personal. Hopefully they were recorded as a personal expense category. This is an area where providing the receipts to the tax preparer would bring out some of those personal expenses. Uniforms (including medical scrubs or construction protective clothing) are deductible; regular streetwear clothing is not. I have seen receipts for more personal items or subscriptions that are clearly not business related for the taxpayer in question.
Travel and meals are a little harder for the tax preparer or bookkeeper to identify as personal. The assumption is by including the deductions in the business accounting, these are business-related deductions. Tax preparers do not audit the deductions as part of our service so taxpayers need to be careful to only claim legitimate deductions.
How should members handle expenses that are paid for with a forgivable PPP loan?
This is an area of considerable concern among preparers right now. The loan amounts may not be forgiven, which would make them deductible. Some members of Congress say the IRS is incorrect in that the deductions are not deductible. Many practitioners are putting all clients with PPP loans on extension to allow Congress to make it clear by law that the amounts are deductible. The language in the IRS interpretation right now says to reduce the specific expenses paid. Thus the loan was recorded as a debit to cash and credit to PPP loan, and the expenses were recorded as a credit to cash and debit to expense paid. The debt forgiveness would be a debit to loan and credit to the expense in 2020 even if the forgiveness does not occur until 2021.
What assets should appear on the balance sheet versus expenses on the P&L? What differentiates them? Expense versus depreciation?
For clients without audited financial statements, the IRS allows immediate purchases of less than $500 per item to be written off. If the state regulator requires accrual financial statements, they may want the assets recorded on the balance sheet regardless. Items capitalized (recorded on the balance sheet) can be expensed with depreciation or 179 election. Trying to balance both what the IRS allows for expensing and what the state regulators require is challenging.
Repairs can generally be deductible if they do not extend the useful life of the underlying asset.
At this point, you might be asking yourself why you need to review your books. Small business owners need to close their books at year end to properly file their income tax returns. Closing your books properly also ensures that your bookkeeping system is in good order and is generating accurate numbers to include in your tax return. Moreover, it gives you a comprehensive understanding of the health of your business.
Getting in the habit of reviewing these easy-to-generate reports will give you insight into how your business is really doing and set you up for success. Don’t be overwhelmed if you're not checking all of these boxes; take it one step at a time, and work through these tasks. If you’re still confused on where to start, get in touch with the Bean Team! We can help you make sense of your accounting and year-end needs.
About the Author
Like everyone else on the Bean Team, Account Specialist Cheryl Lewis gets a kick out of bookkeeping, so much so that she received her Bookkeeping Certificate from Gallatin College in Bozeman in 2015. Cheryl approaches bookkeeping like a puzzle, unraveling the books and uncovering the constants to work as efficiently as possible. In addition to her official certificate, she has years of bookkeeping experience under her belt, having previously specialized in landscaping construction and restaurant businesses. When not counting beans, Cheryl spends her time running, skiing, and just being outdoors, in true Montana fashion.