Posted by Administrator on March 28, 2011 under Accounting, Tax | 
To Depreciate or not, that is the question.
Whether ‘tis nobler in the mind to suffer
The slings and arrows of numerous assets,
Or to take arms against a sea of expenses.
If there were a list of buzzwords that were most commonly used by non-accountants to showcase their accounting knowledge, capitalize and depreciate would be near the top. Business owners and bookkeepers are sometimes obsessed with these concepts. However, I often find that they do not fully understand the concepts.
Most companies set a dollar limit on what items they will expense and what items they will capitalize and depreciate. The most common range I see is between $500 and $1,000. Larger companies will even set $5,000 limits. The thought process behind setting these limits is related to a cost/benefit analysis. Depreciating assets below the range will create an unmanageable list of assets which will require time and effort that are better spent elsewhere. Not depreciating assets, beyond this range will rouse the unwanted attention of the IRS.
The truth is that the concept behind capitalizing and depreciating assets lies in a core principle of accounting known as the Matching Principle. In a nutshell, the matching principle puts forth the concept that revenues and expenses should be matched to the period in which they should be recognized to reflect the most accurate financial picture. For example, if ABC Co decides to pay a full year of rent in January, the expenses should be broken out and allocated for each month of the year. This better represents when the expenses are relevant.
US GAAP and IRS regulations require companies to capitalize and depreciate assets which have a useful life of more than one year. In some ways the dollar value is inconsequential. The idea behind depreciating your work computer is that you will probably have it for at least three years. Therefore you should allocate the expense equally over those three years. Most business assets are used for the purpose of producing revenue. The matching principle tries to match the marginal revenue produced by its assets to the marginal expenses associated with that asset for the same period.
Does that mean you should depreciate every stapler and pair of scissors you buy? The practical answer is no. It would be prohibitively unproductive to do that. That is why most companies set a minimum dollar value for depreciable assets or group assets by similar useful lives.
When it comes time to decide what minimum dollar limits you will set for your company, don’t get too hung up on the dollar value. Keep in mind that the IRS expects you to depreciate all assets with a useful life of more than one year. The best bet is to figure out a policy that makes sense for your business and work with a tax professional to make sure you are in compliance.
Posted by Administrator on under Accounting, Tax |
Tax payers often ask the million dollar question:
“What types of things will trigger an IRS audit?”
The truth is that there are some things we know will trigger an audit, but there is also a sufficient amount of magic that happens behind the scenes which we don’t know. The IRS uses a computer program called the Discriminate Inventory Function System (DIF) to screen tax returns for anomalies. The ones that fall within a certain range pass through and we all breathe a sigh of relief. However, for the chosen few an adventure awaits. These brave souls must slay the IRS dragon or risk losing their fortune for the greater good.
Three Things You Can Do to Avoid an Audit
Whatever you do, don’t spit in the wind. You should always report your income. If you have received K-1’s, 1099’s and or W-2s, you should make sure to keep track of these documents and add them up to make sure the income you report is equal to or greater than the income reported to you on these documents. When these documents are issued by 3rd parties to you, they are also issued to the IRS. They know you received at least that much in income and they are expecting to see it on your tax return.
Another way to avoid triggering an audit is to make sure your lifestyle matches the tale of misery and woe you spin to the IRS. The IRS agent reviewing your return may hard it find to sympathize with the picture of a poor and meager existence you painted on your return if you’re living like the Beverly Hill Billies. Uncle Jed and Jethro may not have been too sharp, but I bet they were at least smart enough to know that it takes some serious cheddar to live in a mansion in Beverly Hills. Guess what? So does the IRS.
Last and certainly not least, don’t let the pressures of procrastination and the angst of the unknown cause you to make careless mistakes. The scarecrow got lucky when the wizard behind the curtain gave him a brain and sent him on his merry way. Take my word for it, there is no wizard behind the IRS curtain and they are certainly not giving out brains. Make sure your return is free of errors. This can be done by using good tax software. Better yet, bite the bullet and hire a good tax accountant. Yeah it’s going to cost you a pretty penny, but you will at least know where you stand. An auditor, on the other hand, is the gift that keeps on giving. They may decide your return is interesting enough to open up previous tax years.
Let sleeping dogs lie the old adage says. This is especially true when it comes to the IRS.
Posted by Administrator on under Accounting, Tax |
Many of our clients operate their business in the form of a limited partnership. Partners record their equity, or ownership in the partnership through their capital accounts. Partners pay taxes on profits and not on the cash they draw from their capital account. It is entirely possible to pay taxes on profits for the year without ever having drawn a penny out of the account. This concept can sometimes be confusing, especially around tax time.
One of the questions we sometimes hear from our clients is “Why am I paying taxes when I didn’t receive any money?”
One way to think about a partner’s capital account is to think of it as a bank account. The partner usually opens the account by putting money into it. The partner can also draw money on the account as long as the account is positive. If the partner draws out too much money then the ‘bank’ account goes negative and the partner owes money to the partnership. All this can be done without any tax consequences because the partner is just putting in or taking out his or her own money.
However, the partnership can also make deposits and withdrawals on this bank account as well. It does this by allocating profits when times are good and losses when times are not so good. When the partnership deposits profits into the bank, the partner must pay taxes on this money. When it’s a loss, the partner can take the loss on his or her personal taxes. These profits and losses must be taken regardless of whether the partner chooses to draw money on the account because this money was added or removed by the partnership and not the individual partner.
The rule of thumb is as follows: If the partner deposits or withdraws money, it is generally a non-taxable event. If the partnership deposits or withdraws money into the individual partner accounts then it is a taxable event.
Keep in mind one last concept. Losses are not always a bad thing. Losses from a partnership can be used to offset income for the tax year and reduce the partner’s personal tax liability to the IRS. With a little tax planning and good professional advice, partnership income and losses can be used to smooth out good years and lean years.
Posted by Administrator on under Accounting, Tax |
Business owners typically wear a lot of hats. They are the sales person, the CEO, the human resources manager, the accountant, and occasionally the psychotherapist. Some of the clients that we meet engage our services, because they just can’t keep their heads above water anymore. The daily demands of the business have stretched them beyond the capacity to keep up with the accounting and tax compliance requirements needed to keep the business out of trouble.
The goal of accounting is to provide accurate, complete, and timely information to the stakeholders of the business. The owner needs this information to understand if the business is profitable, keep expenses under control, and plan for the short and long term. Banks and other lending institutions will evaluate the financials to evaluate the risk associated with lending money to the business. The IRS uses the information to determine compliance with tax laws and regulations.
Most of our clients understand the importance of keeping a good set of books and are have retained our services to help them stay on top of accounting and tax issues. However, we also occasionally meet business owners that want to go it on their own or just don’t see the importance of having a tax or accounting professional on staff or on retainer. At the bare minimum, we recommend having a good bookkeeping resource available. We like to advise our business owners to spend their precious time doing what they do best … making money and realizing ideas!
In the tradition of the comedian Jeff Foxworthy, I offer the following guidelines to help business owners determine that it is time to engage the services of a tax and accounting professional.
If the words “Bank Reconciliation” remind you of the time you talked your banker out of charging you overdraft fees …. You might need an accountant.
If you are on a first name basis with several people at the IRS … You might need an accountant.
If your idea of keeping books is to figure out whether or not to hold on to that copy of Accounting for Dummies … You might need an accountant.
If your balance sheet is more BS than B/S … You might need an accountant.
Posted by Administrator on under Tax |
It is important to file tax returns and pay taxes due on a timely basis. The IRS will assess penalties and interest until the returns are filed and the taxes are paid. There are basically three ways the IRS can penalize late filers.
1. Failure to file penalty
2. Failure to pay penalty
3. Interest
Depending on the type of return which is being filed, there are a couple of different ways it can play out.
Individuals and corporations that do not file a timely tax return must pay a penalty of 5% of the tax not paid by the due date for each month or part of a month that the return is late. This penalty cannot be more than 25% of your tax, but it is reduced by the failure-to-pay penalty for any month both penalties apply. However, if your return is more than 60 days late, the penalty will not be less than $100 or 100% of the tax balance, whichever is less.
Individuals and corporations that do not pay the tax when due may be also be penalized 1/2 of 1% of the unpaid tax for each month or part of a month the tax is not paid, up to a maximum of 25% of the unpaid tax.
Partnerships are a little different since they do not pay income tax directly. The taxes are paid by the partners on an individual basis. However, a penalty may be assessed against the partnership if it fails to file the return by the due date. The penalty is $89 for each month or part of a month (for a maximum of 12 months) the failure continues, multiplied by the total number of persons who were partners in the partnership during any part of the partnership’s tax year for which the return is due.
In addition to the penalties described above, the IRS may also charge interest on the unpaid portion of the tax due. The interest is calculated for each day your balance due is not paid in full. The interest rate used to determine interest charges changes quarterly with federal interest rates.
The IRS may work with tax payers to abate penalties if the tax payer can show just and reasonable cause for late filing or late payment. However, it will not abate interest unless there are extraordinary circumstances in which the tax payer can prove the IRS was at fault.
Posted by Administrator on under Accounting, Tax |
The most important thing any business owner can do to get the best results from a tax preparer is to keep accurate, complete and timely records. The tax preparer has a duty to report income to the IRS. It is up to the taxpayer to provide the details about the deductions.
Some of the more important items a taxpayer can provide are listed below:
- Financials / QuickBooks files;
- Ownership changes;
- Asset changes; and
- 1099’s and K-1s
Financial Statements are great, but QuickBooks (QB) files are better. Providing access to the QB files allows the tax preparer to make end of year journal entries and clean up erroneous or redundant bookkeeping entries. This also allows the tax preparer to investigate unexpected changes to beginning balances for the tax year.
Changes in ownership provide crucial information for partnerships and other flow through entities. These types of entities allocate profits and losses to the individual partners, members, and shareholders. The tax preparer issues K-1s to these individuals and reports this information to the IRS.
Records of asset changes prompt the tax preparer to consider the tax effects. Fixed assets should be capitalized and depreciated according to IRS rules. The purchase price of new assets determines the basis from which depreciation will be determined. The tax payer must also consider short and long term capital gains treatment of assets that are sold at a gain or loss.
The IRS requires businesses to issue 1099’s to report taxable income paid to third parties for services rendered. Similarly, K-1s are issued to report taxable income gained from partnership interests. The tax preparer compares this information to the financial statements to make sure it corresponds to the information reported to the IRS.
Providing a tax preparer with accurate, complete, and timely records equips the tax preparer with the information to be able to recognize tax savings opportunities as well as potential pitfalls.
Posted by Administrator on under Tax |
Tax legislative changes can be stressful for taxpayers, but occasionally the news is good. Here are a couple of items that should help ease the stress.
The good news for 2011 is that the Bush tax cuts will remain in place until 2012 and depreciation rules have been expanded and extended.
The tax rates for 2011 begin at 10% and cap out at 35% for high income earners.
This will have a direct impact on business owners that operate in pass-through tax entities like Limited Partnerships, LLC’s, and S Corps. These types of business entities do not pay income taxes directly. The profits of the business are allocated to the partners, members, or shareholders through the issuance of a K-1 and each individual is taxed based on his or her share of the profits.
Business owners will also be able to take advantage of Bonus Depreciation and increased Section 179 expensing limits. The bonus depreciation extension allows a taxpayer to deduct 50% of the adjusted basis of qualified property placed in service in 2010 (and 2011 for certain aircraft and long term production property).
Bonus depreciation qualified property includes:
- Property which can be depreciated under MACRS;
- Has a recovery period of 20 years or less;
- Some types of computer software; and
- Qualified leasehold improvement property.
Section 179 allows taxpayers to elect to expense certain qualified property rather than requiring the property to be capitalized and depreciated over the useful life of the property. This has the effect of deducting the entire expense immediately and thereby reducing taxable income by the expensed amount in the current tax year.
For 2010 and 2011 the limits have been increased to $500,000 of qualified property for items placed in service in those years. This amount is phased out, dollar for dollar, of the amount of property placed in service, in the same year, which exceeds $2,000,000. Additionally, up to $250,000 of the property can include qualified real property such as qualified leasehold improvements, restaurant property and retail improvements.
