What to consider when keeping business records.
Except in a few cases, the law does not require any specific kind of records. A Corporation (C-Corp or S-Corp) should keep minutes of board of directors’ or officer meetings even if this is a “one-person” operation. You can choose any record keeping system suited to your business that clearly shows your income and expenses. If yu are in more than one business, you should keep a complete and separate set of records for each business. For many small businesses, the business checkbook or credit card statement is the main source for entries in the business books. In addition, you must keep supporting documents, supporting documents include sales slips, cash register tapes, paid bills, invoices, receipts, deposit slips and canceled checks to name a few. Keep in mind a proof of payment of an amount, by itself, does not establish you are entitled to a tax deduction. (This information is expressed in IRS Publication 583).
How long to keep these records? In general, keep the above mentioned records and supporting documents for 7 years after the completion of a transaction. This question has several correct answers, such as businesses with employees are required to keep employment tax records for at least 4 years after the date the tax becomes due or is paid. If we are to list the common scenarios and the holding period for each you would notice 7 years is the longest of each, therefore, instead of remembering several holding periods we default to the longest of 7 years. This of course does not hold true for fraudulently filed returns or when no return is filed; there is not a statute of limitation for these events.
Required documents of a business are as follows. Articles of Incorporation are often the first formal step that is filed with the Secretary of State once a business decides to become a corporation. In contrast, if the business chooses to register as a Limited Liability Company (LLC) than Articles of Organization will be filed with the Secretary of State.
Corporate Bylaws are not mandatory in all states, but play a role in organizing and managing the corporation and therefore are often considered worthwhile. Bylaws might include committee functions or rules or circumstances for changing the business model. Additionally, a corporation should meet periodically (at least annually) and the schedule and functions of these meetings can be addressed in the Bylaws, including rules on notifications and attendance. It is clear to see how corporations with various owners would benefit from carefully written Bylaws.
Similar to the corporate Bylaws, LLC Operating Agreements will describe how an LLC will be managed including voting rights and responsibilities, or how profits are to be distributed. Operating Agreements establish legal guidelines in the event of disagreements between owners. When an Operating Agreement is in place, courts will respect its provisions and allow the owners of the LLC to make formal decisions concerning the company.
How do I know who I should be issuing 1099-Misc forms to each year?
Many clients wait until the end of the year to start the process of determining who should receive a 1099-Misc. The process is easier if you start much earlier. It is not always apparent who will be paid more than $600 during a single year for services or contracted labor, but if it’s likely we suggest you ask the recipient of the payments to complete Form W-9 before the project starts or at the very latest before issuing them any payments which will exceed the $600 amount. Taking an on-going approach to this gathering of ID numbers and addresses will result in a much smoother process at year-end.
How does my business compare to other similar types of businesses?
It is helpful to know if your business’ expenses are reasonable, but who can you ask? The IRS uses bizstats.com and maybe you would like to also. It’s a free service that you can use to find out whether your business has similar financial ratios as businesses in similar industries.
Do I have a Business or do I have a hobby?
There are a lot of would-be artists and novelists out there who need to determine if they are in a business or simply have revenue from the sale of a book, picture or painting and do not intend to earn their living or operate a business, but merely sell the products of their hobby. Ordinary and necessary business expenses are treated differently then expenses incurred for a hobby. If this is applicable to you, please make and appointment with us to discuss the specifies.
What do I need to know about financial statements?
The main financial statements which are important to your business are:
– Balance Sheet (a reflection of the financial condition of the business at a specific point in time i.e., December 31, 2014)
– Income Statement also known as Profit and Loss Statement (this is a summary of the income less the expenses to show the net profit or loss for a period; these statements are for a period of time, usually a month or year)
– Cash Flow Statement (business owners are usually well aware of their cash flow, but this statement will quantify your cash position during a specific period of time allowing you to know the amount of cash you have increased or decreased over the period covered by the statement)
Business owners should have a basic understanding of each of these statements. When compared with statements from prior periods, you can determine whether something is happening in your business that needs your special attention. We can help you understand your financial statements if you are not clear how to read them or use them to help you in your business management decisions.
How can I have profits and owe taxes if I have No Cash to show for it?
I recently read a blog by Rosyan Anyanwa “Where did my profit go?” She wrote a nice summary of why profits don’t equal cash.
The most important fact to remember about Profit is that, Profit has no connection to how much Cash is in the bank. A Profit and Loss Statement shows the movement of transactions, which occur in your Business for any given period (monthly), and the total net effect of these transactions constitute the balance that you see on your reports. An Example is when you enter a Business transaction, and an invoice amount of $3,000 is created in your Books, your Profit and Loss Statement shows the Sale and Resulting Net Profit, but there is NO CASH, until the invoice is paid; this money remains in your Account, only for a period of time, because when you pay your vendors or make your Bill Payments/Loan Payments, the money is being used up. Let’s take a Loan Payment as another example; Most Business Owners forget that only the interest portion of a Loan Payment appears on a Profit & Loss Statement, while the Principal portion of the transaction occurs on the Balance Sheet. In this case, another portion of profit has been used to pay the principal.
She concludes by saying,
It’s not Magic . . . it’s just having a basic understanding of how transactions occur in your Business and its effect on your Profit & Loss Statement, as well as your Balance Sheet. The Ultimate Goal is to make better financial decisions.
What is meant by Reasonable Compensation for S-Corporation owners?
Shareholders who provide services to the S-Corporation, he or she is required to receive an adequate or reasonable amount of compensation for those services. The SCorporation may deduct the compensation expense and must pay the employer share of employment taxes (6.2% Social Security tax FICA, 1.45% Medicare tax, Federal Unemployment Tax Act (FUTA) and state unemployment taxes). Minimizing these taxes provides an incentive to keep the S-Corporation shareholder’s wages low and to characterize most of the pass-through income as distributions. However, the IRS has the authority to reclassify dividends, distributions or payments to the shareholder-employee, including loan repayments, as compensation if they deem compensation inadequate or unreasonable. Thus we want to consider the following factors to determine reasonable compensation: experience and training, responsibilities and duties, time and effort devoted to the business and comparable businesses pay for similar services or compensation agreements are just a sample of the factors we use to determine a reasonable compensation. We suggest documenting all research performed to support the amount claimed as compensation determined and how it was calculated (i.e., include this in your corporate minutes and/or personnel file).
I don’t want to depreciate part of my personal residence, but I want to take advantage of a Home Office what are my other choices?
Beginning in 2013, a Simplified Option for Home Office Deduction is available to taxpayers figuring the deductable amount for business use of their home. The new Simplified method allows for a standard deduction of $5.00 per square foot of home use for business with a maximum 300 square feet ($1500 per year limit). This deduction may appear to be lower than anticipated, but the new rule also allows for a full deduction allowable of home-related expenses on Schedule A Itemized Deduction without the need to pro-rate mortgage interest or real estate taxes to the home office. Additionally, no home depreciation deduction will be taken in the current year or later recaptured of depreciation for the years the Simplified Option is used upon sale of the home. Note: This Simplified Option does not change the criteria for who may claim a home office deduction. It merely simplifies the calculation and record keeping requirement of the allowable deduction.
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