How Not to Keep Your Records

Here, in no particular order, are the five worst accounting systems that I have come across in my twelve years in public accounting:

  • The shoebox accounting system – this is a great idea if you want an extremely high bill from your tax professional. For the best results, have the receipts wrinkled up and mixed in no particular order, add random pictures of your pet or a recent vacation, and make sure you include some receipts from different years just to keep your tax professional on their toes.
  • The handwritten, single page summary of income and expenses – nothing instills confidence in a tax professional like a list of income and expenses with no backup that resembles a grocery list – especially when all the numbers are conveniently rounded.
  • Saving twelve months of banks statements for your tax professional – this is not really even an accounting system, but you would be surprised how many clients save twelve months of accounting input and reconciliation work for their tax professionals to complete during tax season. This is a good system if you enjoy finding a new tax professional each year.
  • The “is it personal or business?” accounting system – mixing your personal and business transactions in a personal finance software file is another winner with tax professionals as it creates hours of never ending trivia.
  • The “good intentions” accounting system – this disaster is often the result of an owner who bought a popular accounting software package with the great intention of getting training and assistance, but in the end just quickly input all the transactions and posted them haphazardly, leaving a big mess for their tax professional to sort out.

Hopefully you get the point from these examples – an accounting system has to be organized, detailed, accurate, and timely. This is can be done manually, with computers, or a mix of the two.

2013 IRS Inflation Adjustments – Tax Benefits and Pension Plan Limitations

While much is uncertain about what taxes will look like for 2013, at least we have a small measure of certainty with a few items. On Thursday, Oct. 18th, 2012, the IRS released IR-2012-77 and IR-2012-78, which contained a number of increased limits and benefits. Here are the main highlights:

  • Annual exclusion for gifts increases to $14,000 for 2013, up from $13,000 for 2012.
  • The 401k elective deferral limit for employees increases from $17,000 for 2012 to $17,500 for 2013. This also applies to 403(b), most 457 plans, and the federal Thift Savings Plan. The corresponding catch-up contribution for employees age 50 and over remains unchanged at $5,500.
  • If your 401k plan has profit sharing, the maximum employer contribution increases from $33,000 in 2012 to $33,500 for 2013.  This increases the maximum defined contribution limit to $51,000.
  • The SIMPLE IRA contribution limit increases to $12,000 in 2013, up from $11,500 in 2012. Like with the 401k, the catch-up contribution limit for SIMPLE plans remains unchanged at $2,500.

Partnership Late Filing Penalty Update

NEW – 2/2/14 – We have added a new updated blog post on this topic with downloadable sample letters.

My original blog post – Partnership Late Filing Penalty Abatement – is one of the most popular articles here on PDXCPA, and that is due the fact that the IRS has become more and more agressive in assessing this penalty over the years.  In fact, last year I encountered some new problems in requesting abatement of these penalties, so an update on the subject is well overdue.

  • First off, the base penalty amount has been increased to $195, so if you have a number of partners or members, this has become a very substantial penalty that seems to far outweigh the offense.
  • The IRS has been denying the standard abatement letters using Revenue Procedure 84-35 – especially for clients that have requested abatement several years in a row.  In priors years, the abatement had been fairly automatic, but last year they fought very hard in some cases to keep the penalties in place.
  • In talking to fellow tax practitioners from TaxQueries.com, I found that I was not being singled out by the IRS and that many others had received similar letters denying abatement and citing new arguments never raised before.
  • The most common new argument I encountered was that the IRS claimed that they could not consider our request for penalty waiver under Rev Proc 84-35 because their records indicated that the partnership elected to be subject to the consolidated audit procedures under IRC 6221 through IRC 6233.  Upon further inquiry, the IRS claimed that a TEFRA election (Form 8893) was filed in a prior year – usually about 10 years prior.
  • The IRS agents were very uncooperative with providing me with additional information, and they simply stated they would have to request a copy of the return from their records department.
  • Fortunately, my clients keep very good records and we pulled up copies of the return that the IRS claimed had a TEFRA election.  Sure enough, the return did not include Form 8893 or any other elections with regard to TEFRA.  After a lengthy phone call, they finally agree to abate the penalties if I faxed them a copy of the complete tax return in question.
  • In talking with the agent, I found that they had been trained on some new procedures earlier in the year, and the TEFRA election was something they were looking at on all abatement requests.  In this case, their records were simply incorrect regarding the TEFRA election, but had I not had a copy of the 10 year old return to prove that it was an error, the IRS might not have been willing to abate the penalty – especially since their records department had taken over a month without finding the return.

Over the next few months, the 2011 batch of late filing penalty letters will be mailed out, so it is important to be aware of some of these new tactics being employed by the IRS.  The standard abatement letter using Rev. Proc. 84-35 is something any business owner can prepare and send to the IRS in response to an initial late filing penalty letter.  However, if you get a denial letter citing a TEFRA election or another similar reason, make sure you engage a tax professional or lawyer to fight the IRS for you.  The IRS is no longer rolling over when they get abatement letters, so be prepared.

Obama vs. Romney Tax Policy Outline

The first 2012 Presidential debate will take place on Wednesday, and this time it will be focused on domestic policy.  One of the most important domestic issues right now is the “Fiscal Cliff” and tax reform that is long overdue.  I highly recommend you read through CCH’s outline of the tax policies of each candidate before Wednesday’s big event.  It was released back on 9/11/12 and provides great analysis that is easy to follow even if you are not a tax professional.

While actual tax reform will likely require a lot of compromise from both parties, it is good to have an understanding of both platforms, as ideas from each could end of shaping eventual reform in 2013 and beyond.

My guess is that most small business owners are a bit apathetic this election cycle, as we all know that some form of tax increase is just around the corner regardless of who wins the election.  After all, it is very likely that the 2% payroll tax holiday will be left to expire at the end of the year, and many high income taxpayers will have to starting paying the additional Medicare taxes resulting from the Health Care reform that the Supreme Court upheld in June.

Personally, I am a bit of a skeptic, as politicians have avoided substantial tax reform for years.  In fact, right now I am more interested in what Caleb Porter will bring to the Portland Timbers in 2013.  Tax increases will be a little easier to take if we make it to the playoffs next year. #RCTID

Be a Pig (Just Don’t Be a Hog)

My new book, The Pocket Small Business Owner’s Guide to Taxes, is scheduled to be released on 10/9/12!  The book is being published by Allworth Press and I have setup a new website to promote the book at www.BeAPig.com.

The book expands upon the content that I have written for this blog over the years and provides both in-depth and practical information for the small business owner.  The main focus of the book  is maximization of tax deductions, LLC and S corporation tax issues, and the tax and accounting essentials that you should understand.  If you have found the articles on this blog to be helpful, I think you will find this book to be a good resource and reference.

Check out the Be A Pig website to find out more.  You can also pre-order the book if you are interested.

Lastly, if you are on FaceBook, you can like the PDXCPA blog and My Book and stay current on all the latest updates and giveaways.

Portland City Council’s Tax Increase on Portland Rental Property Owners

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If you own multiple residential rental properties and at least one happens to be within the City of Portland, you may find yourself subject to a tax you have long been exempted from.

Prior to 2012, if an individual had fewer than 10 residential units, and it was their sole business activity, then they were exempt from both the Multnomah County Business Income Tax (MCBIT) and the Portland Business License Tax (PBL) regardless of gross income from the properties.  This was a great exemption for retired individuals with several rental properties that functioned their main source of retirement income, or a rental property owner that happen to be unfortunate enough to have a property within the city limits even though all their other properties were far outside of the Portland.  Unfortunately, politicians tasked with raising revenue often resort to eliminating exemptions like this one in order to avoid getting blood on their hands.

On June 6th, 2012, the Portland City Council, in their infinite wisdom, amended the Portland City Code and removed the exemption for individuals with fewer than 10 residential units.  This is retroactive change in that it is effective as of 1/1/12 even though we are more than half way through tax year 2012.  This means that if you have some profitable rental units that gross well over $50k, you will want to meet with your tax professional as soon as possible as you may want to start setting aside funds for this tax.  Fortunately, this is only a change for the PBL, and at this time there is still an exemption available for the MCBIT.

If you are unfamiliar with the two taxes, the MCBIT is a 1.45% tax and the PBL is 2.2%; however, both have a minimum tax amount of $100, so even if you have a really bad year, you are still going to pay $200.  There is an exemption if you gross income is less than $50k, but it is important to understand that this is based on your global gross income.  You could have eight rental properties in Bend, OR and only one in the City and still be subject tax since the gross rent for all nine properties is over $50k.  You only have to pay tax on the percentage of income earned within the City limits, but unfortunately not below the minimum tax amounts.

Most rental property owners with only a few units will fall under the $50k gross income exemption limit.  Those with more units or high value residential properties can expect to pay at least $200 each year and possibly much more depending on the profitability of your properties.  For retired individuals who own a number of residential units that are paid off, the tax due could be enough to make you want to go join the circus of protestors outside of City Hall.

If this applies to you, talk with you tax professional today and avoid an unwanted surprise at tax time.

Top 5 Bookkeeping Mistakes That Increase Tax Prep Fees

Are preventable bookkeeping mistakes resulting in large tax preparation fees for your business? Are you puzzled as to why your CPA or tax preparer has to make so many corrections to your accounting data? Below are the top five bookkeeping mistakes you need to be aware of as a small business owner, along with important tips on how to correct these mistakes.

Failure to Gross Up Wages

One of the most common adjustments that your CPA or tax preparer will likely make, aside from posting depreciation, is what we call “grossing up” the payroll. I know, it sounds a little weird, but it simply means that we adjust the total amount of wage expense on your books to match the gross wages on Form 940 and/or Form W-3. This adjustment is crucial, as a discrepancy between the W-3 and the annual business tax return could flag the attention of the IRS.

The problem is that most business owners and bookkeepers fail to post payroll correctly, which leaves a lot of work for their CPA or tax preparer at year-end. The commonly used shortcut of only posting net paychecks and payroll tax payments may save you input time, but if you spent just a few more minutes each time you input payroll, you could keep your books more accurate and reduce your tax preparation fees. Ask your CPA or tax preparer to create a standard entry for you, or have your payroll processor setup their general ledger interface service for you so that payroll data can be automatically imported into your accounting software.

Hiding Fixed Asset Purchases

As much as we enjoy a challenging puzzle, we prefer not to have to go searching for your fixed asset purchases in your profit and loss transaction detail. Some bookkeepers have become lazy about this in recent years because of bonus depreciation and high Section 179 depreciation limits, but regardless of the current depreciation rules, it is still important that fixed assets be properly recorded.

If you want to keep your tax prep fee low, post all capital expenditures over $200 – $500 (or more if you have a larger business) that will last longer than a year to a fixed asset account on your balance sheet. If you are not sure if a specific purchase qualifies, post it to the account anyway. Your CPA or tax preparer can always reclassify the cost if it is immaterial. Also, keep a file of supporting documentation, invoices, or receipts for all fixed asset purchases made during the year, as this makes tax preparation much easier.

Not Reconciling Balance Sheet Accounts

If you are simply inputting transactions and not at least reconciling the bank and credit card accounts, your accounting records cannot be relied upon for accuracy and you are leaving a lot of work for your CPA or tax preparer.

The reconciliation process catches duplicate entries, input errors, stale checks that need to be voided, and missing transactions. More importantly, the transactions are being tied out to a third party document, so your CPA or tax preparer can briefly review the reconciliation and the bank statement and reasonably accept the balance. Most accounting software packages have greatly simplified the reconciliation process, so you should not have an excuse for failing to reconcile all your bank and credit card accounts.

If you are a more experienced accountant and want to further reduce your tax prep fees, talk with your CPA or tax preparer and find out what other balance sheets should be reconciled each quarter or at year-end. For example, loan accounts can be reconciled to statements or amortization schedules, payroll liability accounts can be tied to payroll tax reports, and prepaid insurance accounts can be tied to billing statements.

Date Entry Errors in A/R and A/P at Year-End

QuickBooks and Peachtree have great report customization features that allow you to change a report from cash to accrual basis with one click; however, it will only work correctly if the transaction dates are input correctly. There is nothing worse than finding negative accounts receivable or payable balances on a cash basis balance sheet, and one of the most common culprits is a date entry error. If you date a payment before an invoice or a bill payment before the bill it is applied to, you are going to leave your CPA or tax preparer with some frustrating errors to correct.

The worst part is that A/R and A/P transactions take more work to correct in QuickBooks and Peachtree since customer or vendor names have to be used and multiple accounts cannot be adjusted in the same transaction. Even worse, reviewing the transaction history can be time consuming, and sometimes it can be a tangled mess to make sense of. Make sure you are reviewing your A/R and A/P Aging reports on a regular basis and investigating anything that does not look correct. A little extra work each month can save your CPA or tax preparer a lot of work at year-end and lower your tax prep bill.

Changing Prior Year Data

This is probably the greatest sin a bookkeeper can make, and unfortunately it happens far too often in small businesses. In fact, the first procedure we perform when starting the accounting work for a tax return is to look at retained earnings on the comparative balance sheet and make sure it matches the amount reported on the prior year tax return. If it does not match, it is outright frustrating for us, as we cleaned the books up last year and even sent the exported changes back, but somehow prior year transactions were changed, and now we have to find out what happen.

My recommendation is to password protect and close out the prior year after your tax return is completed and you have received the exported changes back from your CPA or tax preparer. At that point, the numbers are being reported to the IRS, so it is critical that the transactions not be changed. Unfortunately, in QuickBooks it is not always obvious that a transaction will affect the prior reported year, so the password protection works as a great reminder when inputting transactions during the following year. Plus, it protects against prior year changes caused by date entry errors.

Attention S Corporation and LLC Procrastinators

There is less than a month until the final extended deadline for 2011 S corporation and LLC tax returns, and it is crucial you file on time to avoid late filing penalties.  If you have not sent in your 2011 data to your CPA or tax preparer, you might want to work on it this weekend instead of enjoying the summer weather (or lack thereof if you are in Portland this morning).

I have written numerous posts about the S corporation late filing penalty that can only be abated if you have no prior late filing history, and the partnership penalty that the IRS has recently been making more difficult to abate.  If you have never read up on this topic or had to deal with this issue, please take a few minutes and click on the links above to read about the penalties, as they can amount to thousands of dollars in unnecessary, non-deductible costs for your business.

Even though there are automatic abatement procedures in place for entities taxed as partnerships, you should not assume that if it has worked for you in prior years that it will work in the future.  Last year, the IRS made changes to their internal procedures with regard to how they dealt with late filed partnership returns, and I had many abatements challenged or denied that had been approved in prior years.  You can read about some specific problems on my TaxQueries.com post, but I believe the IRS will continue making it more and more difficult for partnership filers that continue to file late each year.

Make finishing your 2011 accounting work a priority this weekend!  Not only will your tax preparer appreciate it, but not having potential penalties hanging over you is even better.

 

The Pocket Small Business Owner’s Guide to Taxes

I apologize for the lack of posts on PDXCPA in the last few months, and for getting behind on comments.  I was given the opportunity last July to write a book on taxes for small business owners, so for seven months I spent countless hours writing and re-writing the manuscript.  As soon as I was finished with that, tax season was upon me – so it has been a very busy year for me.

The good news is that the book, The Pocket Small Business Owner’s Guide to Taxes, is scheduled to be available on October 1st, 2012.  The book contains everything I always wanted to add in this blog and more.  It covers the basics that every small business owners should know, entity selection and tax considerations, and maximizing tax deductions.   The book is concise and practical, and much of the content comes from working in the trenches with small businesses owners over the years.

Stay tuned for more information on the book.  Also, I will also start working on some new content for this blog.  Thanks!

Deducting Convention Travel Expenses

This is a quick tax tip inspired by a unique structure in the Portland skyline, which is currently getting pounded with torrential rain.

If you can show that your attendance at a convention benefits your business, you can deduct your travel expenses.  This requirement applies even if you are appointed or elected as a delegate of an organization.

  • Make sure you keep the agenda or program materials from the convention, as these documents are the best evidence to show that the convention is connected to your business.
  • Avoid conventions that are for investment, political, social, or other purposes unrelated to your business, as you cannot deduct expenses for these events.
  • Finally, you might want to think twice about a foreign convention, as the IRS has a four-point reasonableness test to judge deductions for conventions outside the North American area.  Be prepared to provide a lot of detail on the purpose of the event and activities, the sponsoring organization and the residences of active members in the organization in order to prove that the convention location was reasonable.

Lastly, if you receive a shiny brochure trying to sell you on a convention or seminar on a cruise ship, just throw it away.  Cruise ship deductions are limited to $2,000 per year and the IRS has a long list of rules that disqualify many of the good cruises.  Plus, you have to attach two signed documents to your tax return.  Trust me, stick to conventions on dry land and take the cruise for your personal vacation – any tax savings are just not worth the hassle.