The Most Common Accounting Mistakes Small Business Owners Make and How to Avoid Them

Most small business owners are an expert in their field, but not necessarily in the accounting aspects of building a business. And, with this comes a few common mistakes. Yet, even simple small business accounting mistakes can prove to be financially limiting and costly down the road. With the help of an accounting professional, it is possible to overcome at least some of these mistakes. Take a look at some of the most common mistakes and how to avoid them.

#1: Choosing the Right Accounting Software for My Business
You’ve purchased small business accounting software. You assume it will be ideally matched to your business and easy enough to jump into. It’s not. The problem is, each business requires a carefully selected and even customized accounting method. There are always risks related to regulatory compliance when the wrong accounting software is used or information is overlooked.

To resolve this, work with a professional that listens to your needs, learns about your business, and modifies your bookkeeping methods to meet your goals.

#2: Your Business Has Poor Organization and Recordkeeping
It’s quite common for small business owners to lack the time and skills to effectively manage small business recordkeeping and bookkeeping. There’s much to do and it takes time away from your business. And, there are dozens of apps and cloud accounting options present. Which do you use?

The good news is all of those options are a good thing. It means there are no longer excuses for not getting your business organized. With a bit of help, it is possible to set up a system that streamlines your business operations.

#3: Cash Flow Versus Profit-Loss Statement
Many small businesses are making money on paper, but they end up going under if their float to getting paid is too long. This is financially limiting and stunts your growth as well.

It’s important to understand how this impacts your business. Cash flow is a critical component of any business operation — it determines how much you end up borrowing and paying for, too. Learn the best methods for managing cash flow.

#4: Not Understanding Standard Accounting Procedures and Terminology
Many small business owners don’t understand key business accounting terms and procedures. What does setting up controls mean? What about bank reconciliation? What are your balance sheets and when are they updated? Profit and loss statements are filled with very specific terminology you need to get right.

It’s possible to learn these terms and methods on your own. There’s plenty of information available. However, it takes time to learn it all. More importantly, you may find applying specific procedures and tax laws to your business challenging. To overcome this, work with a tax professional you can depend on.

#5: The Small Business Budget
A budget provides financial insight. It offers guidance to you about where your business is right now and what your goals are. That’s because a budget — which many small business owners lack — creates key goals for your company to manage. Flying blind, on the other hand, is a common small business mistake.

Creating a budget takes some time and a good amount of dedication. Once it is in place, it can be modified each month to meet current needs. Software is available to help with this, but an accounting professional is also an option.

#6: Too Much DIY
To be frank, one of the biggest mistakes small business owners make is simply trying to save money by doing it themselves. Yes, it is true this will cut your accounting costs, but it also creates a scenario in which you have absolutely no control over “what you don’t know.” In other words, just because you can enter it doesn’t mean you should.

Working with a bookkeeping and accounting service capable of handling these tasks for you is the best option. In nearly every situation, these services will work to save you money, far overlapping any DIY savings you are creating.

#7: Lack of Tax Planning
Taxes are not something you should do just one time a year. Year-long tax planning for small businesses is necessary. It’s not just important to pay your taxes, but also to plan for them and plan for savings options.

If you lack a tax planning strategy, work to improve this by simply working with a tax professional. Create a plan for ways you can invest and cut your tax burden.

#8: Lack of Modernization
Are you still balancing your books using pen and paper? It is no longer considered ideal to do so. Yet, many small business owners see the investment in modernization and cloud accounting to be too costly. In fact, moving to a digital accounting system is likely to save you time and money. It doesn’t have to be challenging to implement this system either.

#9: Not Realizing True Profit and Loss
You may have a profit and loss sheet, but you may not have a lot of insight into what each line means. More so, you may not know enough about methods for reducing costs or viewing profit potential.

The investment in an accounting service can alleviate this. We are happy to talk to you about methods to save you money or boost your profit margins with simple changes to your methods.

Most small business accounting mistakes come from a lack of insight into the industry. The good news is solutions are available to help you overcome nearly all of them. Please call us if you have any questions.

Is an Inheritance Taxable?

A frequent question is whether inheritances are taxable. This is a frequently misunderstood question related to taxation and can be complicated. When someone passes away, all of their assets will be subject to inheritance taxation, and whatever is left over after paying the inheritance tax passes to the decedent’s beneficiaries.

Sound bleak? Don’t worry, very few decedents’ estates ever pay any inheritance tax, primarily because the code exempts a liberal amount of the estate from taxation; thus, only very large estates are subject to inheritance tax. In fact, with the passage of the Tax Cuts & Jobs Act (tax reform), the estate tax deduction has been increased to $11,180,000* for 2018 and is inflation adjusted in future years. That generally means that estates valued at $11,180,000* or less will not pay any federal estate taxes and those in excess of the exemption amount only pay inheritance tax on amounts in excess of the exemption amount. Of interest, there are less than 10,000 deaths each year for which the decedent’s estate exceeds the exemption amount, so for most estates, there will be no estate tax and the beneficiaries will generally inherit the entire estate.

* Note that, as with anything tax-related, the exemption is not always a fixed amount. It must be reduced by prior gifts in excess of the annual gift exemption, and it can be increased for a surviving spouse by the decedent’s unused exemption amount.

Because the value of an estate is based upon the fair market value (FMV) of the assets owned by the decedent on the date of their death (or in some cases, an alternative valuation date six months after the decedent’s date of death, which is rarely used), the beneficiaries will generally receive the inherited assets, with a basis equal to the same FMV determined for the estate. What this means to a beneficiary is if they sell an inherited asset, they will measure their gain or loss from the inherited basis (FMV and date of death).

Example #1: Joe inherits shares of XYZ Corporation from his father. Because XYZ Corporation is a publically traded stock, the FMV can be determined by what it is trading for on the stock market. Thus, if the inherited basis was $40 per share and the shares are later sold for $50 a share, the beneficiary will have a taxable gain of $10 ($50 – $40) per share. In addition, the gain will be a long-term capital gain, since all inherited assets are treated as being held long-term by the beneficiary. On the flip side, if the shares are sold for $35 a share, the beneficiary would have a loss of $5 per share.

Example #2: Joe inherits his father’s home. Like other inherited property, Joe’s basis is the FMV of the home on the date of his father’s death. However, unlike the stock, whose FMV could be determined from the trading value, the home needs to be appraised to determine its FMV. It is highly recommended that a certified appraiser do the appraisal. This is something that is frequently overlooked and can cause some problems if the IRS challenges the amount used for the basis.

This FMV valuation of inherited assets is frequently referred to as a step-up in basis, which is really a misnomer because the FMV can, under some circumstances, also be a step-down in basis.

If the decedent was married at the time of death and resided in a community property state, and if the property was held by the couple as community property, the beneficiary spouse will generally receive a 100% basis equal to the FMV of the property, even though the spouse will have only inherited the deceased spouse’s share.

Not all inherited assets received by the beneficiary fall under the FMV regime. If the decedent held assets that included deferred untaxed income, those assets will be taxable to the beneficiary. Examples of those include inherited:

  • Traditional IRA Accounts – These are taxable to the beneficiaries, but the special rules generally allow a beneficiary to spread the income over five years or take it over their lifetime.
  • Roth IRAs – Qualified distributions are not taxable to the beneficiary.
  • Compensation – Amounts received after the decedent’s death as compensation for his or her personal services.
  • Pension Payments – These are generally taxable to the beneficiary.
  • Installment Sales – Whoever receives an installment obligation as a result of the seller’s death is taxed on the installment payments the same as the seller would have been, had the seller lived to receive the payments.

This is just an overview of issues related to being the beneficiary of an inheritance. If you have questions related to the tax ramifications of a potential or actual inheritance, please give us a call.

Credit for Family and Medical Leave Benefits

The Tax Cuts and Jobs Act that was passed last year included a new tax credit for employers that allows them to claim a credit based on wages paid to qualifying employees while they are on family and medical leave.

To qualify for the credit, an employer must have a written policy that provides at least two weeks of paid family and medical leave annually to all qualifying employees who work full time, which can be prorated for part-time. The wages paid during the leave period cannot be less than 50 percent of what the employee is normally paid.

The credit is variable. It begins at 12.5% and increases by 0.25%, up to a maximum of 25%, for each percentage point that the rate of payment exceeds 50% of the employee’s normal pay.

Example: ABC, Inc. has qualifying written policy to pay an employee 70% of their normal wage while on family or medical leave. The rate of 70% is 20 percentage points above the 50% credit threshold. Thus the credit is increased by 5% (.25 x 20), which when added to the base credit of 12.5% results in a credit percentage of 17.5% (12.5% plus 5%). Assuming the total leave wages paid for the year were $15,000, the credit would be $2,625 (.175 x $15,000).

A qualifying employee for this credit is any employee who has been employed for one year or more and who had compensation that did not exceed a specified amount for the preceding year. For 2018, the employee must not have earned more than $72,000 in 2017. Thus leave benefits for higher income taxpayers will not qualify for this credit.

For the purposes of this credit, “family and medical leave” is leave for one or more of the following reasons:

  • Birth of an employee’s child and to care for the newborn.
  • Placement of a child with the employee for adoption or foster care.
  • Care for the employee’s spouse, child or parent who has a serious health condition.
  • A serious health condition that makes the employee unable to perform the functions of his or her position.
  • Any qualifying event due to an employee’s spouse, child or parent being on covered active duty — or being called to duty — in the Armed Forces.
  • Care for a service member who is the employee’s spouse, child, parent or next of kin.

The credit only applies to qualified leave wages paid to a qualifying employee for up to 12 weeks per taxable year, and the employer must reduce its deduction for wages or salaries paid or incurred by the amount determined as a credit. Any wages taken into account in determining any other general business credit may not be used toward this credit.

CAUTION – CREDIT TIME LIMITED
The credit is generally only effective for wages paid in taxable years of the employer beginning after December 31, 2017. It is not available for wages paid in taxable years beginning after December 31, 2019

The credit is part of the general business credit, where business incentive credits are combined into one “general business credit” for purposes of determining each credit’s allowance limitation for the tax year. A general business credit is generally limited to the taxpayer’s tax liability for the year (excluding self-employment tax), and any excess over the tax liability is carried back one year and forward 20 years. “Carrying back” means, in most instances, amending the return of the year to which the credit is carried; if no return was filed for that year, then the carryback credit would be claimed on an original late-filed return for that year.

If you have any questions relating to this credit, please give us a call.

Procrastinating on Filing Your Taxes?

If you have been procrastinating about filing your 2017 tax return or have not filed other prior year returns, you should consider the consequences, including the penalties, interest, and aggressive enforcement actions. Plus, if you have a refund coming for a prior year, you may end up forfeiting it.

If you haven’t filed your return and you owe taxes, you will be subject to both a late payment and a late filing penalty. You should file a return as soon as possible and pay as much as possible to reduce the penalties and interest.

The failure-to-pay penalty is one-half of one percent for each month, or part of a month, up to a maximum of 25%, of the amount of tax that remains unpaid from the due date of the return until the tax is paid in full. Should you put off filing, if the IRS issues a notice of intent to put a levy on your property and any amount billed is not paid within 10 days, the interest rate will be increased to a full one percent per month.

There is also a penalty for not filing on time. The failure-to-file penalty is five percent of the tax owed for each month or part of a month that your return is late, up to a maximum of 25%. If your return is over 60 days late, there’s also a minimum penalty for late filing; it’s the lesser of $210 or 100 percent of the tax owed.

On top of that, in addition to interest and late filing penalties, interest accrues on the unpaid balance at the current federal short-term rate plus 3 percent compounded daily. Even if you have received extension, the late payment penalty and interest will accrue on any balance due, so it’s best to file as soon as possible to minimize them.

Of course, there’s no penalty for filing a late return if a refund is due. Penalties and interest only accrue on the unfiled returns of taxpayers who have a balance due and don’t pay by the deadline. However, you can lose your refund and potentially forfeit any tax credits you are entitled by waiting too long to file. In order to receive a refund, the return must be filed within three years of the due date.

Taxpayers who continue to not file a required return and fail to respond to IRS requests to do so may be subject to a variety of enforcement actions, all of which can be unpleasant.

You are strongly encouraged to bring yourself into compliance with your federal—and state, if applicable—income tax return filings. Please call us so we can help you file back returns and, if necessary, advise you on ways to pay or mitigate any tax liability and, when necessary, assist in establishing a payment plan.

Don’t Have a Budget? QuickBooks Online Can Help

The hardest part of creating a budget is getting started. QuickBooks Online provides tools that can jump-start the process.

You know you should have a budget. You’re aware that it can help you stay on track with your company’s income and expenses throughout the year. Maybe you’ve even tried to make one before, but you got discouraged by the mechanics or by the difficulty of estimating money in and out for the next 12 months.

June may not be the beginning of your fiscal year, but that doesn’t mean you can’t make a serious effort to start building a budget that can help you rein in expenses and set revenue goals.

Here’s a look at QuickBooks Online’s budgeting features.

Creating the Framework
Before you begin, you’ll want to make sure that your fiscal year is set correctly in QuickBooks Online. Click the gear icon in the upper right, then click Your Company | Account and Settings | Advanced. If the First month of fiscal year isn’t correct, click the pencil icon over to the right and change it. Then click Save and exit out of this window.

Click the gear icon again and select Budgeting, then click Add budget in the upper right.

QuickBooks Online asks you the questions that need to be answered before you start filling in your budget grid.

The first thing you’ll do is give your budget a descriptive name by entering it in the Name field. Next, open the drop-down list under Fiscal year and select the correct 12-month period. You can create your budget in one of three intervals: Monthly, Quarterly, or Yearly. If you want to populate your budget with numbers from this year or last, make that selection in the Pre-fill data? field.

There’s one more option at the top of the Budgets Grid screen that’s not shown in the image above. You can Subdivide by Customer, Class, or Location. This can be useful if you want to view budget data specific to a subset of entries in each of those categories. You could, for example, choose three customers and view only their numbers in the grid individually, one at a time.

Providing Your Numbers
Once you’re satisfied with the selections you’ve made, click Create Budget in the lower right. The screen will refresh and display a grid that you can edit.

Let’s say you’re working on a budget for the second half of 2018. QuickBooks Online brought in your numbers for January-May. You see that the numbers don’t vary much from month to month on one specific line item, so you’re going to assume that they will continue to be true (unless you know something that will affect it after May). You could enter a rough average of the first five months in the JUN field.

Hover your cursor over the arrow to the side of that field, and this sentence appears in a small bubble: Click to copy the value across on the row. QuickBooks Online will then enter that number in the JUL through DEC fields.

QuickBooks Online can save you some time as you enter data in your budget grid fields.

When you’re done entering data in all of the fields relevant to your business, click Save in the lower right and close the window. Your budget will now show up in the list.

Tip: If you have multiple blank rows and don’t want them to be displayed, click the gear icon in the upper right corner of your budget page. Click in the box in front of Hide blank rows to create a checkmark.

The Hard Part
QuickBooks Online simplifies the mechanics of creating a budget, but it’s up to you to supply the numbers. There’s lots of common-sense advice that experts offer for this process, like:

  • Remember seasonal upswings and downswings.
  • Make your goals as realistic as possible. You might want to create separate budgets for “needs” and “wants.”
  • Track your expenses carefully for a period of time so you can estimate more confidently.
  • Create reports regularly that compare your budget vs actuals.

QuickBooks Online can help you with that last piece of advice; it offers a report called Budget vs. Actuals. You’ll find it in the Business Overview group.

We can help, too. Once we understand a little more about your business structure and goals, we can take a look at your income and expense history, make some personalized recommendations, and start you on the path to a more focused financial future.

Solar Tax Credit – The Dark Side

There are TV ads, telemarketing phone calls and sales people at your front door all promoting the benefits of solar power, and one of the key considerations and a frequently mentioned benefit is the 30% federal tax credit.

What isn’t included in the ads — and something most potential buyers are unaware of — is that the solar credit is a nonrefundable tax credit, meaning the credit can only be used to offset your tax liability. This can come as a very unpleasant surprise and is often a financial hardship when the purchaser of a home solar system finds out that the credit is nonrefundable and that they won’t get the full credit.

For example, a married couple with three children, all under age 17, and an annual income of $78,000 installed a solar system costing $20,000 in 2018, expecting a $6,000 credit on their tax return. Their standard deduction in 2018 is $24,000, leaving them with a taxable income of $54,000. The tax on the $54,000 is $6,099. They are also entitled to a $2,000 child tax credit for each child, which reduces their tax liability by $6,000 and results in a tax liability of $99. Since the solar credit is nonrefundable, the only portion of the credit they can use is $99, not the $6,000 they had expected.

On top of that, the family is probably financing the solar system, which significantly adds to the system’s cost. If the entire $20,000 cost were financed by a 5% home equity loan for 20 years, then the interest on that loan over its term would be $11,678, bringing the total cost of the solar system to $31,678 or a monthly cost of $132.

Some municipalities even allow home energy improvements to be financed through the property tax system by adding the payments to the quarterly or semi-annual property tax bills. Interest rates on these arrangements are generally higher than home equity loans, reaching levels of 9 to 10%. If the loan in our prior example would have been at 9%, then the interest on the loan over 20 years would be $23,187, bringing the total cost to $43,187 or a monthly cost of $180. It is also a common misconception that solar system payments added to the property tax bill can be deducted as property taxes. That is incorrect; however, the interest portion of the loan payment is generally deductible as home acquisition debt interest. The lender should supply a loan amortization schedule indicating the annual interest amount.

The unused credit does carry over from year to year as long as the solar energy credit is available. Currently, the credit is being phased out, and 2021 is the last year it can be claimed. Furthermore, the credit percentage rate is being phased down, with the 30% continuing through 2019 and then dropping to 26% in 2020 and 22% in its final year.

In lieu of purchasing a solar system, some homeowners opt to lease a system. This arrangement is not eligible for the solar credit.

As you can see, there is a lot to consider before making the final decision to install a solar system. Is it worth it, and is it the right thing financially for you? Please call for a consultation before signing any contract to make sure a solar system is appropriate for you.

Should I Use a Credit Card to Pay My Taxes?

With tax filing season out of the way, paying off those tax bills that weren’t paid by April 18th is the next major concern for people. While there are a few options for payment agreements if you can’t afford to write a check for the full amount immediately, there’s also the option of paying your tax bill with a credit card. It can be less confusing than navigating IRS payment plans, and if your credit card has a nice rewards program, then it’s something to think about.

Depending on how much you owe in taxes and what terms your credit card offers, it may or may not be worth putting your tax bill on your credit card. Here are some of the pros and cons of using a credit card to pay your taxes and why you would or wouldn’t want to pursue this option.

Processing Fees

Legally, the IRS cannot directly accept credit card payments so they use three different approved payment processors for taking credit and debit card payments. At the time of writing, the processor with the most favorable rate is pay1040.com. Their minimum processing fee is $2.59, otherwise charging 1.87% of your balance. So, if you owe $2,000 in taxes, then you’d be charged a total of $2,037.40.

Keep in mind that this processing fee is steeper the bigger that your outstanding balance is, and you need to pay it on top of whatever you’ll owe in interest. If you go on a payment plan and pay by direct debit or check, you’ll only pay the IRS interest rate and any applicable penalties with no processing fees.

Interest Rates and Balance Transfers

Interest rate varies by the credit card that you have, but the average rate is 15.07%. For the first quarter of 2018, the IRS interest rate on underpayments is 4% (expected to go up to 5% for the second quarter.) This interest rate is in addition to any applicable penalties like the .0.50% late fee that applies every month until the balance has been paid off. But the interest rate the IRS charges is a lot less than the average credit card interest rate.

If you anticipate paying your balance off over time, you will definitely pay a lot more interest with a credit card even if it’s less confusing to calculate than the IRS interest rates, which change more often. However, if you open a new credit card intended for balance transfer if your credit’s good, then you can get a few months to a whole year to pay off your balance at a 0% interest rate which both buys time and saves money. But if you’re late on the payments eventually and/or your credit isn’t that great, this isn’t a likely option.

Credit Card Rewards

Credit card rewards, like cash rebates and frequent flier miles, are what often makes the extra fees and interest tempting to put your tax balance on your credit card: Why not get a free vacation for paying your taxes?

But financial experts estimate that most credit card rewards only net you about 1% back of what you purchase. It’s worth sitting down and doing the math on how much the IRS interest rates and forgoing processing fees would save you so you can take that vacation out of pocket instead. Unless you plan on paying off your entire balance immediately and the reward offered is worth what you’ll pay in fees, reward programs aren’t likely to completely defray the costs of using a credit card for your taxes.

Tax Bills and Your Credit Report

Ultimately, if you need extra time to pay your taxes, you are better off with an IRS installment or short-term payment agreement since owing money on these plans does not appear on your credit report. However, carrying a balance will appear once you shift the responsibility from the IRS to your credit card company. In addition to impacting your available credit, it also affects your credit utilization score based on how much of your available credit is being used.

If you’re looking for housing, more credit, or other situations that warrant your credit report being pulled, then you’ll want to avoid paying your taxes with a credit card.

Ultimately, it’s up to you to weigh the risks and benefits of using a credit card to pay your taxes. If you’re taking a longer-term approach, an installment agreement is likely to cost you less both upfront and in the long run. If you have any questions related to the pros and cons of using a credit card to pay your taxes, please give us a call.

Is a Roth Conversion Right for You? Be Careful, They Can No Longer Be Undone!

Roth IRA accounts provide the benefits of tax-free accumulation and, once you reach retirement age, tax-free distributions. This is the reason why so many taxpayers are converting their traditional IRA account to a Roth IRA. However, to do so, you must generally pay tax on the converted amount. After making a conversion, your circumstances may change, and you may find yourself wishing you had not made the conversion. In the past, you could change your mind later and undo the conversion. But that option is no longer available under tax reform. So, be careful: once a conversion is made, there is no going back.

Timing is everything, and a favorable time to make a traditional IRA to Roth IRA conversion is a year when your income is abnormally low or the value of your traditional IRA has declined. You can also convert portions of your traditional IRA over a number of years, thereby gradually converting the traditional IRA to a Roth IRA, spreading the tax liability over a number of years, and keeping it in a lower tax bracket. If you previously made non-deductible contributions to a traditional IRA, those amounts can be converted tax-free but must be converted ratably with the other funds in the traditional IRA.

Many taxpayers overlook some great opportunities to make conversions, such as years when your income is abnormally low or a year when your income might even be negative due to abnormal deductions or business losses. Even the new higher standard deductions may offer a taxpayer the opportunity to convert some or all of their traditional IRA to a Roth IRA without any conversion tax.

Everyone’s financial circumstances are unique, and issues to consider include:

  • Will there be enough years before retirement to recoup the conversion tax dollars through tax-free accumulation?
  • Is your income low enough or are your deductions high enough to enable a tax-free or minimal tax conversion?
  • Will you be in a lower or higher tax bracket in the future?
  • Where would the money to pay the conversion tax come from? Generally, it must be from separate funds. If it is taken from the IRA being converted, for individuals under age 59½, the funds withdrawn to pay the tax will also be subject to the 10% early distribution penalty, in addition to being taxed.
  • It might be appropriate for you to design your own custom conversion plan over a number of years, rather than converting everything at once.

Conversions can be tricky, and once made, they can no longer be undone. If you are considering a conversion, it might be appropriate to call for an appointment so that we can help you properly analyze your conversion options or develop a conversion plan that fits your particular circumstances.

Summer Employment For Your Child

Summer is just around the corner, and your children may be looking for summer employment. With the passage of the most recent tax reform, the standard deduction for single individuals jumped from $6,350 in 2017 to $12,000 in 2018, meaning your child can now make up to $12,000 from working without paying any income tax on their earnings.

In addition, they can contribute the lesser of $5,500 or their earned income to an IRA. If they contribute to a traditional IRA, they could earn up to $17,500 tax free, since the combination of the standard deduction and the maximum allowed contribution to an IRA for 2018 is $5,500. However, looking forward to the future, a Roth IRA with its tax-free accumulation would be a better choice.

Even if your child is reluctant to give up any of their hard-earned money from their summer or regular employment, if you have the financial resources, you could gift them the funds to make the IRA contribution, giving them a great start and hopefully a continuing incentive to save for retirement.

With vacation time just around the corner and employees heading out for their summer vacations, if you are self-employed, you might consider hiring your children to help out in your business. Financially, it makes more sense to keep the family employed rather than hiring strangers, provided, of course, that the family member is suitable for the job.

Rather than helping to support your children with your after-tax dollars, you can instead hire them in your business and pay them with tax-deductible dollars. Of course, the employment must be legitimate and the pay commensurate with the hours and the job worked. A reasonable salary paid to a child reduces the self-employment income and tax of the parents (business owners) by shifting income to the child.

Example: You are in the 25% tax bracket and own a self-employed business. You hire your child (who has no investment income) and pay the child $15,000 for the year. You reduce your income by $15,000, which saves you $3,750 of income tax (25% of $15,000), and your child has a taxable income of $3,000 ($15,000 less the $12,000 standard deduction) on which the tax is only $300 (10% of $3,000).

If the business is unincorporated and the wages are paid to a child under age 18, the pay will not be subject to FICA (Social Security and Medicare taxes) since employment for FICA tax purposes doesn’t include services performed by a child under the age of 18 while employed by a parent. Thus, the child will not be required to pay the employee’s share of the FICA taxes, and the business won’t have to pay its half either.

Example: Using the same information as the previous example, and assuming your business profits are $130,000, by paying your child $15,000, you not only reduce your self-employment income for income tax purposes, but you also reduce your self-employment tax (HI portion) by $402 (2.9% of $15,000 times the SE factor of 92.35%). But if your net profits for the year were less than the maximum SE income ($128,400 for 2018) that is subject to Social Security tax, then the savings would include the 12.4% Social Security portion in addition to the 2.9% HI portion.

A similar but more liberal exemption applies for FUTA, which exempts from federal unemployment tax the earnings paid to a child under age 21 while employed by his or her parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting solely of his or her parents. However, the exemptions do not apply to businesses that are incorporated or a partnership that includes non-parent partners. Even so, there’s no extra cost to your business if you’re paying a child for work that you would pay someone else to do anyway.

If you have questions related to your child’s employment or hiring your child in your business, please give us a call.

Choosing Your Accounting Method Under New Tax Laws

Businesses today must take a closer look at their accounting methods. Since the passage of new tax laws, with changes to thresholds for choosing accounting methods, all companies need to take an inward look at their current accounting methods to determine if they are the most beneficial permissible method applicable. It is important to work closely with accounting professionals here — making changes as well as decisions on how accounting methods need to be updated.

What Is Changing?
The Tax Cuts and Jobs Act put into place new laws for a variety of sectors. One key area impacted that many business owners do not immediately consider is accounting. The overall method of accounting and the type of business can be key factors to consider. This tax reform set out to support small business owners and offer key ways to reduce some taxes. It also put into place provisions and accounting method reform with a focus on keeping things simple. Outdated methods of accounting minimized the amount of information shared, but they tend to overcomplicate methods. This is especially true with outdated gross receipt thresholds. Old methods required business owners to use accrual basis accounting which tends to increase overall administrative costs and compliance requirements.

Here is a look at some of the key changes businesses should recognize moving forward.

Limits on Cash Method of Accounting Improved
One key change is the limitation on which businesses can use the cash method of accounting. Previously, companies could not use the cash method of accounting — commonly considered the most natural and more affordable method — as an option if they reached a threshold in revenue. Previously, this method could not be used if the average annual gross receipts for the company were limited to companies with revenue under $10 million, except for the following companies that are that are limited to $1 Million:

  • Retailing (NAICS codes 44 and 45);
  • Wholesaling (NAICS code 42);
  • Manufacturing (NAICS codes 31 – 33);
  • Mining (NAICS codes 211, 212);
  • Publishing (NAICS code 5111); or
  • Sound recording (NAICS code 5112).

The new law changes this. First, it increases the threshold to $25 million. It also indexes this to inflation (meaning it can rise over time due to inflationary measures). Companies who are now able to use this method will note an accounting method change. It will allow the company to recognize ratable taxable income from this change over a period of four years — you do not have to adjust this all at one time. Additionally, any losses are recognized immediately.

Changes in Inventory Accounting
The law also changes Internal Revenue Code Section 263A. These UNICAP rules made for very specific restrictions for business owners. Prior to the changes, the revenue threshold was subject to the UNICAP rules. It requires businesses that maintain an inventory to apply specific costs to their inventory. When this cost is applied, it raises the company’s balance sheet. Overall, it increases the amount of taxable income the company has, therefore making it harder to overcome the threshold.

Now, companies with $25 million in revenue that qualify for the cash method of accounting will be able to note their inventories as non-incidental supplies or materials. Another option is to use their financial accounting treatment for inventories.

Long-Term Contract Changes
Another key area of the law has to do with long-term contracts. Previously, any business with $10 million or less in average annual gross receipts and maintained contracts expected to end within two years were considered small contractors. As a result of this classification, the businesses did not have to use a percentage of completion method of accounting. This helped streamline efforts for the company. The new law still applies for the most part. However, the new law increases that threshold from $10 million up to $25 million. And, it is indexed for inflation. This means more companies — those with revenue under $25 million — now achieve this same benefit.

What Does This Change Mean for You?
As a business owner, it can mean significant changes. When you meet with your accounting professionals, it will be important to look at several things:

  • Do the changes apply to your situation? Any business around the gap of $10 million ($1 Million for certain companies) to $25 million may need to consider the new methods of accounting available to them.
  • Do the changes benefit the company? Choosing the cash method of accounting over the accrual method is often beneficial, but not to all organizations.
  • Does the change require substantial changes to business operations? Though operations may stay the same, tax planning will change.

For these reasons, companies should work closely with accounting professionals to apply the changes under these laws. The law went into effect in December of 2017 – which means it applies to 2018 and beyond. For this reason, it is important to get up to date now. If you have questions or would like to schedule an appointment to discuss your accounting methods, please give us a call.