I can remember real well what my grandmother would say when her guests would load up more on their plate than they would eat. "Don't bite off more than you can chew." Or, "His eyes were bigger than his stomach." When I planned this article, I knew there was a lot of information, but doing all of it may have been 'biting off more than I could chew'. So, I am going to break this article up into two so that I can be fair to each and every one of you who may be struggling to figure out what to do with that last line in the edit accounts window. The first article will cover the Schedule C Income and Deductions part of the tax line and the second will examine the K1 and Balance Sheets along with the M-1 and the 8825A-E forms.
Remember that this is what I do for a living, so I have to know this information, I have to get excited about it, (yes I know, I need a hobby) because it's a big part of my practice. Don't feel bad if you happen to nod off in the middle of information about this or that section number, I will attempt to make this as informative and entertaining as the subject of taxation will allow. (The IRS doesn't like it when we have fun discussing taxes!)
II. Schedule C Income and Expenses.
Depending on the version of Quickbooks you have, you may or may not see the description 'Schedule C' in the tax line information. Regardless this is the place that you would put income and expenses for your business.
1. Gross Receipts or Sales – You may have as many income accounts as necessary and assign this tax line to them. Whether you call the accounts daily sales, or Credit Card sales, it is revenue brought in to the business by your daily activities.
2. Returns and Allowances – When you purchase items for your business, sometimes it becomes necessary to return them to the vendor. You can't delete the original entry or purchase information but you can record the return using this tax line because technically, though it is not revenue, it is income, because your money is being returned to you.
3. Other Income – This covers income not generated through sales or returns, interest on your business checking account (not investments, that is another line.) Charges that you pass on to your clients, bounced checks, late fees, etc. This will help you distinguish what your business is generating on a regular operating basis and will help give you a more accurate picture of your finances.
4. COGS (Cost of Goods Sold) – Purchases – for those businesses that must purchase materials to construct or build products for their customers. A stool manufacturer for example must purchase the legs, the seat, the cushions separately and sometimes from different vendors. A retail store must purchase goods for resale. This is where those purchases must go.
5. COGS – Cost of Labor – These are not salaries, these are the costs of getting the product built and out to the customer. Subcontractors' labor, etc would go here.
6. COGS – Additional Section 263A Costs – This involves the capitalization of certain items of inventory in the possession of the company owner. The good news is that unless the business is producing more than $ 10,000,000 a year, chances are, this won't apply to you.
7. COGS – Other Costs – If it costs your business to get the item shipped to you or shipped to your customers, that's where this expense goes. Shipping marketing materials, or items for use in your business does not go here.
8. Compensation of Officers / Shareholders – If you have your business set up to pay you a regular salary, that amount would go here. The good news is that most business owners who initially started their companies, if they have put a sizable investment in, can draw out some of their 'pay' in a Distribution to Shareholder category, which means you will only be taking out part of which you put in, and thus, it is not taxable personally to you. A lot of small businesses do not even pay out to the owners until the business is on more solid footing.
9. Compensation of Other Officers – Same as above without the Distribution option unless the 'other' officers are partners who invested in the corporation too.
10. Salaries and Wages – This is of course, where you put in what you paid your employees, not the 1099 vendors, but the weekly, hourly workers.
11. Repairs and Maintenance – This one is self explanatory, just make sure that your accountant is depreciating your machinery correctly so that the costs of repairs doesn't escalate beyond the useful life of the asset.
12. Bad Debts – What is a bad debt? When you sell goods or services on account, be aware that some clients won't pay you. Be prepared to either confiscate the goods sold, or continue to bill for services. At what point does the debt become bad? I'd say probably past 180 days and your chances of collecting are close to zero. There are two ways of handling bad debts in your accounting. One, the Allowance for Bad Debts account. This assumes that a certain percentage of your Accounts Receivable will turn bad. (.5 – 2%) You create the account in QB and estimate that a certain percentage will never pay and you put it into this account. Two, only count those who have indicated that they will not pay or cannot pay and add them to the Bad Debts account after 180 days. Keep in mind that if a bad debt does get paid in a following year, you have to make a reverse entry to take that amount from the bad debt account and put it back into accounts receivable.
13. Rents – Office space, warehouse space, storage space all goes here.
14. State Tax – These are NOT state sales taxes, these are state taxes you pay to operate your business.
15. Local Property Tax – County, City, Parish, etc charges that you pay for to own property in that particular county, city or parish.
16. Payroll Taxes – Quickbooks puts the appropriate payroll taxes here automatically when you subscribe to the Add on service of Assisted Payroll. If you are not subscribed to QB payroll you have to enter in the correct information as to employee and employer contributions to Social Security and Medicare.
17. Other Misc. Taxes – In Northern states that seem to tax residents and businesses out of existence, things like parking taxes, etc would go here. Have you considered moving to Florida?
18. Licenses – Each occupation (legal ones, that is) requires a license to operate. These are usually paid to the county separately from the county taxes. Those fees would be in this tax line.
19. Interest Expense – Are you paying interest expenses? Again, this is self explanatory.
20. Depletion – This is the natural resources version of Depreciation, so unless your business owns forestry land, oil reserves, or farms, you won't have to deal with Depletion.
21. Advertising – Experts say that unless you are spending 10% of your revenue on advertising, you are not spending enough. However, you have to be wise about it. Any kind of marketing from yellow pages ads (least effective) to radio, television and bench ads would go here.
22. Pension / Profit Sharing – A deal you might make with potential employees is to pay less hourly and pay bonuses based on performance. This keeps a sort of 'ownership' attitude amongst the employees and the bonuses would be put here.
23. Employee Benefits – Insurance packages, etc would be put here.
24. Meals and Entertainment – When going about your daily business you have to eat. Remember that only 50% of these expenses are deductible, however, if you have a staff party and pay for a meal for all of them, it is all deductible. Oh, and the IRS isn't stupid, you can't have a staff party every day.
25. Other Deductions – If you are unsure of the category and it doesn't seem to fit anywhere above, use this one and be sure to ask your accountant later where it would go.
Hopefully this little article has been helpful. Some of this information is clearly self explanatory but some is not. The second part of this article is coming soon.