If you operate a small business, you know that you need a decent, working accounting system, right?
Decent accounting means you know things like whether or not you’re making money. And such a system lets you make better decisions about the products and services you sell and which customers and employees you want to work to keep.
Unfortunately, small business accounting isn’t always easy or straightforward. Accordingly, consider these five tips to simplify your business’s bookkeeping.
Tip #1: Don’t Incorporate
Incorporation complicates your accounting. By incorporating, for example, you’ll automatically add payroll accounting to your bookkeeping duties–even if you’re the only employee.
What’s more, by incorporating, you’ll typically have to provide more information when you do your tax return than is the case if you operate as a sole proprietorship. A corporation tax return is several pages long, for example, as compared to the typical one or two page sole proprietorship tax form.
If you want to incorporate for legal reasons, by the way, you should know that you have another option for limiting your liability. You can set up a one-owner limited liability company. A one-owner business operating as a limited liability company is treated for tax accounting purposes as a sole proprietorship.
Tip #2: Don’t Depreciate
If your business is profitable or if you or your spouse have earned income from wages and you’re operating as a sole proprietorship, you may be able to use something called the Section 179 election to avoid dealing with depreciation.
Rather than go to the bookkeeping burden of allocating a $500 desk as “depreciation” expense over seven years, for example, you can use the Section 179 election to just immediately write off the entire $500 furniture cost in the year you purchase and begin using the asset.
Not all states allow Section 179, so you’ll want to confer with your tax advisor. But by simply writing off asset purchases, you greatly simplify your accounting. You don’t, for example, find yourself a few years down the road doing the depreciation calculations for, say, several dozen or several hundred items you’ve purchased. Ugh.
Note: Most assets that a small business purchases can be immediately expensed using the Section 179 election. Some assets can’t, however, including real estate.
Tip #3: Don’t Combine Business and Personal Items
Another tip for keeping your business accounting simpler: Don’t combine business and personal items. For example, setup a separate bank account for the business and use that account only for business deposits and withdrawals.
Another example… Don’t go try to buy a car, call the purchase a business expense, and then attempt to deduct a portion of the car’s price and operating expenses.
A general rule about tax accounting: Any deduction that’s been abused by taxpayers in the past is probably closely watched by the IRS and the state revenue folks. And that close monitoring almost always means that in order to take the deduction you need to go to a bunch of extra bookkeeping work. That extra bookkeeping work not only costs you time and money, the extra work also tends to truly complicate your accounting.
With a car, for example, deducting some portion of your auto expenses will require you to carefully track all of your car expenses (fuel, service, insurance, and so on) and also your business, commuting, and personal use of the vehicle. Furthermore, whenever you trade-in your “business vehicle,” you or your accountant will also probably have to do the tax accounting for a like-kind exchange.
Seriously, small businesses commonly make the mistake of deducting items like cars only to find (if they’re honest with themselves) that after all the wailing and gnashing of teeth (and perhaps a bit of dishonesty, too) the deduction saves only an extra two to three hundred dollars.
Tip: Do keep track of any business miles so you can claim the easy standard business miles deduction. That deduction, for many businesses, is an easy tax deduction.
Tip #4: Do Consider Using Cash-basis Accounting
Tax laws don’t allow all businesses to use cash-basis accounting. For example, if your business resells inventory or manufactures items, you probably can’t use cash-basis accounting.
However, service businesses typically can use cash-basis accounting. And cash-basis accounting, while a little frowned upon by accountants, should always been considered if the resulting accounting lets you prudently run your business.
Cash basis accounting simplifies your accounting because you don’t have to setup and then work with an accounts payable system. And because you don’t have to do accrual journal entries at the end of each month and year.
Note: The popular small business accounting program QuickBooks lets you do both cash-basis accounting and accrual-basis accounting.
Tip #5: Do Consider Outsourcing
A final quick tip that’s especially applicable once you have employees: You should consider outsourcing your accounting, or some part of your accounting, once you’ve got employees or too little time to do the job yourself.
And this outsourcing option is actually very simple, straightforward, and even economical as compared to the options of letting your books turn into a mess or hiring a modestly competent full-time bookkeeper.
You can typically pay a service bureau a couple of thousand dollars a year, for example, to do your payroll. And a few hundred dollars a month is often enough to pay for a general bookkeeping service.
Starting a new business? You’ve got all sorts of ways you can complicate your accounting and your taxes. But if you want to keep your small business finances clean, lean, and low-cost, follow these five tips:
Accounting Tip #1: Don’t Incorporate
Yes, incorporation may reduce your taxes (in same cases). And, true, incorporation typically reduces your legal liability. But unless you really need a standard, old-style corporation, you should keep your accounting and your taxes simple and more straightforward by staying “un-incorporated.”
Here’s why: Incorporation means annual corporate income tax. And even if you’re the only person working in the business, incorporation means annual and quarterly payroll tax returns. That’s just too much paperwork for your new business.
By the way, if you are concerned about your legal liability, know that you have another great option for protecting yourself. You can set up a limited liability company. You should get the same legal protection. And if you’re a one-owner LLC, you’ll be able to treat your business just like any other sole proprietorship, which means no corporate income tax returns and maybe no payroll tax returns.
Accounting Tip #2: Setup a Simple Accounting System
If you own and operate a business, you really do need a simple accounting system. Don’t fool yourself. Invest the time (an hour?) and the money (about $100?) to get a simple accounting system like Quicken Home & Business or Microsoft Money Home & Business.
You’ll need an accounting system to track your profits anyway. That’s actually the law. Furthermore, by starting out with a good accounting system, you’ll much more effortlessly capture tax deductions that will later save you money.
Accounting Tip #3: Use a Separate Bank Account for Your Business
You don’t want to co-mingle your personal and business accounting. Get your business its own business bank account. Use that account for your business’s deposits and for your business’s payments.
Only bad things happen, accounting-wise, when you pay personal expenses out of your business account and business expenses out of your personal account. For example, you’ll miss tax deductions. You’ll inappropriately count personal expenditures as business expenses. And you’ll lose your ability to precisely measure how much money you’re making or losing.
Accounting Tip #4: Make Quarterly Estimated Tax Payments
One of the responsibilities you shoulder when you become self-employed is paying quarterly tax payments using the 1040ES form (both form and instructions are available from www.irs.gov). But this makes sense.
Someone who is an employee doesn’t have to worry about paying income taxes on their wages. Their employer automatically deducts taxes from their payroll checks and then remits that money to the Internal Revenue Service.
But you need to pay the income taxes on your business profit. And you should do so in quarterly chunks as the year progresses: one-quarter of your tax bill on April 15, another quarter on June 15, another quarter on September 15, and, finally in the next year, the last quarter on January 15.
In general, you’ll owe a combined tax of about 20% to 25% of what your business makes. So you want to use your accounting system to regularly estimate your profits and then you want to set aside 20% to 25% of that profit in a savings account for later paying your income taxes.
If you make $80,000, for example, you’ll owe $16,000 to $20,000 in tax. And you would pay $4,000 to $5,000 a quarter in estimated taxes.
By the way, the big crisis you want to avoid here is not a penalty. That’s the least of your troubles, in a sense, if you don’t make quarterly payments.
The big crisis is having April 15th roll around and then finding you need to pay a surprise $16,000 or $20,000 tax bill. Ouch.
Accounting Tip #5: Don’t Put Personal Assets into the Business
And a final tip for keeping your accounting clean, simple and low-cost: Don’t put personal assets like cars or home computers into your business and then think or try to write off the purchase.
The accounting rules for expensing these kinds of “easily-used-for-personal-stuff” assets are cumbersome. You’ll find the rules hard to follow and easy to break. And if your accountant charges for the extra work he or she needs to go to on your tax return, the money you save is embarrassingly modest.