For example, if you’re anticipating a big Section 199A deduction on your return? Like a $1,000,000 deduction say? Or even bigger? You can maybe save any extra $400,000, $500,000 or more in federal taxes by starting a new business using a fiscal year or by changing the fiscal year of your existing business.

Let me quickly go into the details. You can see if you agree. One comment to make up front. I didn’t always think this. When I wrote my book “Maximizing Section 199A Deductions” in 2017, I thought what I’m about to describe did not work. Now? Yeah, I do. But let’s step into the weeds.

The Statutory Language of Section 199A(i)

The first thing to look at is what the Section 199A(i) applicability “end” date language says in the actual statute. That language appears below:

(i)Termination

This section shall not apply to taxable years beginning after December 31, 2025.

You and I want to pay attention to the precise language. Section 199A doesn’t apply to taxable years that begin after December 31, 2025. So, obviously, a calendar taxable year that begins on January 1, 2025 works. We  all agree on that.

And it’s no big jump to realize, “Okay. Yeah. Starting on February 1, 2025? Or March 1, 2025? Or any other date within 2025? That works too. None of those dates begin after December 31, 2025.”

One other comment: If Congress, the writer of the law, wanted to prevent someone taking a Section 199A deduction on a fiscal year tax return that starts in 2025 but ends in 2026? It seems like it could and should have written Section 199A(i) differently. Something like this, to my mind, does the trick:

(i)Termination

This section shall not apply to taxable years beginning ending after December 31, 2025.

If you agree with what I’ve said or maybe always thought what I describe in the earlier paragraphs? You can stop reading. You know what you need to know. And you don’t need to spend any more time on this.

For people who vaguely remember reading something different? For accountants who maybe recall a training session where the presenter described things differently? Let me keep going. Because I maybe know where things went off the rails.

The Applicability Date Language of Regulation 1.199A-1(f)

The source of my initial confusion? And possibly your confusion too if you’re part of the brotherhood or sisterhood who fell down this rabbit hole? The applicability “starting” date language from the regulations works differently. And that language really triggered the fog here. That language says this:

(f) Applicability date—(1) General rule. Except as provided in paragraph (f)(2) of this section, the provisions of this section apply to taxable years ending after February 8, 2019.

(2) Exception for non-calendar year RPE. For purposes of determining QBI, W-2 wages, UBIA of qualified property, and the aggregate amount of qualified REIT dividends and qualified PTP income, if an individual receives any of these items from an RPE with a taxable year that begins before January 1, 2018, and ends after December 31, 2017, such items are treated as having been incurred by the individual during the individual’s taxable year in which or with which such RPE taxable year ends.

To summarize the general rule? The regulations apply to taxable years ending after February 8, 2019. (Not very relevant here. We’re only talking years ending after February 8, 2019 anyway.) But then the tweak that benefits taxpayers. For a non-calendar year RPE, or “relevant pass-through entity,” so a partnership or S corporation? If the fiscal year started in 2017 and ended in 2018? The Treasury gave the taxpayer a Section 199A deduction on his or her 2018 tax return.

In effect, even though the Section 199A only became effective for tax years beginning after December 31, 2017? Yeah. Christmas came early for fiscal year pass-through entities. They enjoyed the Section 199A deduction on qualified business income earned in calendar year 2017 but reported by the pass-through entity on the tax return that ended its fiscal year in 2018.

What a number of people did—me included—is apply this special rule about how Section 199A started in 2018 to how things work when it ends after 2025. Awkwardly, that reading is wrong.

A tangential note: Section 11011(e) of the Tax Cuts and Jobs Act set the applicable date of Section 199A as “taxable years beginning after December 31, 2017.”

The Obvious First Section 199A(i) Question

Let’s jump to the obvious first question: Can a relevant pass-through entity use a fiscal year or change its fiscal year and enjoy an extra year of Section 199A deduction? Answer: Maybe.

You just read what Section 199A(i) says. The section shall not apply to taxable years beginning after December 31, 2025. So that’s not a problem. But you need a way to wriggle into using a fiscal year. And two possible wriggles exist.

Wriggle #1: Section 442 says a partnership or S corporation—the two relevant pass-through entities that Section 199A applies to—can change from a calendar year to a natural year. (A natural year exists when a business generates at least 25 percent of its gross receipts in a two-month interval.)

Wriggle #2: Section 444 says a new partnership or S corporation can adopt a fiscal year that ends September 30, October 31, or November 30. (An existing calendar year partnership or S corporation probably cannot use Section 444 to change its fiscal year.)

Thus, theoretically any partnership or S corporation might be able to change its taxable year from a calendar year to a fiscal year that begins before December 31, 2025 using Section 442. New partnerships or S corporations can make a Section 444 election that begins their fiscal year on October 1, November 1, or December 1 of 2024 or 2025.

To adopt a fiscal year or make a fiscal year change, predictably, the entity must comply with requirements of Section 442 or 444. Some entities will surely fail to qualify for technical reasons. (Again, for example, note that it is not possible to move from an established calendar year S corporation to fiscal year using a Section 444 election.)

But assuming an entity does get a fiscal year to work, if an entity calculates and reports a Section 199A deduction to its owners on its fiscal year tax return that starts in 2025 but ends in 2026? Owners include a Section 199A deduction on their 2026 1040 tax return.

The Obvious Second Section 199A(i) Question

Next question: Should new pass-through entities adopt a fiscal year and should existing entities change their fiscal year (when possible) to get an extra year of Section 199A deduction?

This question seems trickier. Sure, you probably can do this in many situations. But should you? My sense is the cost of adopting a fiscal year (for a new business) or of making a fiscal year change (for an existing business) exceeds the benefit for most pass-through entities.

I think our CPA firm’s rule of thumb might be something like “you need to anticipate getting a Section 199A deduction well into six figures to adopt a fiscal year or to make changing to a fiscal year worth considering.”

Someone who enjoys a $100,000 Section 199A deduction in 2025 might possibly save $30,000 to $40,000 in federal income taxes by getting one more year. Someone who enjoys a $200,000 Section 199A deduction in 2025 might save $80,000 with one more year. Grabbing that additional savings probably makes sense.

Furthermore, someone who makes ten times that much and enjoys a $1,000,000 or larger Section 199A deduction?  They maybe save $400,000 or more in federal income taxes by getting one more year of Section 199A treatment. Grabbing that additional savings absolutely makes sense.

But the typical successful small business owner who makes, say, $100,00o? So, that guy who currently gets a $20,000 Section 199A deduction? That size deduction may save $4000 or $5000. Which sounds good and is good. But that amount may not be enough to justify the fiddling. Or the costs of the accountants.

The Timeclock is Running Out

One other factor to consider here is timing. CPA firms and pass-through entities do not have much time to prepare and file the paperwork that effects a change in the accounting year assuming they even want to do so.

To change to a Section 442 natural year that ends on, for example, April 30, 2025 (if that’s possible), one files a Form 1128. That form’s due date would typically be July 15, 2025. But you probably want to file sooner. You can and probably should file the Form 1128 on January 1, 2025

To make a Section 444 election that adopts a taxable year ending on November 30, 2025 (if that’s possible), one files a Form 8716. That form’s due date would typically be February 15, 2025. But again, you can and probably should file the Form 8716 earlier on in that first fiscal year.

All in all, then, not much time considering that most of the time between now and then is tax season.

Not Everyone Agrees Yet

A final point. Some tax practitioners probably still think you in effect look at the Section 199A regulations’ instructions about how one handles fiscal year entities that start their taxable year in 2017 to determine how you should handle fiscal year entitites that start their taxable year in 2025. (This is the stuff I talked about in the preceding discussion of Regulation Section 1.199A-1(f).)

For example, here’s the relevant blurb from the Bloomberg BNA Tax Management Portfolio, “Portfolio 537-1st: Qualified Business Income Deduction,” that talks about how the fiscal year thing affects the Section 199A deduction:

However, the regulations do not provide a similarly favorable “mirror image” rule in the case of an RPE with a taxable year beginning on or before December 31, 2025, and ending after such date. As a result, a taxpayer that is a partner or shareholder in such an RPE would not be able to take a §199A deduction with respect to amounts allocable to such taxpayer even if realized by the RPE during 2025.

The authors then provide this example:

Example 9: Assume the same facts as Example 8, except that the S corporation’s taxable year begins on November 1, 2025, and ends on October 31, 2026. A is not entitled to a §199A deduction with respect to any portion of A’s share of QBI, W-2 wages, UBIA of qualified property, and the aggregate amount of qualified REIT dividends and qualified PTP income from the S corporation for the months of November and December 2025.

But I think that’s wrong.

Again, for the record, I was originally saying the same thing (and long before the BNA tax management portfolio said it.) But now? Now I think you don’t expand the regulation’s language that tweaks the applicability start date and then apply that language to the applicability end date. Rather you look at the statute’s termination date language. The rule Congress wrote.

Other Resources about Section 199A(i) Fiscal Year Charges

For an overview of changing an accounting year of a partnership or S corporation, you may want to refer to Revenue Procedure 2006-46. (It describes the mechanics of using Form 1128 to request an accounting year change based on a natural business year.)

For instructions for making a Section 444 election, you want to refer to the Form 8716 and its instructions as well as the Form 8752 and its instructions.

We also have a Section 199A(i) Fiscal Year Change FAQ available at our CPA firm website. That appears here: Section 199A(i) Fiscal Year Change FAQ.

The post Section 199A(i) Fiscal Year Change Extends Deduction appeared first on Evergreen Small Business.

And how do you do this? Consider the following six hacks to simplify your small business accounting and taxes:

Operate Sole Proprietorship

You can operate a business using a variety of entities: sole proprietorship, corporation, partnership, and so on.

But to keep things simplest? At least in the beginning? Use a sole proprietorship. That simplifies your accounting. (You’ll only need a profit and loss statement.) And it simplifies your taxes. (You’ll just report your income on a Schedule C form inside your regular individual income tax return.)

Use Limited Liability Company

Concerned about your legal liability? Tempted to incorporate? Maybe reconsider that.

You should be able to form a limited liability company, or LLC. And if the LLC has a single owner—called a member—you’ll get to use the sole proprietorship entity classification. Even though you’ve limited your liability risks.

Note: We give away free copies of do-it-yourself kits for forming LLCs for most states.

Go with Cash Basis Accounting

Here’s another tactic. Keep your bookkeeping simple by using cash basis accounting. Count income when you receive payments, for example. And count expenses when you make payments.

The alternative to cash balance accounting? Accrual accounting. But accrual accounting greatly complicates your work.

Use Equity Not Debt

Your capital structure will either make your accounting and bookkeeping harder or easier.

But one thing you can do to keep things easier? Use owners equity to fund the business. In other words, don’t use a bunch of debt to fund the business. Or parts of the business.

Leveraging up your small business with debt obviously increases your financial risks. But even beyond that? It makes your accounting way too complicated.

Keep Balance Sheet Sparse

A related suggestion? Keep your balance sheet lean. Clean. As sparse as you can.

So of course your balance will show cash. Maybe some inventory. But anything else? Try to avoid that.

If you avoid debt, that of course keeps your balance sheet lean and clean.

And then the other thing to do: Don’t put a bunch of assets onto the balance sheet. Write off as supplies anything that costs $2500 or less. Or that probably lasts less than a year.(See this blog post for more information: Tangential Property Regulations.)

And then, sorry, don’t buy vehicles and put them onto the balance sheet. Or anything that IRS considered a so-called “listed asset” which triggers extra reporting. (Cars are listed assets. And so is other stuff that’s likely to be used personally.)

Use a SEP as Pension Option

The easiest pension option? Just skip a formal pension and use an Individual Retirement Account. Maybe one for your spouse, too, if you’re married.

If you want to put bigger numbers onto your return, look at using a SEP-IRA plan. That’ll let you contribute up to 20 percent (roughly) of your business profit up to about $60,000 a year. (The limit in 2022 is $61,000 but that limit gets adjusted for inflation.)

With a SEP-IRA? You just shuffle some paperwork. And then sometime before the tax return filing, decide whether or not you want to contribute to the SEP-IRA account.

Outsource Payroll

When or if you hire employees? Outsource the payroll. Do not do this yourself. Or even a worse idea do this for your spouse’s business.

You can outsource payroll to someone like Gusto.com. Pay a few hundred bucks a year. And get all your payroll taken care of: quarterly returns, tax deposits, W-2s and so on.

Shoulder Season Scheduling

A final idea: If you do need help from a CPA or bookkeeper?

Well, first, don’t wait until the last minute. Terrible labor shortages exist in the world of accounting right now. And that will probably continue, especially for CPAs, for years. (It takes about five years to get the schooling necessary to become a CPA. And it probably takes another five years to really know how to do the job.)

And then if you can, try to schedule your work outside of tax season. Schedule your working with CPAs and bookkeepers in the shoulder season that falls between April 15 and the fall extended tax return season.

The post Six Hacks to Simplify Small Business Accounting and Taxes appeared first on Evergreen Small Business.

That misconception? That distributions from partnerships, S corporations and other pass-through entities get taxed. (They usually don’t, by the way.)

The misconception regularly leads to a minor financial tragedy. Because often times a business owner sits on a huge cash balance in their business checking account. That money, they actually need to use on, you know, life things like rent or mortgage payments, insurance, taxes, day care, food, clothing, vacations and so forth.

But the business owner doesn’t want to distribute the profits. Because she or he fears paying tax on the money. Which is ironic. And wrong.

So this article explains what’s going on here. I’ll discuss what you get taxed on. When you get taxed. I’ll explain how the mysterious thing the accountants call “basis”works. And then I’ll end with a warning about a common error you want to avoid because it unnecessarily triggers additional taxes.

To start, a quick discussion about taxable income and basis…

Taxable Income from Your Business

Each business entity type calculates taxable income in basically the same way. Taxable income equals taxable revenues minus deductible expenses. This number gets reported in box 1 of the K-1 form you receive from the business, which in turn gets plugged into and taxed on your individual 1040.

For example, you start a business at the beginning of the year and collect $100,000 of revenues and pay $50,000 of deductible expenses.  Your business’s taxable net income at the end of the year equals $50,000. Suppose you only used the revenue you collected to pay the business expenses and now have $50,000 in your business checking account.

Money left over in the bank is the confusing part. Because you might think you avoid taxes on this money if you leave it in the business. And that you only pay taxes on the money when you take it out of the partnership or S corporation or sole proprietorship.

But that’s not the way the accounting works. You pay taxes on the business profit. Not, usually, on the distributions of profit paid to an owner.

Now let’s have a quick chat about basis.

Basis and Why It Matters

I want this discussion to remain as simple as possible. (If you would like to dive deeper, you can read the statute for S Corporations here and the statute for Partnerships here.) But to generalize, a business owner’s basis consists of the cash and adjusted-for-depreciation cost of property contributed to a business, adjusted for certain items that increase and decrease said basis.

Let’s look at the common increases and decreases…

Increases to Basis:

• Contributions of cash and property into the business
• Taxable income from the business
• Sale of appreciated property the business owns
• Non-taxable income (think PPP and EIDL grants)
• Recourse and qualified non-recourse debt for partnerships
• Partner loans to the business
• Credit cards used for business issued personally to the shareholder for S Corporations

Decreases to Basis:

• Distribution of cash and property from the business
• Loss from the sale of property the business owns
• Non-deductible expenses (meals, entertainment, etc.)
• Decreases in partner loans and decreases in recourse and qualified recourse debt
• Payments made by the business to pay off S Corporation owner owned credit cards

The general rule: As long as you have basis, you pay no taxes on distributions. Which is why basis matters.

Examples Show How Mechanics Work

But the problem here? Basis constantly fluctuates from year to year. That reality means you or your accountant need to carefully track the basis each tax year in order to know whether distributions trigger tax.

Let me show you some examples so you see how this works.

Example 1

Let’s circle back to our example where you earned $50,000. Pretend you spent no money funding the startup for this business because there is little to no overhead.

Your basis at the beginning of the year is $0.00. The $50,000 of net income increases your basis by $50,000. Now what?

You can take the total $50,000 as a distribution and pay $0.00 in taxes. In this case, your basis at the beginning of year 2 is $0.00. Remember, your basis increased by the net income of $50,000 (what you paid tax on), and decreased by the distribution of $50,000.

Alternatively, you decide to leave the whole $50,000 in the business in year 1.  Maybe you are living off of savings.

But remember, you are still taxed on $50,000 of income, regardless of where the money goes.

By the way? If in year 2 the business loses $25,000 and you never extracted any profits from year 1? You can still distribute $25,000 to yourself tax free at the end of the year, so year two, ending year 2 with $0.00 basis.

Example 2

Another example. You start your business with a personal contribution of $100,000.  You use the money to buy some equipment, lease an office space, and hire an employee.  Year 1 net income equals $200,000, and you distribute $100,000 to yourself to pay your personal expenses.  Your basis looks like this:

Year 1

You pay tax on $200,000 of income, the distribution is tax free, and you end the year with $200,000 of basis.

Year 2 profits are down a bit, and net income equals $50,000 for the year. You took the same distribution of $100,000, and your basis at the end of the year is $150,000.

Year 2

Year 3 you try to aggressively expand and require more capital to do so. Your business secures a $500,000 loan to pay for more equipment, employees, advertising and general overhead. This year you are also purchasing an investment property to take advantage of the deductions offered by a short term rental.

The aggressive expansion is a success, and you end the year with $200,000 of net income. But you had to distribute $400,000 to yourself to put a down payment on your rental property and pay the same living expenses. Whoops, now part of your distribution is taxable. Lets break it down:

Year 3

You probably noticed that doesn’t foot out. And it’s because basis can’t dip below $0.00.

In this third year, you are taxed on $200,000 of net income (taxed at ordinary income tax rates) and are left with $350,000 that can be distributed tax free.

But the additional $50,000 of distribution?  This is called “a distribution in excess of basis.” The $50,000 of distribution which you do not have basis for becomes a capital gain and gets taxed at capital gains rates.

Guaranteed Payments or Distributions?

One final important point. I want to discuss a mistake we often see on partnership returns.

Distributions to partners are commonly but incorrectly coded as guaranteed payments.  And this can have negative income tax consequences.

But first, a little background on guaranteed payments. A company uses guaranteed payments to incentivize a potential partner to join a partnership, most often in professional service firms. The partnership pays a specified amount to the partner each year, regardless of how the company performs. Their payment is “guaranteed,” kind of like a salary.

However, a majority of partnership agreements I read have no clause for guaranteed payments. And still, tax preparers frequently incorrectly code distributions as guaranteed payments.  Why does this matter?

Reason #1

Guaranteed payment income is not eligible income for the Section 199A, Qualified Business Income Deduction (QBID).  The partner forfeits a 20% deduction because their distribution is coded incorrectly.

Reason #2

Limited partners are not subject to self-employment taxes.  But guaranteed payments are subject to self-employment taxes.  A limited partner unnecessarily pays an additional 15.3% in taxes when their distribution is incorrectly coded as a guaranteed payment.

Pretend a tax preparer codes a $50,000 distribution as a guaranteed payment.  The partner pays income tax on $50,000 instead of $40,000 by missing out on QBID.  Assume a 25% tax rate and that’s an additional $2,500 they pay in income taxes.

Additionally, the partner pays $7,065 ((92.35% x 50,000) x 15.3%) of self employment tax on the $50,000!

The point I’m trying to make is you want to get this right for partners.

Final Thoughts

I hope this clears up some confusion on what actually gets taxed when a flow-through business generates profits.  And also that the discussion not only eases your anxiety about taking distributions–but allows you to avoid the one or two bookkeeping blunders that trigger tax.

The post Why Profit Distributions Usually Don’t Get Taxed appeared first on Evergreen Small Business.

This blog post describes the mechanics of calculating these revenue reductions. And don’t worry. I’ll make this short as possible.

The General Rule

The general rule about how large a revenue reduction you need to qualify for a second draw PPP loan? You need to have a quarter in 2020 when your revenues fell by at least 25 percent as compared to the same quarter in 2019.

Example: Your business generated $100,000 of revenue each quarter in 2019. If in any quarter in 2020, your revenue equaled $75,000 or less? You qualify.

What Counts as Revenue

The first big question then? What exactly counts as revenue. The new Interim Final Rule provides this definition:

all revenue in whatever form received or accrued (in accordance with the entity’s accounting method) from whatever source, including from the sales of products or services, interest, dividends, rents, royalties, fees, or commissions, reduced by returns and allowances.

The rule further elaborates:

Generally, receipts are considered “total income” (or in the case of a sole proprietorship, independent contractor, or self-employed individual “gross income”) plus “cost of goods sold,” and excludes net capital gains or losses as these terms are defined and reported on IRS tax return forms.

Finally, the rule explains what doesn’t count:

Gross receipts do not include the following: taxes collected for and remitted to a taxing authority if included in gross or total income (such as sales or other taxes collected from customers and excluding taxes levied on the concern or its employees); proceeds from transactions between a concern and its domestic or foreign affiliates; and amounts collected for another by a travel agent, real estate agent, advertising agent, conference management service provider, freight forwarder or customs broker. All other items, such as subcontractor costs, reimbursements for purchases a contractor makes at a customer’s request, investment income, and employee-based costs such as payroll taxes, may not be excluded from gross receipts

The quoted definitions get gritty. But that’s good. You and I can work with gritty. We want the details.

Calculating Quarterly Revenues with QuickBooks Desktop

Your accounting system, assuming you’re using something like QuickBooks Desktop or QuickBooks Online should make it relatively easy to calculate quarterly revenues. Also changes in quarterly revenues.

In QuickBooks Desktop, for example, you first produce a profit and loss statement by choosing the Reports⇒Company & Financial⇒Profit & Loss Standard command. That tells QuickBooks to generate a financial statement that shows income and expenses.

To tell QuickBooks to calculate the quarterly percentage change, click the Customize Report button at the top of the report window to open the Modify Report dialog box, check the Previous Period and % Change boxes, and then click OK to close the Modify Report dialog box.

Finally, to compare quarterly revenues—including calculating the percentage change–use the Dates From and To boxes to look at revenues and percentage changes for each quarter.

Tip: Click the Refresh button to get an updated version of the profit and loss statement.

You need the % Change in total income to show up as -25% or larger than -25%. Note that little hyphen barely visible. You need a minus 25% change or worse.

Calculating Quarterly Revenues with QuickBooks Online

The steps for calculating quarterly revenue amounts and changes in QuickBooks Online work similarly.

First, you want to produce a profit and loss statement by choosing Reports⇒Standard⇒Profit & Loss. That tells QuickBooks to generate a financial statement that shows income and expenses.

Next, indicate you want to compare quarterly revenues by using the Report Period boxes to look at revenues for each quarter.

Finally, to tell QuickBooks to calculate the quarterly percentage change, drop down the Compare Another Period box and check the Previous Year and % Change boxes.

Once you click Run Report, QuickBooks generates a new report. You need the % Change in total income to show up as -25% or larger than -25%.

Accounting Method Options

One final remark. It appears borrowers may use either cash basis accounting or accrual basis accounting to calculate revenues and make calculations. As already quoted once but now quoted again (boldfacing added this time), the interim final rule says this:

gross receipts to include all revenue in whatever form received or accrued (in accordance with the entity’s accounting method)

I think we can read that to say either cash or accrual—whichever the entity uses for its accounting method.

Note: Accounting programs including QuickBooks Desktop and QuickBooks Online let users easily flip between cash and accrual basis accounting. Both versions of QuickBooks, for example, include Cash and Accrual radio buttons you can use to switch accounting methods.

Finally, just because someone will wonder: Surely, you need to make apples to apples comparisons. You compare accrual revenues to accrual revenues. Or compare cash revenues to cash revenues. You don’t mix and match.

The Simple Qualification Formula Based on Annual Revenues

Comparing quarterly revenues requires a decent accounting system. Probably a system based on accounting software. Probably a system the owner or bookkeeper keeps up-to-date. That may be a bridge too far in some small business settings…

Accordingly, the rules also let you look at annual revenues if a firm operates all of 2019 and 2020.

For example, say your business earned $100,000 each quarter in 2019. Quarterly revenues of $100,000 equal annual revenues of $400,000. Because 4 times $100,000 equals $400,000.

If your 2020 revenues equal $300,000? Or less? You qualify.

Note: The reason this simplifying rule works? If your annual revenues fell by 25 percent or more, at least one quarter’s revenues fell by 25 percent.

If you use the simplified annual approach, you can probably just use your tax returns once the 2020 tax return is done.

But this caution: Using the annual approach makes qualifying more difficult. Returning to the example where a firm generates exactly $100,000 each quarter in revenues, a firm qualifies for a second draw if in some quarter, revenues drop by $25,000. To qualify based on annual revenues, the firm needs its annual revenues to drop by $100,000.

Other Resources

The actual 42-page IFR appears here: https://home.treasury.gov/system/files/136/PPP-IFR-Second-Draw-Loans.pdf

Our earlier discussion of how Second Draw Loans work.

The second draw PPP loan application form.

The post Calculating Revenue Reductions for Second Draw PPP Loans appeared first on Evergreen Small Business.

Good job for getting that done. Seriously. Your initiative may help you comfortably march through the next few weeks of the COVID-19 pandemic.

But a bit of sort of bad news. Your Paycheck Protection Program loan—let’s start calling it a PPP loan–includes a day of reckoning. Roughly 2 months from now, you need to explain to the bank and the Small Business Administration how you spent the money.

And your explanation—both your accounting records and your documentation–will determine how much of the loan the bank forgives.

Example: You borrow $100,000 using a PPP loan and do a good job on the PPP loan accounting? You don’t need to pay the loan back.

Example: You borrow $100,000 using a PPP loan but do a bad job on the PPP loan accounting? You do need to pay the loan back.

Accordingly, this blog post discusses how to do good PPP loan accounting. The post also discusses how to appropriately document the loan transactions. And then the post provides some practical ideas related to you not losing forgiveness.

The laundry list format usually works pretty well. So I break the discussion that follows into a list of tips…

PPP Loan Accounting Tip #1: A Good Payroll System (Probably a Payroll Service)

Mostly, you receive forgiveness for your PPP loan based on your payroll costs over the eight weeks that follow you receiving the loan funding.

The formula limits the forgiveness you receive for non-payroll-costs to less than 25%. (Restated another way, to get a $100,000 of forgiveness, you need at least $75,000 of payroll costs.)

Accordingly, you really want a good payroll system at least over the eight weeks your PPP loan covers.

For this reason, I suggest you upgrade to a good payroll solution if you don’t already have one. Like the system offered by one of the payroll services companies. ADP. Paycheck. Gusto. Or someone else like this.

No, no, I understand. In the past, the ad hoc, informal payroll approach you’ve used? Sure, that worked. Sort of. Mostly.

But with the PPP loan forgiveness formula, your business must accurately account for its payroll costs, including timing and amounts. This is no job for an amateur. Not even if you’re trying to save a few hundred bucks.

And just to say this? I have no horse in this race. No backdoor deal, no economic incentive, nothing prompts me to push you to call one of the payroll companies.

I just want you to avoid screwing up your payroll costs. Period.

PPP Loan Accounting Tip #2: A Real Accounting System

A related suggestion: Maybe you should also use the whole PPP loan thing as the prompt to step up to a real small business accounting program: Quicken, Xero accounting, QuickBooks, FreshBooks, and so on.

By the way, full disclosure: I sort of have a horse in this race. I’m the author of QuickBooks for Dummies.

But seriously, I’m not trying to gin up my book royalties with this statement. I’m thinking about the damage of you goofing up the accounting for things like the other, non-payroll costs you get forgiveness for: rent, utilities, and the interest on mortgages and other loans.

PPP loan accounting Tip #3:  Track the Funds Flow

Okay, another accounting-y tip: You want to set up a way to track the disbursements that result in forgiveness. And this may be the most important action you take.

Two good approaches exist here, I think.

One approach I saw an attorney recommend in a news article (I can’t now locate that article. Otherwise I’d give the attorney credit.)  You may want to set up a new bank account for the PPP loan money. And then, what you can do is, pay amounts that trigger forgiveness from this bank account.

With a separate bank account, you can easily show the forgivable spending clearly comes from the PPP loan funds.

And if setting up a separate bank account for the PPP loan funds doesn’t work? Yeah, I think you use whatever features your accounting software provides to carefully segregate PPP loan transactions.

QuickBooks, for example, provides a feature called “classes” that you can use to track all of the transactions that connect to a PPP loan.

Note: This comment for the accountants: Nonprofits often use QuickBooks’ “classes” to do fund accounting. So, classes should prove adequate for showing the flow of funds for a PPP loan.

Tip: If you use QuickBooks classes, you would probably use a class like “PPP loan” to tag the income and the spending related to the PPP loan. The payroll costs, rent, utilities and mortgage interest funded with the PPP loan proceeds would be classified as “PPP loan.” The PPP loan’s “cancellation of debt” income would be classified as “PPP loan.”

PPP Loan Accounting Tip #4: Over-document Owner Compensation

Your small business should receive funding for paying the business owner’s payroll or compensation (up to $8,333 a month).

And the S corporation shareholder-employee W-2 wages easily get accounted for. (You just look at the wages amounts shown in your payroll records and tax filings.).

The owner compensation received by a sole proprietor or a partner, however, gets problematic.

Here’s how you handle this trickiness according to the additional eligibility criteria the Small Business Administration published on April 14, 2020..

Use the 2019 owner compensation information to document the appropriate 2020 pay rate. In other words, use the Schedule C from the sole proprietor’s 2019 tax return to document the owner’s payroll cost. Or use what a working partner’s K-1 shows in boxes 1 and 4a.

Let’s say for example this amount equals $52,o00 for 2019. Exactly. So, $1,000 a week. (I’m trying to make the math easy.) That amount equals the owner’s weekly compensation.

Then? Within the eight-week period in 2020 that the PPP loan forgiveness formula looks at? I think the sole proprietor or partner takes a $1,000 a week draw.

Just to make this point, the sole proprietorship or partnership probably loses money over the eight weeks. That’s the terrible economic reality of trying to run a business during a pandemic.

But for purposes of forgiveness, you count the owner draws during the eight weeks as payroll. Even if in 2020, firm actually loses money. (As the Small Business Administration notes in its discussion of how to treat sole proprietors and partners, this approach allows the firm to replace the owners compensation using the 2019 “pay rate.”)

PPP Loan Accounting Tip #5: Document Every Disbursement

A final tip? Document the dollar amount, timing and deductibility of every disbursement.

So, like you’re being audited by the Internal Revenue Service. And by a really suspicious auditor.

For example, for payroll costs? Document the dollar amount and the payment date with actual copies of the payroll checks or electronic payment receipts. And be sure you have any other appropriate documentation too: Timecards? W-4s? Payroll reports from the payroll service company? You see the pattern.

For employee health insurance which also counts as payroll? Same sort of stuff. Use checks and electronic payment receipts to prove the dollar amounts and payment dates. Use the monthly insurance company statement to document the deductibility.

Retirement plan contributions? Yeah, treat those like employee health insurance.

For any rent, mortgage interest, and utilities services? Again, use the actual checks or electronic payment receipts to document the amounts and dates of payments. Then collect copies of the actual rental lease, the mortgage or bank loan agreement, and the utility service contract.

This note about non-payroll costs: The legal agreement for the rent, the mortgage or the utility services needs to have been in entered into before February 15, 2020.

Note: The additional eligibility criteria published on April 14 indicate for a sole proprietor, a deduction should appear on the sole proprietor’s 2019 Schedule C in order to be a permissible expenditure during the “eight-week period following the first disbursement of the loan.”

One other point: Only the interest on the mortgage or business loan qualifies for forgiveness. So, you want to have a monthly statement or bill from the lender that breaks the payment into interest and principal.

Three Closing Comments

Let me throw out three quick comments to close…

First, do verify that your payroll schedule “runs” enough payroll within the eight weeks following the PPP loan funding to get you maximum forgiveness. Most small businesses use cash basis accounting. Which is fine. But that may mean the payroll for the last two weeks of the eight week period of forgiveness falls outside the eight weeks.

Second, make sure you quickly rehire any employees you need in your full-time employee headcount to qualify for full forgiveness. I talk about how reductions in employee headcount reduce forgiveness in the paycheck protection program loans: a small business lifesaver blog post. See that blog post if you have any questions.

A third and final tip? Stay alert to additional guidance the Small Business Administration provides as to how the forgiveness works. We have pretty good information about the math already. But surely the SBA will provide additional instructions. If the rules change, you may want to make changes to your payroll or other forgivable spending in order to optimize.

Other COVID-19 Blog Posts

If you’re still trying wrap your head about the paycheck protection program, this blog post is a good place to start: Paycheck Protection Program Loans A Small Business Lifesaver.

Interested in learning about the other tax breaks for small businesses related to the COVID-19 pandemic? See this blog post: COVID-19 Small Business Tax Breaks and also our discussion of the employee retention tax credit, which is an alternative to the PPP loan.

Finally, if you need to first figure out just what counts as payroll cost for the PPP loan formulas, this discussion should bring you up to speed:  Paycheck Protection Program Loan Formula.

The post PPP Loan Accounting: Tips to Do It Right appeared first on Evergreen Small Business.

Simple on the surface, the formula gets complicated once you collect the inputs and try to do the math.

Further complicating the effort? As practical matter, you can’t get personalized help from either your accountant or banker. Neither has time for a personalized consultation. Both are overwhelmed.

To try to help you, your accountant and your banker a bit, then, this blog post explains the paycheck protection formula. And it provides a bunch of examples to illustrate how the formula works.

Before We Start

But before we start, let me say something.

One can’t responsibly write a blog post like this without citing the relevant bits of the statutes and the other guidance from the Treasury and the Small Business Administration.

However, the usual way of doing that won’t in my opinion work very well. I can’t imagine it’s very effective, for example, if I point you to Section 1102(a)(1)(A)(viii)(I)(aa)(AA).

Accordingly, I point you to page numbers of the CAREs Act PDF document available here from the Congress.gov website.

What you want to do is print pages 6 to 21. (This range includes both the Section 1102 statute that sets up the paycheck protection loan program and the Section 1106 statute that defines how you ask for forgiveness.)

You can then refer to the appropriate page if you want to see the bit of the law I’m discussing.

And now we start.

The Basic Paycheck Protection Loan Formula

The way to understand the formula: It provides money to pay employees and then a small business’s owners for eight weeks. Plus a little extra to keep the doors open and the lights on.

For example, suppose a small business annually pays employees $60,000 in W-2 wages. Further suppose the firm generates self-employment income for the two owners equal to $40,000. In addition, the firm provides employee healthcare insurance that costs $20,000 a year.

This firm’s annual payroll costs total $120,000: $60,000 of wages + $40,000 of self-employment earnings plus $20,000 of health insurance.

That annual payroll cost equates to a $10,000 average monthly cost. (You divide the $120,000 by twelve months.)

That $10,000 monthly payroll cost determines the paycheck protection loan. The loan equals 2.5 times the monthly payroll costs. With $10,000 in monthly payroll costs, for example, the loan amount equals $25,000.

So, it sounds simple, right? We only wish. The formula gets complicated in real life. Small business owners (and their accountants and bankers) ask dozens of questions. Accordingly, in the paragraphs that follow I share the best answers I’ve heard from others or find in the statute or agency guidance.

W-2 Wages Paid Employees

The statute obviously looks at employee W-2 wages. So, you need to determine that value.

My suggestion? Use the Box 1 amount shown on the W-3 but add to that amount the retirement account elective deferrals listed in Box 12.

A W-3, in case you don’t know, summarizes the information on the W-2s an employer gives employees.

Example: The W-3 shows $120,000 in Box 1, $150,000 in Boxes 3 and 5, and $40,000 in Box 12 for employee 401(k) elective deferrals. In this situation, you might be tempted to just grab the total wages subject to Medicare shown in Box 5. That amount equals $150,000. But don’t. If you do that, you may miss the part of the wages that represents the owner’s self-employed health insurance.

A caution: The error some of the payroll services and maybe the banks made initially with regard to wages? They wanted to deduct the federal payroll taxes shown in Boxes 2, 4 and 6. That approach? Clearly wrong. (See here for the Small Business Administration’s primary guidance on this.)

Wages More than $100,000 Don’t Count

The statute specifically limits its funding to only the first $100,000 of salaries an employee or owner earns. (See page 7 if you printed the PDF pages of the statutes.)

Further, the statute converts the $100,000 annual figure, in effect, into a monthly amount of $8,333. (If you divide $100,000 by 12, you get $8333.)

Example: A firm has two employees: One earns $5,000 a month. One earns $10,000 a month. The paycheck protection formula in effect counts $5,000 as the monthly payroll cost for the first employee. The formula counts $8,333 as the monthly payroll cost for the second employee.

Tip: To calculate the “excess” wages, the small business can look at each employee’s W-2. You want to look at Box 1 but add back the elective deferrals for things like a 401(k) shown in Box 12.

Partial Year Wages

The loan formula also doesn’t let you average wages over the year. The statute requires pro rata calculations. (Page 7.)

Example: Say a business starts operations halfway through the year and hires a single employee at an annual rate of $200,000. Because the employee works only half the year, she earns $100,000. For purposes of the paycheck protection loan, however, the payroll cost equals $50,000. Only the first $8,333 of payroll paid each month counts.

Independent Contractors Receiving a 1099-MISC

Much confusion has occurred with regard to how a firm treats its independent contractors. These are the folks the business sends (or should send) 1099-MISC forms at the year-end.

The interim final rule from the Small Business Administration states payroll costs do not include 1099-MISC.

Your 1099-MISC contractors should get their own paycheck protection program loans (PPP loans.)

Note: If your bank funded your PPP loan to include amounts you pay to 1099 independent contractors, you may want to hire these contractors as W-2 employees. Talk with your accountant about this. The PPP loan forgiveness formula, something I’m not talking about in this blog post, reduces the PPP loan for employee W-2 wages but not for 1099-MISC contractor payments.

S Corporation Shareholder Payroll Costs

An S corporation owner’s compensation–including appropriately accounted for self-employed health insurance–counts as payroll cost. The amount to include then? What the W-2 shows in box 1 (as adjusted for any elective deferrals to things like a 401(k).)

Example: An S corporation shareholder-employee earns $48,000 in her business and this amount shows on her W-2 in Box 3 and Box 5. Box 1 shows $60,000 because her compensation includes $12,000 of health insurance because the IRS says the S corporation counts this amount as wages. Use the box 1 value, or $60,000, for the payroll costs.

Example: An S corporation shareholder takes no wages from his corporation. Only shareholder draws. His K-1 shows $60,000 of income and distributions. The S corporation unfortunately counts his payroll costs as zero.

Sole proprietors

The statute and the agency guidelines only precisely described how to calculate the payroll cost for a sole proprietor on April 14. (That guidance appeared in a document that discussed additional eligibility criteria related to paycheck protection program loans.)

The approach the new guidance says you use? Look at the Schedule C form’s “business income” amount. (The Schedule C tax form appears inside a sole proprietor’s 1040 tax return.)

Example: A sole proprietor’s Schedule C form inside her 1040 return calculates $52,000 of business profit. That $52,000 counts as her annual payroll cost. In combination with any other W-2 employee wages, it determines the total annual payroll costs and the average monthly payroll costs. If the sole proprietor also paid another $68,000 in W-2 wages to employees, for example, the total firm’s annual payroll costs equal $120,000. The average monthly payroll then equals $10,000. The PPP loan amount then equals $25,000 or 2.5 times the $10,000 average monthly payroll.

Partners in an Active Trade or Business

The “Additional Eligibility Criteria” document just referenced also describes how partners in an active trade or business calculate their payroll costs. For these folks, self-employment earnings count as the payroll costs.

Example: A working partner in an active trade or business receives a K-1 that reports $50,000 in Box 1 of the K-1 and another $50,000 in Box 4a of the K-1. Box 1 shows the partner’s share of the partnership’s profits. Box 4a reports on the partner’s guaranteed payments received for working in the business. Assuming both of those amounts count as self-employment earnings–they probably do–the partner’s payroll costs equal $100,000.

Health Insurance

The statute says that group health insurance counts as a payroll. But two questions pop up regarding health insurance and the PPP loan amount formula:

• First, whether health insurance counts toward that $100,000 limit.
• Second, whether self-employed health insurance counts.

With regards to whether health insurance counts toward the $100,000 limit? The answer is “no.” On April 7, 2020, the Small Business Administration published an FAQ that said the $100,000 includes only cash compensation.

With regard to whether self-employment insurance counts, I think it doesn’t… The statute says group health insurance counts (see page 7.)

However, indirectly business owners actually do get to count it because of the way the self-employed health insurance works. Why? For a business owner, the self-employed health insurance gets baked into another “number” that explicitly counts as a payroll cost.

Example: For an S corporation shareholder-employee, self-employed health insurance gets included in the W-2 wages and so is included in payroll costs because it’s part of the wages.

Example: For a sole proprietorship, the self-employment health insurance deduction doesn’t reduce the Schedule SE calculation of “self-employment earnings.” Rather, those “self-employment earnings” provide the money that gets used to pay for health insurance.

Example: For a partner working in an active trade or business, self-employed health insurance counts as a guaranteed payment. That means it counts as self-employment income. And of course self-employment income counts as a payroll cost.

Retirement Benefits

Pension costs count as retirement benefits. And further, they don’t count toward the $100,000 ceiling. (This guidance comes from that same FAQ mentioned in the preceding discussion of healthcare costs.)

Example: A small business has two employees. One makes $50,000. The other makes $100,000. The company operates a SEP-IRA plan which means 25% contributions to employee’s IRA accounts. That means a $12,500 contribution for the first employee and a $25,000 contribution for the second employee. Both pension contributions count. And that’s the case even for the second employee who makes $100,000 before the SEP-IRA contribution.

Three Quick Comments to Close

Sorry, this is another long post. But three quick comments before I close.

First, the guidance from the Treasury and Small Business Administration changes almost daily. So you want to stay alert and also show patience here.

Second, I would not make “perfect” the enemy of “good” here. If you have an easy way to calculate and then document you’re entitled to $50,000 of paycheck protection loan money, don’t waste time trying to legitimately nudge that amount up a bit to, like, $52,000.

Third, understand that the loan forgiveness formula works differently than the loan amount formula. I’ll try to write about that when good details come out. (You may want to subscribe to our email newsletter to make sure you get that information. There’s a sign-up form just below the blog post.)

The post Paycheck Protection Loan Formula Explained and Illustrated appeared first on Evergreen Small Business.

But let me explain what’s what and then walk you through the steps for doing the bookkeeping.

What’s the issue with Washington state sales tax?

Sales tax isn’t the only type of excise tax Washington State levies on businesses. It also levies a tax on gross receipts, often referred to as “B&O”.

To minimize the administrative burden of these taxes, Washington’s Department of Revenue doesn’t make businesses file a separate tax return and make a separate payment for each type of tax. Instead, it has businesses calculate each type of tax owed on one return, and has the business submit all the taxes owed as a single payment. (Experienced QuickBooks users can already see the problem…)

What Intuit has done in QuickBooks—again, to try and make things easy for small business owners—is it’s come up with a system for how it can take care of most the bookkeeping for sales tax behind the scenes.

The QuickBooks Excise Tax Approach

The QuickBooks system is to have a special feature, called “sales tax tracking,” to automatically calculate correct sales tax on invoices and sales receipts, as long as sales tax jurisdictions have already been set up, and as long as the person recording the invoice can identify which sales tax jurisdiction to use when recording the transaction. Then, when a business remits sales tax to the proper taxing agency, the bookkeeper records this event with a special type of transaction. QuickBooks calls this transaction a “sales tax payment.” In order for QuickBooks sales tax tracking to work properly, the business must record every sales tax payment as, well, a “sales tax payment,” and it must record only sales tax payments as sales tax payments.

You can see how this approach collides with how Washington State collects sales tax. Two systems that were supposed to make things easier have come together to make things much more complicated and difficult for Washington small business owners.

Luckily, there are two workarounds to this conundrum.

Workaround #1: Record Sales Tax and B&O as Two Separate Payments in QuickBooks

The upside: this is easy to record, and easy to make accrual vs. cash basis accounting work correctly in QuickBooks (assuming your version of QuickBooks allows you to track Accounts Payable).

The downside: it makes working in the bank feed and reconciling the bank account more complicated, because the single payment that posts to the bank’s ledger won’t match the two separate payments you recorded in QuickBooks.

Workaround #2: Record the B&O Portion of Sales Tax as a “Sales Tax Adjustment”

The upside: this method won’t complicate working in the bank feed or reconciling the bank account

The downside: this method is more complex to enter, and WA B&O payments won’t show up properly on accrual-basis financial statements.

The tutorial at the end of this article will show you how to use this second workaround, and it will also illustrate the limitations of this workaround.

A quick clarification: Which sales tax system are we talking about?

QuickBooks Online has two different sales tax systems: old and new.

The old system is like what’s available in QB desktop, where the user manages their own sales tax rates. This system works just fine for brick-and-mortar shops that don’t deliver their goods to customers and only have a handful of locations.

The new system, called “Automatic Sales Tax,” appears to be Intuit’s answer to AvaTax and TaxJar, but it doesn’t cover as many jurisdictions yet. This system is designed to work better for stores (whether online or brick and mortar) that deliver goods to their customers, and thus have hundreds, or maybe even thousands, of sales tax jurisdictions to keep track of.

As of this writing, new QuickBooks Online accounts start off using the new, more-automated sales tax system. Accordingly, the images in this article illustrate the new system (because that’s what we had to work with when we created a demo account for this tutorial). If you use the old system, stuff will conceptually work much the same way, but the interface will look a little different and fewer tasks will be automated.

Note: these images come from QuickBooks Simple Start. If you use a different version of QuickBooks Online, or if Intuit has just updated the user interface since we published this article, then what you see in the software might be a little different then what we show below.

How to set up sales tax and WA B&O in QBO

If you’ve already set up sales tax in QBO, skip ahead to the next section. But if you’re just getting started, this section is for you.

As I mentioned earlier, if you’re setting up sales tax in a brand-new account from scratch, QuickBooks Online will guide you through the process of setting up Automatic Sales Tax.

First, navigate to Taxes in the left navigation menu (between Reports and Accounting). You’ll see this screen, or something close to it:

Perhaps obviously, click the green “Set up sales tax” button. The next few screens you’ll see will look something like this:

The address you use for this step is important, because it tells QuickBooks what taxing jurisdiction you’re in. For example, our hypothetical coffee shop is located in Redmond, WA. That means that, as of this writing (and for the purposes of this example), its sales are subject to a state sales tax rate of 6.5% and a local sales tax rate of 3.5%.

Note that if you’re using QuickBooks’ old sales tax system, or if you’re using sales tax tracking in QuickBooks desktop, you’ll need to look up these rates yourself and add them to the program manually. You’ll also need to update the rates manually any time they change. But if you’re using Automatic Sales Tax in QuickBooks Online, QuickBooks will use the address of the sale location as the jurisdiction for the sale.

Three other quick points before I move on.

First, in Washington State, we have what’s called “destination-based sales tax.” That means if your business operates in, say, Duvall, but you sell a product to a customer in Redmond and deliver the product to the customer, you need to use the Redmond sales tax rate for the sale. If, on the other hand, you have a bricks-and-mortar shop in Duvall, and you don’t deliver to customers (i.e. you only sell and transfer title to your goods at the Duvall location), then you use the Duvall rate.

Second, note that even if two jurisdictions use the same local rate (for example, both the City of Redmond and the City of Bellevue have a local rate of 3.5%), you can’t just use the same sales tax item for Bellevue sales and Redmond sales. This is because when you go to file your sales tax return with the Washington Department of Revenue, the form is going to ask how much of the sales tax you’re remitting is Washington State’s share, how much is Bellevue’s share, how much is Redmond’s share, and so on. So, you’ll need your accounting system to provide you data not just on how much sales tax to collect, but which jurisdictions you’re collecting it for. The Washington Department of Revenue keeps a list of current and historical local sales tax rates here. It even has a file you can use to import tax rate information if you’re using a desktop version of QuickBooks.

This isn’t an issue to worry about if you’re using Automatic Sales Tax in QBO (or a similar product like AvaTax or TaxJar), but if you’re using an older, less-automated version of sales tax tracking in QuickBooks, it’s a mistake that novice small business owners can sometimes make.

Finally, if you’re in a business where you sell tangible goods and deliver them to out of state customers, you want to get up to speed on the recent Supreme Court case South Dakota v. Wayfair. You may have an obligation to collect sales tax not just in Washington, but in other states as well.

After this initial setup, QuickBooks will ask you how frequently you file sales tax in Washington State (see below). Your business’ filing frequency is based on your estimated sales tax liability. In our example, the combined state and local sales tax rate is about 10%. So, a business with about 48,000 or more in monthly taxable sales would need to file monthly, whereas a business with smaller sales volume might be able to file quarterly or even annually.

Once you’ve finished setup, here’s what the Sales Tax Center looks like in QuickBooks Online:

Note that you can edit your sales tax settings after the fact from this screen by clicking “Sales tax settings” in the upper right corner. That will bring up a page that looks something like the image below; just click the “Edit” button for the particular agency you want to edit settings for:

All right, that’s sales tax set up. But for Washington State businesses, there’s one final step you’ll need to take to get things really working right for recording payments, and that’s creating an account in the chart of accounts for Washington B&O (see below).

How to Record a Sales Receipt with WA Sales Tax in QBO

Once you’ve set up sales tax in QuickBooks Online, you’re ready to start recording sales receipts that include sales tax.

To do so, first, click the Plus icon, then click Sales Receipt.

The next screen you’ll see will look something like this:

As illustrated in the above image, what’s nifty about automated sales tax tracking is that it will take the location of the sale (see in upper right corner) and use it to calculate sales tax on the sale, assuming you’ve checked the checkbox under the “Tax” column to indicate that the sale is subject to sales tax. (Sales of tangible property are generally subject to sales tax, while sales of services generally aren’t.)

If you’re curious about where QuickBooks is getting its calculation from, you can click the blue Sales tax label and it will bring up an overlay of the details, as shown below:

How to Record Paying Sales Tax and WA B&O Using the Sales Tax Adjustment Method

Okay, we’ve set up sales tax and we’ve been recording our sales receipts in QuickBooks to automatically calculate sales tax. And now a month has gone by, and we have to record the tax payment made to the Washington DOR. How do we do that?

Well, here’s what it will look like when you use the sales tax adjustment method in QuickBooks Online.

When a sales tax return is fileable, you’ll see a button in the sales tax center that lets you record the payment. Click this button and you should see a screen that looks something like the image below.

What you’ll do to get WA B&O working right is click the “+ Add an adjustment” button. That will bring up the overlay shown below. For the reason, indicate “Other”, and for the account, choose B&O. Then, enter the amount of B&O you owe for the tax period. (For most retailers, B&O is 0.471% of gross receipts.)

Once you’ve added the adjustment, the amount QuickBooks indicates for Tax Due should be the same as the amount you actually paid with your Washington Excise tax return when you filed it using MyDOR. (We have more information on MyDOR accounts in this article on our blog.) If the amount looks correct, click the green “Select filing method” button.

As of this writing, QBO’s automatic sales tax doesn’t support e-filing for WA sales tax (and if they did, this workaround probably wouldn’t be necessary). So, choose “File manually” as your filing method. Then, be sure to scroll down far enough so you can see where to enter information about when you paid sales tax. Enter the date paid and which bank account you paid it out of, then click “Record Payment.”

This is the last screen you’ll see, and it just confirms you recorded the sales tax as paid in QuickBooks.

Limitations of the Sales Tax Adjustment Method

There’s a lot to like about the sales tax adjustment method as a workaround for dealing with Washington B&O. It’s not too much work, it gets the right number in the right account, and because it records a single payment in the register for your business bank account, it keeps bank account reconciliations and working in the bank feed easy.

The one major drawback to be aware of is that, using this method, Washington B&O expense will only show up as an expense as of the date the expense was paid, regardless of whether or not you’re generating reports on cash or accrual basis. In other words, you won’t be able to track B&O accrual’s properly with this method (as shown below).

And there you have it, that’s how you deal with Washington sales and B&O tax in QuickBooks Online.

The post How to Record Washington State Sales Tax in QuickBooks Online appeared first on Evergreen Small Business.

An accurate balance sheet delivers several valuable benefits.

Accurate Balance Sheet Benefit #1: Obtaining a Loan

If your business needs or wants a loan in the future, the bank is likely going to want copies of full financial statements for your business. This includes both your income statement and your balance sheet.

That means if you don’t have an accurate balance sheet to provide your loan officer, it can upend your whole loan application.

Just so you know? Loan officers don’t always catch wacky-looking errors on balance sheets, but the underwriter certainly will.

What’s more, you’ll almost certainly be considered responsible for giving the bank accurate information for the sake of approving the loan.

And this awkward reality: Your accountant likely isn’t going to have time to help you quickly fix errors in your balance sheet if you ask for this help when you’re already midway through the loan application.

Accurate Balance Sheet Benefit #2: Protecting Yourself in a Legal Dispute

If you’re a small business owner and you find yourself in a legal dispute, such as a divorce, the court is often going to expect a balance sheet for your small business as part of the process of figuring out your net worth.

Balance sheet errors that overstate or understate your equity in the business are both really undesirable in this scenario, each for their own (hopefully obvious) reasons.

Accurate Balance Sheet Benefit #3: Selling the Business

Someday you might want to cash out by selling your small business.

If you do, any sensible buyer is going to want an accurate statement that explains to them what assets they’ll be buying, and possibly what liabilities they’ll be assuming.

You balance sheet provides this information in a commonly-understood, well-designed format.

Accurate Balance Sheet Benefit #4: Tracking Partner Capital Accounts

An awkward comment: Partner capital accounts are one of those things that’s tempting to ignore in the books as years go by, since it’s one of the more complicated aspects of partnership general accounting.

Furthermore, most years most people seem to not really care what their partnership K-1 Box L says.

This tends to change, however, at key milestone events in a partnership.

For example, when a real estate investment partnership sells a property and calculates liquidating distributions, partners will care—a lot—about partner capital accounts.

Unless the partnership has been using a dead-simple allocation formula, in our experience, often there’s at least one partner who ends up unpleasantly surprised to find out how much less cash they’re getting out of the deal than they thought.

One way to prepare to deal with this issue? An accurate balance sheet that keeps partners informed of who really is entitled to what—including correct liquidating distributions.

Accurate Balance Sheet Benefit #5: Finding Hidden Errors on the Income Statement

A final benefit of a good, accurate, up-to-date balance sheet: Sometimes visible errors on the balance sheet are how you can find errors in your income statement that aren’t obvious on their own.

For example, weird A/R balances sometimes result from errors that also cause sales revenue to be misstated. And erroneous payroll liability balances sometimes result from errors that also cause payroll expense to be misstated.

Finding errors on your income statement not only helps you run your business better by providing you with high-quality information about how much money your business makes; it also helps keep you out of trouble with the IRS.

The post Why You Want an Accurate Balance Sheet for Your Small Business appeared first on Evergreen Small Business.

This short blog post identifies these tasks. And know this: Fortunately none of these tasks burden you too heavily.

You just want to get them done now before New Year’s Eve.

Year-end S Corporation Accounting Task #1: Reimburse Shareholder-employees

Make sure before the year ends that you reimburse S corporation shareholders and shareholder-employees for any personally paid business expenses.

For example, if some shareholder-employee has run up a bunch of business mileage on their personal vehicle, reimburse them this year to get the  deduction onto this year’s tax return.

Similarly, if someone has purchased office supplies on their personal credit card, reimburse them for that outlay before the year ends to get the deduction this year.

Year-end S Corporation Accounting Task #2: Verify Reasonable Shareholder Compensation

Sometime soon, and for sure sometime before the last payroll of the year, verify that all shareholder-employees have received reasonable compensation for the year.

In other words, if Joe, one of the owners, is supposed to get $60,000 in salary for year, make sure he’s going to hit that target before December 31^st.

If one or more shareholder-employees does not yet have reasonable compensation for the year, be sure to pay that employee or employees enough in wages in the final paychecks of the year to get their total wages for the year up to some reasonable amount.

A related point: You really do need to pay shareholder-employees reasonable compensation  in order to get the S corporation to safely work over the long haul.

Year-end S Corporation Accounting Task #3: True Up Shareholder Distributions

Before the year ends, you want to double check that shareholder distributions reflect ownership percentages if you have more than a single shareholder.

For example, if you have two equal 50% shareholders, Adam and Bethany, make sure that the distributions paid to Adam and to Bethany match.

A shareholder who owns X% of the subchapter S corporation needs to receive X% of any shareholder distributions.

Note: If you don’t make distributions that reflect shareholder’s ownership percentages, the mistake may cause the IRS to terminate your Subchapter S status.

Year-end S Corporation Accounting Task #4: QuickBooks A/R and A/P Clean-up

Are you using QuickBooks desktop for your accounting? If you are, make sure that both the accounts receivable and accounts payable records don’t have missing transactions.

To check for missing transactions, generate a cash basis balance sheet as of the current date. Then look at the accounts receivable balance and the accounts payable balance shown on the balance sheet.

If the accounts receivable balance shows up as a negative value, that negative value probably signals to you that customer payments have been recorded but that you need to record additional customer invoices, too.

Similarly, if the accounts payable balance shows up as a negative value, that negative value probably signals to you that vendor payments have been recorded but you need to record additional vendor bills.

You can get step-by-step instructions for finding and fixing half recorded accounts receivable and accounts payable transactions here.

And a final plea on  behalf of tax accountants everywhere… Do be sure to do this clean-up before the tax return is prepared. Negative accounts payable and accounts receivable values indicate that your QuickBooks data needs additional transactions in order to accurately reflect your income.

Year-end S Corporation Task #4: Check Your Balance Sheet for Goofiness

Can I make one final suggestion? No matter what your accounting system, you want to produce a balance sheet as of the current date—like today—and look for any goofy values.

Absurdly high or low cash balances, suspicious looking liability or loan balances, anything else that seems wrong or old or off, that stuff signals to you that one or more errors exists in your financial records.

If you see stuff like this, clean the errors up if you can or outsource the work to an accountant or competent bookkeeper as soon as possible.

Fixing the errors on your balance sheet will mean your profit and loss statement and tax return more accurately reflect your income for the year.

Tip: Doing your financial housekeeping before the year ends is a good way to make sure errors don’t accumulate and compound over time.

A Final Tip for S Corporations

One final tip related to your year-end accounting: Do remember that your subchapter S corporation tax return, the 1120S return, goes to the Internal Revenue Service by March 15^th. So a month earlier than the usual April 15^th date a regular individual tax return is due.

I mention this because whoever prepares the 1120S return needs to get going on the return as soon as possible after the new year starts. (In our CPA firm offices, we will actually start working on 1120S tax returns the day after New Year’s!)

The post Year-end S Corporation Accounting Checklist appeared first on Evergreen Small Business.

But can I suggest something? Power law dynamics can (and should) show up in small firms too.

In fact, small business power law dynamics may just be the secret to you jacking the profits of your venture.

But let me give you the theory and then some real-life examples so you get what I’m rattling on about…

Power Law Dynamics: A Definition and Generic Example

The power law dynamic refers to a situation where a change in some formula input triggers a disproportionately big change in the formula output.

A simple example from the world of carpentry shows this visually.

Say you have a square hole in a floor. If each side of the square measures 2 feet, covering this 2×2 foot square hole requires a chunk of plywood that measures 4 square feet. (The red square below shows this.)

But what if you double the side of square to 4 feet? Now covering the hole requires 16 square feet of plywood. (The yellow square below shows this.)

A doubling of the “size of side” input, therefore,  quadruples the formula result from 4 square feet to 16 square feet:

A quick side bar: The reason people call something like this a “power law” is because there’s an exponential expression that “raises some value to an Nth power.”

For example, you can express the plywood required to cover a square hole measuring two feet by two feet like this:

2²

And then you can express the plywood required to cover a square foot measuring four feet by four feet like this:

4²

See that superscript 2 that appears in both formulas? That’s the two feet or the four feet being raised to the 2^nd power.

And now, you know what? You can just ignore this stuff about “exponents” and then also that gibberish about “to the Nth power.”

We don’t need to spend any more time on that.

Instead you can focus on the core logic: a small change in some formula input can produce a big change in the formula result output.

And here’s where this gets really interesting in terms of small businesses and entrepreneurship…

Small Business Power Law Dynamics Real-life Example

I am absolutely sure that you and I, as small business owners, encounter small business power law dynamics all over the place.

Let me tell you about three examples we’ve experienced in our little operation.

Example #1 – Search Engine Ranking

You may know this if you use your website to attract new customers, but your relative rank on a search engine results page hugely impacts the new customers you get.

If you sit at the 8^th spot on the search results list, for example, you might get 1 new customer a month. If, however, you get a decent link from a reputable website (maybe a small weekly newspaper), you may move up to the 7^th spot… and then you will maybe get 2 new customers a month.

So, to summarize, every step up in rank your small business earns very possibly doubles the number of customers you get. (The math really does work almost like this, for the record.) And that’s a power law dynamic.

Example #2: e-Book Cover Design

Let me share an example from a sideline business I run. For a shamefully long time we sold our do-it-yourself incorporation kits with an incredibly amateurish “cover” that I whipped up myself using Microsoft Word.

One week I finally got smart and paid a professional designer a couple hundred bucks to create covers that show the states’ flags as each ebook’s cover, as illustrated below.

The new covers are nothing fancy as you can see. But people liked seeing their state’s flags. And they really were way better looking than the original covers,

But here’s the really important point: Our sales doubled the very next day.

I’ve mentioned this experience a few times. And sometimes folks laugh and laugh pointing out that of course better packaging makes a difference, that of course a professional designer does better graphic design than an amateur. I agree with all that.

But that’s not really the insightful point,  I submit.

The insight is that a very economical modest change–you’ve surely heard the phrase “don’t judge a book by its cover” right?–immediately doubled sales. Immediately!

Example #3: Small Revenue Changes Trigger Big Profit Improvements

Let me give you one final example of where a relatively small change in an input triggers a surprisingly large change in an output.

Let’s say you run a small business with $100,000 of revenue. Further, say that your cost of goods sold for the stuff you sell equals 40% and that your fixed overhead equals $40,000.

The simple profit and loss statement shown below gives your operating profits: about $20,000.

But what if you can bump your revenues by 10% but keep your fixed costs “fixed” at $40,000.

In this case, because only your revenues and costs of goods sold increase by 10%, your profits rise to $26,000,  as shown in the profit and loss statement below.

Notice the small business power law dynamic here: A 10% bump in revenues triggers a 30% bump in profits. Wow.

Again, a relatively minor change in a formula input triggers a surprisingly major change in the formula output.

Three Quick Comments in Closing

To wrap up this discussion, three quick comments:

1. Surely the real-life formulas that accurately describe your or my business are too complicated to discover and then mathematically manipulate with precision. So what I propose we do is this: Let’s just recognize that there’s a power law dynamic to lots of the changes we can make. And that means small improvements, for example, may produce big changes in our profits.
2. A related important point. We need to be careful. Because power law dynamics work in both directions. You and I might inadvertently or carelessly change some input and then find the formula results dramatically decrease, too.
3. A tangential remark… The whole nature of small business power law dynamics suggests to me that seemingly-entrepreneurial activities like side hustles and part-time micro businesses don’t really make sense…  As Peter Thiel discusses in his book, you want in a small business to actively search out all of the power law type opportunities that exist—and then exploit them. Another way to say the same thing? You need to go big.

The post Small Business Power Law Dynamics:  Secret to Jacking Profitability? appeared first on Evergreen Small Business.