Episode 29 ā More Tax Season Stuff
Iām recording this episode in Feb, right in the middle of tax season, so you might hear a little more stress in my voice, but itās still me. And because itās so busy right now, situations come up that I want to talk about in this episode, so I will do just that. Iām Paul Rosenblum.
The other day, I had a client who does their own bookkeeping give me the books to clean up some things and do year end closing of the books for the accountant, and the payroll has always consisted of labor costs at the clientās location. Itās a service business. Payroll was originally set up by as an expense, which is normal. However, in a case like this, the people on payroll could be considered a āCost of Laborā kind of expense. Cost of Goods are a kind of an expense that is directly related to a sale made. Office supplies are an expense of a company in any case, but if people are hired to specifically go out and perform services for clients āOn the roadā, then they very well could be considered COGS. The main change in the books is that the gross profit (Revenue minus COGS) is lower because you are adding payroll into the cost of goods, but the net profit (Revenue minus COGS minus Expenses) stays the same. My client wanted to change the payroll from a company expense to a cost of labor in the COGS section. I suggested to the client that the IRS is looking for consistency in the books, and if you change the COGS value by a lot from one year to another, it could be a flag and the chance for audit increases.
The client had a friend who used to work for the IRS and they wanted to ask him or her their opinion. They got back to me a couple of days ago and said that the friend said āNoone knows what triggers an audit, and thereās no problem at all moving the payroll from an expense to the COGS.
The truth of the matter is that we DO know what a flag for the IRS is. A flag doesnāt guarantee an audit, itās a flag. You need more than one flag, usually, to be on the audit list, unless itās something big that was flagged. Consistency is important. If the COGS goes dramatically up one year and the expenses go dramatically down, then it could be a flag for an audit.
The IRS gives in person seminars and webinars to CPAās who need āProfessional Creditsā to keep their licenses valid. The IRS actually tells people who attend these seminars and webinars what the IRS is looking for to keep people out of a possible audit situation. And one of the things that Iāve been told over the years is that the IRS is looking for consistency. If the numbers in particular categories change radically from year to year, it might be a flag and the IRS computers might question the numbers. Why take a chance to move a large value category into another category?
I suggested to the client in a strong email that we can ācallā payroll a cost of goods, but keep it as an expense in the books, so that the tax return prepared by the CPA would still reflect payroll as an expense. I also suggested that we look at last yearsā tax return and see how payroll costs were counted. If they were on the tax return as a cost of goods, then we can do the same thing in the books with no chances taken.
This client only gives me the bank statements and credit card statements to be reconciled once a year in December. I donāt actually do the bookkeeping, and I have never had access to the bank account to really check the bookkeeping to see if itās accurate. So, if the client doesnāt take my advice, I wonāt be too surprised because there is a trust issue there anyway. As I have mentioned before, most of my clients give me access to their bank account, which helps me make sure that their books are as good as they possibly can be.
Sometimes with new clients, I donāt get access to their bank accounts at the very beginning, but by the time tax season comes around, we have a good relationship and there is a trust, and I do get an ID and a password to get into the bank account.
Business owners (and I mean this in a good way) are interesting people. Many of us small business owners like to be in control of things (and Iām 100% that way myself if you havenāt noticed), but if you canāt trust your bookkeeper by giving them access to the credit card info and the bank info and logins to the accounts, who can you trust?
My goal is to give clean books to the tax preparer every time, and if I canāt see every deposit going into the bank and know specifically what it was, then I canāt hit my goal.
This is why itās so important to hire a bookkeeper who you can get to know, feel comfortable with and have a relationship with, so that you can build trust with us bookkeepers.
Another year-end situation that has recently come up is a company who is really struggling to make a profit. They have 2 partners working at the business and a few outside investors who donāt. They have 6 or 7 cost of goods accounts in the books, and they are really trying to see specifically what is working and what isnāt. So, they are scrutinizing each and every cost of goods account to make sure that every single transaction is in the correct cost of goods account. Very rarely do I see that happening, since the cost of goods section is reported on one line on the tax return. But they are very serious in really wanting to keep this company going, and although itās more work for me to reclassify each transaction that are telling me needs to be moved, I am more than happy to do that because of what they are trying to do. Good for them!
Another situation that I have to deal with very soon is two companies owned by the same people. And since itās a partnership, the due date to file taxes is March 15th.
There are transfers between the two companies every other day. When both companies bookkeeping is done each year, I have to check an account in both companies called āDue To/From (the other company) (Name withheld). They have to be the same amount in both, since they are transfers between companies, both of which use the same bank. So, aside from all the other things that have to be checked at year end (like bank and credit card reconciliations ā 7 credit cards and 3 bank accounts in one company, and one credit card and one bank account in the other company), I also have to reconcile the transfer account.
I have another situation where a husband and wife have 3 companies between the two of them. An IT company, a food truck, and a soon to be opened restaurant. Money is withdrawn from the IT company and used to āfundā the construction for the restaurant. One should not do that as a transfer from one company to another. The accountant asked me to show it in the books as a ādrawā from one company and a capital investment (both equity accounts) in both companies, and not a DueTo/Due From account. This way, itās not booked in the system as a loan, itās booked as Equity. So, I have to try and make sure that as I see withdrawals during the year, that I check with each part of the married couple and determine if a withdrawal really went to the other spouseās company or their personal bank account which would be considered a draw.
I hate to say many bookkeepers these days just donāt think that way. They donāt check these things ā they let the accountant figure it out later and make adjustment entries. Some clients are very hard to reach, and they donāt return emails, so I try the best I can, and if I canāt get the information from the client, I let the accountant know and maybe their personality will jar the client into getting back to them with the information that he or she needs to put together a good accurate tax return.
Iām not perfect, and there are sets of books that I do my best on, but the accountant and I have to work together to clean things up. But as much as possible, I try and complete the books so that they are clean, accurate, and good looking (I know, I sound like Iām talking about a child) ābut the books that I create are kind of that to me, but you know that if you have been listening to other episodes.
It's the middle of tax season when Iām recording this and there are about 6 more weeks to go before the pressure calms down for me and a little longer for my Canadian bookkeeper colleague. But eventually, itāll slow down and our lives outside the office can continue to roll on.
Please let me know if you like episodes like this, and if they are a help to you as a business owner or a bookkeeper. After tax season, I plan to record more interviews and explore different directions for this podcast.
Hoping that the rest of your late winter and early spring are less stressful than mine and that you file taxes on time, so that you can move on with your lives without the possibility of getting letters from the IRS demanding payment. Leave me a voice mail at the website, or an email and let me know the subject matter that youād like to hear in future episodes.
Would you like more interviews? Are you tired of just my voice? I can take it ā looking forward to hearing from all of you. Again, Leave me email or go to the website and leave me a voicemail.
Iāll be āin your āAir podsā or speakers again soon --
Iām Paul Rosenblum