Goverment reporting and tax issues

IRS Reporting

When you are in business the government is your partner, like it or not. Besides the general reports and requirements that I have listed here, each business has reporting requirements specific to that type of business, which you will need to research. I hope you will get assistance with this from your bookkeeper or CPA.

The IRS has rules on how you must account for profits, losses, cost of goods, labor, and shipping cost, to name a few. I will cover these areas briefly so that you have some understanding of them.
Not To Worry!

Government Reports & Forms:

Do not let all this reporting overwhelm you! Most of this stuff will become routine and you will only deal with it a few times a year. Once your bookkeeping method is set up, concentrate on running your business. If reporting requirements is bothering you, get a bookkeeping service and let them keep you in compliance.

Most of the required reports can be found on the IRS web site. Most of the reports have to do with employees. Listed here are the main reports & forms you will deal with. If you use a book keeping service, they can handle most of this for you. Some CPA offices have a service to help keep you in compliance. The IRS has booklets on all of these forms and their proper use. http://www.irs.gov/ also see Helpful Links.

1. Monthly state sales tax report.

2. You must make quarterly IRS tax deposits if you have a profit.

3. Monthly tax deposits for employee withholdings. IRS form 941

4. Quarterly federal unemployment tax report. IRS form 940

5. Annual 1099, report for any sub contractors who earned over $600.

6. Annual W-2 report, on with holdings from employee.

7. Annual W-2, to employees.

8. Form W-4, employee-withholding instructions, keep on file in your office.

9. INS form I-9, Employment eligibility verification. You must have I-9s on file if you are audited.

10. Your state may have a new hire reporting rule, call the state atty. gen. office for your state an inquire.

11. Schedule C, for your profit or loss from a business or profession, to be filed with your federal tax return. (Sole-proprietorships)

12. OTHERS: State tax report, Corporation tax report, franchise tax report, depletion, farm & ranch etc. If you need any of these you should be using a CPA to keep you in compliance.

Information on starting a business, IRS forms, tax information for businesses, and more can be found ont he IRS web site

Profit & Loss:

In theory computing profit or losses is simple. Take gross income and subtract business deductions. The actual computation to arrive at the business deductions can be quite complicated. Some definitions.

Gross Income: All income coming into the business, sales, interest, rents received, commissions, and fees.

Net Income or loss: The difference between income and business deductions.

Business deductions: The IRS states that a business deduction must meet the following conditions to be a business deduction.

1. The expense has to business related (not personal) and incurred in the conduction of your business.

2. The expense must be ordinary and necessary. The expense must be such as is normally incurred by this particular type of business. The expense must be a business necessity.

3. The expense has to be for items used in business with a useful life of less than a year. Equipment, tools, machinery, furniture are not expenses but rather are assets that have to be depreciated.

4. The expense amount must be reasonable.

Business Use of Auto or truck:

Use of an auto or truck for business can be taken either as a standard mileage deduction or as actual cost of owning and operating the vehicle. The standard mileage method is much easier to use and usually more lucrative. You cannot deduct that part of the vehicle use that is personal or that involves commuting to and from work.

1. Keep a log of the use of the vehicle on a daily basis. Note the who, what, where, when, and why. In an audit the log will be invaluable.

2. For actual expense method you will need a detailed log of all expenses and copies of all receipts. Batteries, tires or any item with a useful life over one year has to be depreciated and the car as a whole is depreciated

3. Interest on the loan is also deductible.

4. For the standard mileage method, log the mileage every time you use the car for business. The law requires that you substantiate your expenses by keeping adequate records or by sufficient evidence to support your own statement. From The IRS.gov web site.
Topic 510 - Business Use of Car

If you use your car in your job or business and you use it only for that purpose, you may deduct its entire cost of operation (subject to limits discussed later). However, if you use the car for both business and personal purposes, you may deduct only the cost of its business use.

You can generally figure the amount of your deductible car expense using one of two methods: the standard mileage rate method or the actual expense method. Before choosing a method, you may want to figure your deduction both ways to see which gives you a larger deduction. For 2004, the standard mileage rate is 37.5 cents a mile for all business miles driven. If you use the standard mileage rate, you can add to your deduction any parking fees and tolls incurred for business purposes.

To use the standard mileage rate, you must own or lease the car. The car must not be used for hire, for example, as a taxi. You must not operate two or more cars at the same time, as in a fleet operation. You must not have claimed a depreciation deduction using the Accelerated Cost Recovery System (ACRS) or the Modified Accelerated Cost Recovery System (MACRS) on the car in an earlier year. You must not have claimed a Section 179 deduction on the car, and you must not have claimed actual expenses after 1997 for a car you leased. You cannot use the standard mileage rate if you are a rural mail carrier who received a "qualified reimbursement."

Further, to use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your business. Then, in later years, you can choose to use the standard mileage rate or actual expenses.

However, for a car you lease, you must use the standard mileage rate method for the entire lease period. For leases that began on, or before December 31, 1997, the standard mileage rate must be used for the entire portion of the lease period (including renewals).

To use the actual expense method, you must determine what it actually cost to operate the car for business purposes. Include gas, oil, repairs, tires, insurance, registration fees, licenses, and depreciation (or lease payments) attributable to business miles driven. Also include garage rent, parking fees, and tolls attributable to business use.

Generally, the Modified Accelerated Cost Recovery System is the only depreciation method that can be used by car owners to depreciate any car placed in service after 1986. However, if you use the standard mileage rate in the year you place the car in service, and change to the actual expense method in a later yea,r and before your car is fully depreciated, you must use straight–line depreciation over the estimated remaining useful life of the car. There are limits on how much depreciation you can deduct. For cars first placed in service in 2002, the maximum depreciation for that car is $4,900, for 2003 it is $2,950, and for each succeeding year it is $1,775. These maximum amounts vary for cars placed in service before 2002. Also, the amount of the deduction is reduced if you use the car less than 100% for business. Multiply the maximum amount by your percentage of business and investment use to determine the deductible amount.

Bad debts:

You can deduct bad debts owed to the business if the debts were ordinarily recorded as income. You must keep a record of the debt in the event the IRS asks to see them.

Insurance:

You can deduct insurance for fire, theft, workman comp, business interruption, liability, automobiles used in business, bonds, group insurance and other business related insurance.

Personal health and life premiums have special rules on deductibility see the IRS web site for more specific information.

Freight:

Shipping cost requires special handling. Freight income that you charge a customer is recorded as income. The cost of shipping the items to your customer is a cost of goods or expense. Freight out is deductible.

Freight-in cost, on any repeatable assets such as equipment, gets added to the cost of the equipment and depreciated along with the equipment. For example, you order a new computer, the cost of shipping the computer gets added to the cost basis and depreciated over the three-year useful life of the computer.

Freight-in charges on merchandise gets added to the cost of the items and carried as part of your inventory assets. When the item is sold the shipping charges become part of the cost of goods sold or expensed at the time of the sale. For example, You sell widgets costing $10.00 each, it costs $10.00 per case of 10 widgets you bring in for a shipping cost of $1.00 per widget. The shipping cost of $1.00 each gets added to the cost of the widgets giving you a landed cost of $11.00 per widget. The same would be true of any duty or other shipping related fees.

A freight-in charge on consumables is considered an expenses item, and deductible when paid. For example, you order paper bags to put your customers purchase in, the cost of shipping is an expense because bags are consumed in the normal course of doing business.

Repairs Verses Improvements:

Repairs: You generally deduct the cost of repairing business property in the same way as any other business expense. However, if a repair or replacement increases the value of your property, makes it more useful, or lengthens its life, you must treat it as an improvement and depreciate it. Example; You patch a section of roof at your place of business. You deduct the cost of the repair as a business expense. However, if you completely replace the roof, the new roof is an improvement because it increases the value and lengthens the life of the property. You must depreciate it.

Improvements to rented property: You can depreciate permanent improvements you make to business property you rent from someone else. Example; you pay for leasehold improvements to make rented space conform to your use. You depreciate the improvements cost over the life of the lease.

If you improve depreciable property, you must treat the improvement as separate depreciable property.

If you build a new building you can depreciate the component sections or parts based on the useful life of the components rather than the normal life of the building as a whole. You will be asked to prove that the useful life of the component is less than the building as a whole. Hint: I always get a letter from my supplier stating the useful life of the component part I am installing. For example; when installing an A/C system the unit life is normally ten years, not the 39.5 years the IRS allows for the main structure. This method complicates the accounting but the tax savings can be considerable.

Travel:

Commuting costs are not deductible, but some local transportation expenses are. Deductible local transportation expenses include the expense of going from one workplace to another when you are in the area of your tax home. If your home office qualifies as your principal place of business, you may deduct the cost of going between your residence and workplaces in that business. You may deduct the cost of going between your residence and a temporary work location, trade shows, business education seminars, or other travel for other normal and customary business reasons. If you regularly work at one or more regular business locations away from your office, you may deduct the cost of going to a temporary work location or to see customers. Transportation expenses include the cost of transportation by car, air, rail, bus, taxi, etc.

Business entertainment expenses and business gift expenses may be deductible, but subject to certain limits. For information on business entertainment expenses, see the IRS web site.

You must keep records to prove the expenses you deduct.

Contractor? or Employees?

It is critical that you, as an employer, correctly determine whether the individuals providing services are employees or independent contractors. Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.

If you incorrectly classify an employee as an independent contractor, you can be held liable for employment taxes for that worker, plus an IRS penalty.

Who is an Independent Contractor?

A general rule is, the person paying the contractor has the right to control, or direct only the end result of the work done by the independent contractor, and not the means and methods of accomplishing the result.
One of the tests the IRS will use to determine the independence of the contractor will be whether or not it is usual and customary in your industry to treat the worker as an in-depended contractor. There should be a written agreement between the parties.

A general rule is that anyone who performs services for you is your employee if you can control what will be done and how it will be done.

Statutory Non-employees

There are two categories of statutory non-employees: licensed real estate agents and direct sellers. They are treated as self-employed for all Federal tax purposes and unemployment tax purposes.

Substantially all payments for their services as direct sellers are directly related to sales, rather than to the number of hours worked. Their services should be performed under a written contract providing that they will not be treated as employees for Federal tax purposes. This normally covers outside salespeople paid substantially on commission.

There is a form on the IRS web site to help you with this determination. More info on independent contractors and form SS-8 .

Depreciation:

Property used in a trade, business, or in an income production activity, can be depreciated. The property must be something that wears out or becomes obsolete and it must have a determinable useful life. The kinds of property that can be depreciated include, but are not limited to, machinery, equipment, buildings, vehicles, and furniture.

Depreciation is a complicated subject. I suggest you determine what is depreciation property, account for it as an asset, and then let your CPA handle the correct calculation.

Getting help & Forms:

The IRS web site is user friendly and makes checking out any subject fast and easy. From starting a business questions, record-keeping rules to tax forms and compliance the IRS web site will help you keep up to date.

IRS Reporting:

Visit the IRS.gov web site for reporting information on businesses

Business Information Links

The US Government printing office is a great source for all kids of business publications.

http://www.pueblo.gsa.gov
Federal information center: Go to Small Business.

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