The Necessity of Taxes and Value of Business Reports

Dealing with a Professional

Have you ever wondered why businesses have CFOs (chief financial officers), vice presidents of finance, CPAs (certified public accountants), and bookkeepers? It’s because keeping the books is the backbone of any company’s business. Once you have a business, trusting your taxes to an online service can be problematic, because your relationship with your tax preparer is a personal one.

Do you have a professional going over your books at least once a year? You should. A paid professional experienced in your type of business knows what to do when it comes to your taxes. Due to the complexity of the tax code, not just any paid preparer will suffice when it comes to preparing your business taxes. Here’s a list of possible people who can prepare your tax returns.

Tax preparer (or consultant): This is the person you visit at the local we-file-for-you tax office. Did you know that a tax preparer could be anybody? There is no licensing involved. H&R Block hires as many as 70,000 seasonal workers as tax preparers each year. I’m sure that some may be familiar with the tax code, but the sheer number of tax preparers and the lack of regulation can make using a we-file-for-you tax office a risky proposition for businesspeople who want to minimize their tax liability.

The United States General Accounting Office report once estimated that 2.2 Americans overpaid their taxes by an average of $610 per year because they claimed the standard deduction when it would have been more beneficial to itemize. Half of those taxpayers used paid preparers who clearly were not cognizant of the full tax law as it applied to these individuals. Scary, huh?
Volunteer IRS-certified preparers: AARP (American Association of Retired Persons) does an outstanding job of assembling nearly 35,000 tax preparers to serve the needs of low-to-middle-income taxpayers (special attention going to those over 60). Their goal is to maximize legal deductions and credits, resulting in “tangible economic benefits” for their clients. These volunteers have to study, take a test, and become certified by the IRS before they can lend their services to the cause.

In recent years, AARP volunteers served a total of 2.6 million seniors in the United States. My mother was a retired corporate comptroller, and she volunteered in this program for many years. (She was disappointed when she made her lowest score on the IRS test — a 94 percent!) They staff nearly 5,000 sites nationwide. To find the one near you, call 1-888-227-7669 and select Tax-Aide Information or go to the AARP Foundation Tax-Aide locator at

www.aarp.org/applications/VMISLocator/searchTaxAideLocations.action
Public accountant: A public accountant, or PA, must fulfill educational, testing, and experience requirements and obtain a state license. PAs must take an annual course to maintain their status.
Enrolled agent: Often called one of the best-kept secrets in accounting, an enrolled agent is federally licensed by the IRS. (CPAs and attorneys are licensed by the state.) EAs must pass an extensive annual test on tax law and tax-return preparation every year to maintain their status. (They also have to pass annual background checks.) Enrolled agents are authorized to appear in place of a taxpayer before the IRS.

Many EAs are former IRS employees. To find an enrolled agent near you, go to www.naea.org and click the Find a Tax Expert button at the top of the page.
Certified public accountant: Certified public accountants (CPAs) must complete rigorous testing and fulfill experience requirements as prescribed by the state in which they practice. Most states require every CPA to obtain a state license.

CPAs are accountants. They specialize in recordkeeping and reporting financial matters. Their important position is as an advisor regarding financial decisions for both individuals and businesses. CPAs must take an annual course to maintain their status.

Keeping the Books: Basics to Get You Started

Although posting bookkeeping entries can be boring, clicking a button to generate your tax information is a lot easier than manually going over pages of sales information on a pad of paper. That’s why I like to use software, particularly QuickBooks (more about that program later).

I suppose that you could use plain ol’ paper and a pencil to keep your books; if that works for you, great. But even though that might work for you now, it definitely won’t in the future. Entering all your information into a software program now — while your books may still be fairly simple to handle — can save you a lot of time and frustration in the future, when your eBay business has grown beyond your wildest dreams and no amount of paper can keep it all straight and organized. I discuss alternative methods of bookkeeping in Chapter 3 in this minibook. For now, I focus on the basics of bookkeeping.

Tracking everything in and out

To effectively manage your business, you must keep track of all your expenses — down to the last roll of tape. You need to keep track of your inventory, how much you paid for the items, how much you paid in shipping, and how much you profited from your sales. If you use a van or the family car to pick up or deliver merchandise to the post office, you should keep track of this mileage as well. When you’re running a business, you should account for every penny that goes in and out.

Bookkeeping has irrefutable standards called GAAP (Generally Accepted Accounting Principles) that are set by the Financial Accounting Standards Advisory Board. (It sounds scary to me, too.) Assets, liabilities, owner’s equity, income, and expenses are standard terms used in all forms of accounting to define profit, loss, and the fiscal health of your business.

Understanding double-entry accounting

Every time you process a transaction, two things happen: One account is credited while another receives a debit (think yin and yang). To get more familiar with these terms (and those in the following list), see the definitions in the chart of accounts in Chapter 3 in this minibook. Depending on the type of account, the account’s balance either increases or decreases. One account that increases while another decreases is called double-entry accounting:

When you post an expense, the debit increases your expenses and decreases your bank account.
When you purchase furniture or other assets, it increases your asset account and decreases your bank account.
When you make a sale and make the deposit, it increases your bank account and decreases your accounts receivable.
When you purchase inventory, it increases your inventory and decreases your bank account.
When a portion of a sale includes sales tax, it decreases your sales and increases your sales tax account.

Manually performing double-entry accounting can be a bit taxing (no pun intended). A software program, however, will automatically adjust the accounts when you input a transaction.

Separating business and personal records

As a business owner, even if you’re a sole proprietor (see Chapter 1 in this minibook for information on business types), you should keep your business books separate from your personal expenses. By isolating your business records from your personal records, you can get a snapshot of which areas of your sales are doing well and which ones aren’t carrying their weight. But that isn’t the only reason keeping accurate records is smart; there’s the IRS to think about, too. In the next section, I explain Uncle Sam’s interest in your books.

Okay, posting bookkeeping can be boring. But at the end of the fiscal year, when you have a professional do your taxes, you’ll be a lot happier — and your tax preparation will cost you less — if you’ve posted your information cleanly and in the proper order.

Records Uncle Sam May Want to See

One of the reasons we can have a great business environment in the United States is because we all have a partner, Uncle Sam. Our government regulates business and sets the rules for us to transact our operations. To help you get started with your business, the IRS maintains a small-business website (shown in Figure 2-1) at the following address:

www.irs.gov/businesses/small-businesses-self-employed

FIGURE 2-1: IRS page for small businesses, complete with handy links.

In this section, I highlight what information you need to keep and how long you should keep it (just in case you’re chosen for an audit).

Supporting information

Aside from needing to know how your business is going (which is really important), the main reason to keep clear and concise records is because Uncle Sam may come knocking one day. You never know when the IRS will choose your number and want to examine your records. In the following list, I highlight some of the important pieces of supporting information (things that support your expenses on your end-of-year tax return):

Receipts: Please heed this advice: Save every receipt you get. If you’re out of town on a buying trip and have coffee at the airport, save that receipt — it’s a deduction from your profits. Everything related to your business may be deductible, so you must save airport parking receipts, taxi receipts, receipts for a pen that you picked up on your way to a meeting, everything. If you don’t have a receipt, you can’t prove the write-off.
Merchandise invoices: Saving all merchandise invoices is as important as saving all your receipts. If you want to prove that you paid $400 and not the $299 retail price for that PlayStation 2 that you sold online for $500, you’d better have an invoice of some kind. The same idea applies to most collectibles, in which case a retail price can’t be fixed. Save all invoices!
Outside contractor invoices: If you use outside contractors — even if you pay the college kid next door to go to the post office and the bank for you — you should get an invoice from them to document exactly what service you paid for and how much you paid. This is supporting information that will save your bacon, should it ever need saving.
Business cards: It may sound like I’m stretching things a bit, but if you use your car to look at some merchandise, pick up a business card from the vendor. If you’re out of town and have a meeting with someone, take a card. Having these business cards can help substantiate your deductible comings and goings.
A daily calendar: This is where your smartphone or tablet comes in. Every time you leave your house or office on a business-related task, make note of it on your calendar. Google Calendar syncs easily with your mobile devices. Keep as detailed a hoard of minutiae as you can stand. At the end of the year, I print out my Google calendar by month for tax backup. Staple the pages together and include the hard copies in your files with your substantiating information.
Credit card statements: You’re already collecting credit card receipts, right? Why not just download your credit card statements from the web at the end of every month — and back them up. If you have the statements, you have a monthly proof of expenses. When you get your statement each month, post it into your bookkeeping program and itemize each and every charge, detailing where you spent the money and what for. (QuickBooks has a split feature that accommodates all your categories.) File these statements with your tax return at the end of the year in your year-end envelope.

To check for new information and the lowdown on what you can and can’t do, ask an accountant or a CPA. Also visit the IRS Tax Information for Businesses site (they even have videos), shown in Figure 2-2, at

www.irs.gov/businesses

FIGURE 2-2: Don’t rely on rumors, get tax information from links on this page.

How long should you keep your records?

How long do you have to keep all this supporting information? I hate to tell you, but I think I’ve saved it all. I must have at least ten years of receipts and statements. But you know, I’m not too extreme; the period in which you can amend a return or in which the IRS can assess more tax is never less than three years from the date of filing — and can be even longer.

The IRS wants you to save anything related to your tax return for three years. But if you take a look at Table 2-1, the IRS may want backup documentation for up to six years. So for safety’s sake, keep things for six years, if only to prove you’re innocent. (As an aside, because I’m paranoid, I still keep everything for the maximum mentioned by the IRS — seven years.)

TABLE 2-1 Keep Records for This Length of Time

Circumstance	Keep Records This Long
You owe additional tax (if the following three points don’t apply)	3 years
You don’t report all your income and what you don’t report is more than 25% of the gross income shown on your return	6 years
You file a fraudulent tax return	Forever
You don’t bother to file a return	Forever
You file a claim of refund or credit after you’ve filed	3 years or 2 years after the tax was paid (whichever is longer)
Your claim is due to a bad debt deduction or worthless securities	7 years
Employment Tax records	At least 4 years after the date that the tax becomes due or is paid, whichever is later
You have information on assets	Life of the asset

Even though I got the information in Table 2-1 directly from the IRS website and literature (Publication 583, “Starting a Business and Keeping Records”), it may change in the future. You can download a PDF copy of the booklet by going to the following address:

www.irs.gov/pub/irs-pdf/p583.pdf

It doesn’t hurt to store your information for as long as you can stand it and stay on top of any changes the IRS may implement.

Getting the Most from Your Reports

After you’re up and running with your business, you can look forward to having lots of reports to evaluate. Of course, you get a bunch of reports from PayPal, eBay, and so on, but the most important reports are those you generate from your bookkeeping program, whether it’s software such as Excel or QuickBooks, or an online service such as GoDaddy Online Bookkeeping (formerly Outright).

Because my business consists of more than eBay sales, I use QuickBooks to manage my business records, and it keeps several common reports (Balance Sheet, Accounts Payable, P&L, and so on) in an easily accessible area. If you check out the Reports tab in your bookkeeping program, I’ll bet you find similar items. Before your eyes glaze over, though, check out this section for straightforward descriptions of these reports and the information they provide.

Similar sales and financial reports are common to all businesses, and reviewing them on a monthly basis can help you stay on top of yours.

To get your business reports when you need them, you must post your sales receipts regularly — and thereby update the “money in” and “inventory out” figures. Post your payments as often as you can (especially on your company credit card — post those transactions the minute you get the statement) — and reconcile your bank account the moment your bank statement arrives.

What does posting and reconciling tasks get you? The opportunity to press a button and get a complete picture of your business. From the reports you generate, you find out whether your business is profitable, what products are selling, and if you’re spending too much money in a particular area. Keeping your books up to date allows you to find problems before they become unmanageable.

If you run your sales and financial reports only quarterly rather than monthly, a problem — such as not pricing your items high enough — could be mushrooming out of control before you can detect and correct it.

Understanding the balance sheet

Your balance sheet provides the best information on your business. It pulls data from all the other reports and gives you a complete look at the financial condition of your business.

Your balance sheet shows all your assets:

Cash in bank: The money in your business bank account.
Accounts receivable: If you’ve invoiced anyone and not received payment as yet, that amount is reflected here.
Inventory assets: This is the value of the merchandise you’ve purchased for resale but have not sold yet.
Other assets: Things owned by your business (not by you), such as furniture and vehicles. These are long-term assets that build accumulated depreciation. They’re not considered in the current asset figure.
Accumulated depreciation: This is depreciation, over time, of your long-term assets. This is either calculated by your accounting program or given to you by your accountant.

Your balance sheet also shows your liabilities:

Accounts payable: Money you owe vendors and money due on unpaid credit cards show up here.
Sales tax: The money you’ve collected on sales tax (that is due to your state) is a liability.
Payroll liabilities: If you haven’t made a bank deposit (it’s faster to make payment on the Federal online payment system at www.eftps.gov/eftps) covering the money you’ve withdrawn from employees (withholding taxes, Social Security, Medicare, and so on), it shows up here.

Your equity shows up in the (literal and figurative) bottom line. It will include the initial investment in your business and the net income total from your profit-and-loss statement.

An important business ratio — the net working capital ratio — is drawn from your balance sheet. Subtracting your current liabilities from your current assets gets you the net dollar amount of your working capital (that is, how much capital you have left to work with). But to get the net working capital ratio, divide your current assets by your current liabilities. Any value over 1.1 means you have a positive net working capital. If you need a loan from a bank, this is the first figure a loan officer will look for.

Tracking your accounts payable

When bills come in, post them in your accounting program. This will generate the accounts payable report. Accounts payable is the area that shows how much you owe and when it’s due. This is crucial information for meeting your obligations on time.

When you pay an outstanding bill, the bookkeeping program deducts the money from your checking account and marks the bill as paid. That bill will no longer appear on this report.

Knowing your sales-tax liability

One of the vendors you’ll owe money to is your state. (In California, the State Board of Equalization collects such debts.) Every time you post an invoice or sales receipt that charges sales tax, that amount shows up in the sales-tax liability report. You run this report on a timeframe determined by the state; you may be required to report monthly, quarterly, or yearly. Also, how often you report may depend on your total in-state sales. Just make sure you match your reporting with your state’s requirements.

COGS — the cost of goods (merchandise) sold — is a separate consideration from sales tax. For a closer look at COGS, see Intermediate Accounting For Dummies by Marie Loughran (Wiley), available at www.dummies.com.

Analyzing your profit and loss statement

If your accountant asks for your income statement, he or she is asking for your profit-and-loss statement, or P&L. This report lays out clearly every penny you’ve spent and brought in. You can set these reports to generate by any period of time; usually eBay sellers produce them by calendar month.

A summary P&L itemizes all your income and expense accounts individually and totals them by category. This way, you’ll be able to isolate individual areas where you may notice a problem, such as spending too much in shipping supplies.

Please use the following list of income and expense accounts as a guide, and not as gospel. I am not a tax professional, and I suggest that when you set up your own income and (especially) expense accounts, you go over them with a licensed tax expert. Here’s a glimpse at the kinds of accounts and categories you see on a P&L statement:

Income: Every dollar you bring in is itemized as income. For many sellers, this can break down into several individual accounts. These figures are automatically generated by your bookkeeping program from the sales receipts you input. The total of all these income areas is subtotaled at the bottom of this area as total income.
- Sales: This totals eBay sales and shipping income in separate totals. These figures subtotal as total sales.
- Website advertising: If you’re a member of any affiliate programs (Google Ads on your site count here too) or have a newsletter that takes advertising, this income posts here.
- Consulting: Income from providing consulting services or teaching others.
Cost of goods sold (COGS): This area itemizes by category all the costs involved in your eBay (and website) sales only. None of your business operating expenses, such as your telephone bill, show up here; they’re farther down on the report. To get the current information from the IRS as to what constitutes COGS, visit their website here:
www.irs.gov/publications/p334

Your cost of goods sold is subtotaled under the heading total COGS.
Gross profit: Your bookkeeping program magically does all the calculations — and you’ll be able to see in a snapshot whether your eBay business is in good, profitable health. This particular figure is the gross profit before you figure in your company expenses (often called G&A, for general and administrative costs).

Now come your expenses. Listed in individual accounts, you have subtotals for your various business operating expenses, as follows:

Payroll expenses: The total amounts you pay your employees.
Taxes: Broken out by state and federal, the taxes you’ve paid to the regulating agencies for running your business.
Supplies: Computer and office supplies. How much paper goes through your printer? Not to mention those inkjet cartridges, pens, computers, telephones, copiers, and network equipment. All those expenses appear here.
Seminars and education: Did you buy this book to educate yourself on your eBay business? It counts. Have you attended a seminar to educate yourself on eBay? Going to a business conference? Those count too.
Contract labor: This is the money you pay to anyone who is not an employee of your company, such as an off-site bookkeeper or a company that comes in to clean your office. The federal government has stringent rules as to who classifies as an independent contractor. Check this website for the official rules:
www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee
Automobile expenses: This is where you post expenses, such as parking, gas, and repairs for an automobile used for your eBay business. If you have only one vehicle that you also use for personal transportation, your tax person may have you post a percentage of its use in this area.
Telephone: Do you have a separate phone line for your business?
Advertising: Expenses you incur when running advertising campaigns, such as in Google AdWords or in your eBay banner program.

Your expenses will come to a whopping total at the bottom. Then, at the very bottom of the page, will be your net income. This is your bottom-line profit. I wish you all a very positive bottom line!

Keeping Your Records and Data Safe

If the hazard of not backing up your computer isn’t a tired subject, I don’t know what is. Whenever you hear someone talking about their latest computer crash, all the person can do is stare blankly into the distance and say, “I lost everything!” I admit it’s happened to me — and I’m sure that you’ve heard this cry from others (if you’ve not uttered it yourself): “If only I’d backed up my files!”

What about a natural disaster? It can happen, you know. When I went to sleep on January 16, 1994, I didn’t know that the next day, when I attempted to enter my office, everything would be in shambles. My monitors had flown across the room, filing cabinets turned over, and oh, did I mention the ceiling had collapsed? The Northridge earthquake taught me some solid lessons about keeping duplicate records and backed-up data copies in an offsite location.

Reasonably priced, secure backup can be accomplished in the cloud these days through Microsoft OneDrive, Google, Amazon, or any one of a group of providers for a reasonable cost. Consider these — along with a backup drive on premises — for your own peace of mind.

If a computer crash or natural disaster has happened to you, you have my deepest and most sincere sympathy. It’s a horrible thing to go through.

What’s another horrible thing? A tax audit: It can make you feel like jumping off a cliff if you’ve been filing your hard documentation with the shoebox method. (You know, one box for 2011, one for 2012, and so on.) Filing or scanning your receipts and PDF backup documentation in an organized, easy-to-find format can pay off in future savings of time (and nerves). (Again: Back up these PDFs to the cloud.)

I want to tell you up front that I don’t always practice what I preach. I don’t always back up my stuff on time. I do make an attempt to back up to OneDrive every time I remember. Following best practices for backing up your computer data and safeguarding the hardcopy documents that you inevitably will have just makes life easier.