small business taxes for the U.S.

[esantoro]

Each business has its own peculiar ways of accounting for expenses, so I thought I'd start a thread on taxes.

For 2008, I will have to be itemizing deductions and declaring profits and losses.

On schedule C, there are a few options for lists material costs. One option is "other." I have a list of materials and there costs for one leather bag: glue, conditioner, leather, rivets, thread, etc. I've figured out the costs for all of these. Is it appropriate to use this standard cost sheet for all bags?

Thanks,

Ed

[Ian]

I don't itemize in that detail - Just add up the total reciepts - seperate material costs from tools ('Other') and then there's 'Office' for any junk I buy from Staples, even if it's something like poster board for making patterns. It doesn't really matter how you categorize, as long as you have reciepts to justify it all. Other places for rent, advertising, mileage, etc all have their own place on the form.

I use a cash register, so I don't even remember what the actual items were that I sold. As long as I have a daily total. Credit card saless are recorded on the reciept. And, the credit card company charges, I throw in with 'Other'.

I don't it like that for quite a while and no problems so far (cross fingers). Just watch me get an audit after saying that.

Ian

[esantoro]

I don't itemize in that detail - Just add up the total reciepts - seperate material costs from tools ('Other') and then there's 'Office' for any junk I buy from Staples, even if it's something like poster board for making patterns. It doesn't really matter how you categorize, as long as you have reciepts to justify it all. Other places for rent, advertising, mileage, etc all have their own place on the form.

I use a cash register, so I don't even remember what the actual items were that I sold. As long as I have a daily total. Credit card saless are recorded on the reciept. And, the credit card company charges, I throw in with 'Other'.

I don't it like that for quite a while and no problems so far (cross fingers). Just watch me get an audit after saying that.

Ian

Thanks, Ian. This was a big help. I think I'll write up a standard materials sheet that can be added to or subtracted from.

Ed

[LadyJ]

I don't mean to confuse you, but the difference in your approach and Ed's is the difference between a Cash accounting method and an Accrual accounting method. Either is acceptable but once you choose a method, you need to stay with it.

The cash method assumes that all materials purchased are an expense when you buy them (cost of goods) and all goods sold are income when you recieve the money for them. This method is generally used for most retail sales businesses and is probably your best choice. It is the method Ed is using.

You are describing the accrual method when you talk about recapturing your expenses from an item at the time you actually sell that item. For some of the saddlemakers in this group who have commissions for custom saddles that take longer than a year to complete, an accrual method might have some advantages. For example, you get an order for an expensive saddle in October in a slow year. You bought and paid for the materials at that time. As of December 31st, you have more expenses than you can deduct against the income you earned and the extra loss does not help you on your taxes. You get paid for the saddle in the new tax year but have no expenses left to deduct from the income. You now pay taxes on the entire amount of the saddle which my artificially distort your taxable income in the new year. For some businesses, the Accrual method helps distribute expenses to the time when the income needs to be protected from the tax.

Ed's method is the easiest for most of us to use to account for retail sales. It is probably best for you too.

Lady J

[HorsehairBraider]

I agree with what Lady J said.

What I ended up doing (finally) was getting an accountant. He has given me so much good advice, and always reminds me of things that are part of the cost of doing business that I sometimes forget. I think it costs me $150 a year, and is well worth it. He also helped me out when I had made a mistake in reporting my state taxes. He explained to me how to do it correctly and the procedure to take to report my mistake. If they had caught it first I could have been in trouble, so I was pretty glad when he noticed!

[esantoro]

Hi Lady J,

Thanks for your response. It seems that what I am doing is the accrual method.

Every bag requires the same materials, same amount of thread, conditioner, edge coating, rivets, packing materials, etc. I just add or subtract for more expensive or less expensive leather. When I sell a bag I, I immediately have deductions for materials and have a tunning total of profit and loss.

If I'm understanding correctly, the cash method wouldn't allow me to deduct for, say, edge coating until I use up the bottle. It may take more than a year to use up a particular color of edge coating. I figure one 4 oz bottle can do eight bags, so for each bag, I add to my list of materials consumed 1/8 of the price of edge coating.

Does this sound correct, or am I missing something?

Ed

I don't mean to confuse you, but the difference in your approach and Ed's is the difference between a Cash accounting method and an Accrual accounting method. Either is acceptable but once you choose a method, you need to stay with it.

The cash method assumes that all materials purchased are an expense when you buy them (cost of goods) and all goods sold are income when you recieve the money for them. This method is generally used for most retail sales businesses and is probably your best choice. It is the method Ed is using.

You are describing the accrual method when you talk about recapturing your expenses from an item at the time you actually sell that item. For some of the saddlemakers in this group who have commissions for custom saddles that take longer than a year to complete, an accrual method might have some advantages. For example, you get an order for an expensive saddle in October in a slow year. You bought and paid for the materials at that time. As of December 31st, you have more expenses than you can deduct against the income you earned and the extra loss does not help you on your taxes. You get paid for the saddle in the new tax year but have no expenses left to deduct from the income. You now pay taxes on the entire amount of the saddle which my artificially distort your taxable income in the new year. For some businesses, the Accrual method helps distribute expenses to the time when the income needs to be protected from the tax.

Ed's method is the easiest for most of us to use to account for retail sales. It is probably best for you too.

Lady J

[David Genadek]

Hi Lady J,

Thanks for your response. It seems that what I am doing is the accrual method.

Every bag requires the same materials, same amount of thread, conditioner, edge coating, rivets, packing materials, etc. I just add or subtract for more expensive or less expensive leather. When I sell a bag I, I immediately have deductions for materials and have a tunning total of profit and loss.

If I'm understanding correctly, the cash method wouldn't allow me to deduct for, say, edge coating until I use up the bottle. It may take more than a year to use up a particular color of edge coating. I figure one 4 oz bottle can do eight bags, so for each bag, I add to my list of materials consumed 1/8 of the price of edge coating.

Does this sound correct, or am I missing something?

Ed

Ed,

It all depends on what you want to inventory. You can lump a bunch of things into a supplies catagory. Things like dye and glue is pretty hard to keep an accurate count on and really as a percentage of the COGS is pretty small so you can exspense that when you buy it. The leather on the other hand would be worth counting as inventory because it will give you a better idea of where your assets are. In the end you can do it however you want as long as your consistant so the real question becomes what information do you need to run your business? The IRS just wants to know how much money you made which boils down to how much did you bring in and what did it cost you to do it. They don't care how you slice that up but they want you to slice it the same way all the time.

David Genadek

[esantoro]

Ed,

It all depends on what you want to inventory. You can lump a bunch of things into a supplies catagory. Things like dye and glue is pretty hard to keep an accurate count on and really as a percentage of the COGS is pretty small so you can exspense that when you buy it. The leather on the other hand would be worth counting as inventory because it will give you a better idea of where your assets are. In the end you can do it however you want as long as your consistant so the real question becomes what information do you need to run your business? The IRS just wants to know how much money you made which boils down to how much did you bring in and what did it cost you to do it. They don't care how you slice that up but they want you to slice it the same way all the time.

David Genadek

Thanks, David.

I like to stock up on supplies when I find good prices. Lets say I buy five gallons of Tanners Bond because the price is right. I may not use all of that glue in the year I buy it. Can I still deduct the entire glue cost for that year. The same goes for Aussie wax, Bick 4, Dual 88, beeswax, rivets, etc.

Also, I don't want to report a loss for any year . but rather have any losses apply to the next year's deductions.

Thanks, again, for this help. I will soon be contacting an accountant.

Ed

Edited April 27, 2008 by esantoro

[David Genadek]

Thanks, David.

I like to stock up on supplies when I find good prices. Lets say I buy five gallons of Tanners Bond because the price is right. I may not use all of that glue in the year I buy it. Can I still deduct the entire glue cost for that year. The same goes for Aussie wax, Bick 4, Dual 88, beeswax, rivets, etc.

Also, I don't want to report a loss for any year . but rather have any losses apply to the next year's deductions.

Thanks, again, for this help. I will soon be contacting an attorney.

Ed

Can I still deduct the entire glue cost for that year? Yes but you have to do it that way all the time. I call those things supplies and I do supplies on a cash basis. Those things that I view as assets I treat as inventory but they have to be worthe enough for me to take the time to count them all the time. If it costs more to track than it is worthe, treat it on a cash basis. If not then treat it on an accrual basis. I am speaking from the stand point of a corperation so it may be different on a different bussiness structure. You really should talk to an accountant and have them set you up it is worthe the money but find some one you can trust. This is really an important step!

David Genadek

[esantoro]

I've purchased and downloaded a few Nolo press ebooks on tax deductions for small businesses. Very informative.

Thanks for helping to get the ball rolling.

Ed

[esantoro]

Can I still deduct the entire glue cost for that year? Yes but you have to do it that way all the time. I call those things supplies and I do supplies on a cash basis. Those things that I view as assets I treat as inventory but they have to be worthe enough for me to take the time to count them all the time. If it costs more to track than it is worthe, treat it on a cash basis. If not then treat it on an accrual basis. I am speaking from the stand point of a corperation so it may be different on a different bussiness structure. You really should talk to an accountant and have them set you up it is worthe the money but find some one you can trust. This is really an important step!

David Genadek

I'm meeting with an accountant this Saturday. Thanks.

Ed

[bruce johnson]

Ed,

Not sure if I shared this one with you before. There is a CPA named Bernard Kamaroff who has written a few books on small businesses. I was steered by my advisor to "Small Time Operator - How to Start Your Own Business, Keep Your Books, Pay Your Taxes, and Stay Out of Trouble". I would recommend it. I see he also has some new ones, one is "422 Tax Deductions for Businesses and the Self-Employed". Now that sounds interesting too. He writes in a pretty easy to follow style.

[esantoro]

Ed,

Not sure if I shared this one with you before. There is a CPA named Bernard Kamaroff who has written a few books on small businesses. I was steered by my advisor to "Small Time Operator - How to Start Your Own Business, Keep Your Books, Pay Your Taxes, and Stay Out of Trouble". I would recommend it. I see he also has some new ones, one is "422 Tax Deductions for Businesses and the Self-Employed". Now that sounds interesting too. He writes in a pretty easy to follow style.

Thanks, Bruce. I've ordered these books. By the way, these tax books and whatever I pay to the accountant are deductible, right?

ed

[CitizenKate]

What I ended up doing was getting a copy of QuickBooks Mfg edition. My raw materials are tracked as assets until sold as part of something I make, then they become an expense, exactly the way LadyJ describes. It took a little work to get it all set up, which included taking inventory for the first time - ugh!

But now that I have all that done, I can just tell QB, "I just built X of item Y," and it automagically transfers the right amounts from raw materials to finished goods, two asset accounts. Then when I sell the item, I create an invoice, and QB automagically posts the sale and moves the amount spent on raw materials to the GOGS account. At any time, I can tell how much I've got invested in raw materials, and what kind of a profit margin I'm getting on what I've sold. That is some very valuable visibility into my business that really helps me determine what I need to do to become more profitable, and now that it's set up, I don't work very hard at it at all.

I've also got QB set up to spit out a report every year with all the numbers I need to fill out a schedule C. You can tell it what line on schedule C each account must be added into.

Kate

[LadyJ]

The Accrual method is not a good choice if you complete and sell products in one year and they are not big ticket items. In fact, there are few retail sales businesses that benefit from using the accrual method. That said, I really think that you are making your accounting more difficult than it needs to be.

When you talk about the cost of producing an individual item compared to its actual sales price, you are talking profit and loss --- not income and expenses which are used in tax preparation.

You use profit and loss to evaluate your overall productivity. Am I making money on this item? Which items are the better expenditure of my time? Is my volume high enough to allow me to make a profit on this item if I sell enough of them? All of these questions are important to help you decide how to develop your product lines. The profit and loss from any one item will still not give you a fair picture of your real business expenses, however. To see the impact of overhead expenses (rent, utilities, transportation, postage, fuel), you have to flip to an Income and Expense analysis.

Income and Expense is the basic analysis for tax preparation. For you, all cash/payments should be included as income at the moment they are received. All "expenses" are a cost of doing business and should be deducted at the moment you pay for them (or charge them on credit). I agree with Horse Braider -- a good accountant/CPA is a valueable part of your business team and worth every penny you invest in him.

You should use the easiest accounting system that is adequate to reflect your business. Don't get carried away. It can be a simple check book that has certain tax categories listed like income (deposits from sales) and expenses (employees, supplies,advertising, etc). As you write each check, just list it in the appropriate column and at the end of the month, total each column and your income and expense log is done (it is also your totals for your taxes). Every check will fit into a predetermined category for your business if you get a list from your fellow leather workers about what categories they use.

In fact, creating a list of tax categories for a leather working business would be a good topic. Start with:

Employee expenses (salaries, taxes, insurance, benefits)

Rent for facility

Utilities

Insurance for the business itself

Equipment:

Large items used for more than a year need to be depreciated

small items used up on one year are "supplies"

Supplies (I would suspect this will be your biggest expense category)

Inventory (if you purchase goods at wholesale and resell without much modification)

Advertisement/ business promotion

Vehicles/transportation

WHAT ELSE ?????

[esantoro]

What I ended up doing was getting a copy of QuickBooks Mfg edition. My raw materials are tracked as assets until sold as part of something I make, then they become an expense, exactly the way LadyJ describes. It took a little work to get it all set up, which included taking inventory for the first time - ugh!

But now that I have all that done, I can just tell QB, "I just built X of item Y," and it automagically transfers the right amounts from raw materials to finished goods, two asset accounts. Then when I sell the item, I create an invoice, and QB automagically posts the sale and moves the amount spent on raw materials to the GOGS account. At any time, I can tell how much I've got invested in raw materials, and what kind of a profit margin I'm getting on what I've sold. That is some very valuable visibility into my business that really helps me determine what I need to do to become more profitable, and now that it's set up, I don't work very hard at it at all.

I've also got QB set up to spit out a report every year with all the numbers I need to fill out a schedule C. You can tell it what line on schedule C each account must be added into.

Kate

Hi Kate,

I just got QB Mfr and Wholesale Edition 8.0. Can you recommend a good book to help me learn how to use it?

Thanks,

Ed

[HorsehairBraider]

The Accrual method is not a good choice if you complete and sell products in one year and they are not big ticket items. In fact, there are few retail sales businesses that benefit from using the accrual method. That said, I really think that you are making your accounting more difficult than it needs to be.

When you talk about the cost of producing an individual item compared to its actual sales price, you are talking profit and loss --- not income and expenses which are used in tax preparation.

You use profit and loss to evaluate your overall productivity. Am I making money on this item? Which items are the better expenditure of my time? Is my volume high enough to allow me to make a profit on this item if I sell enough of them? All of these questions are important to help you decide how to develop your product lines. The profit and loss from any one item will still not give you a fair picture of your real business expenses, however. To see the impact of overhead expenses (rent, utilities, transportation, postage, fuel), you have to flip to an Income and Expense analysis.

Income and Expense is the basic analysis for tax preparation. For you, all cash/payments should be included as income at the moment they are received. All "expenses" are a cost of doing business and should be deducted at the moment you pay for them (or charge them on credit). I agree with Horse Braider -- a good accountant/CPA is a valueable part of your business team and worth every penny you invest in him.

You should use the easiest accounting system that is adequate to reflect your business. Don't get carried away. It can be a simple check book that has certain tax categories listed like income (deposits from sales) and expenses (employees, supplies,advertising, etc). As you write each check, just list it in the appropriate column and at the end of the month, total each column and your income and expense log is done (it is also your totals for your taxes). Every check will fit into a predetermined category for your business if you get a list from your fellow leather workers about what categories they use.

In fact, creating a list of tax categories for a leather working business would be a good topic. Start with:

Employee expenses (salaries, taxes, insurance, benefits)

Rent for facility

Utilities

Insurance for the business itself

Equipment:

Large items used for more than a year need to be depreciated

small items used up on one year are "supplies"

Supplies (I would suspect this will be your biggest expense category)

Inventory (if you purchase goods at wholesale and resell without much modification)

Advertisement/ business promotion

Vehicles/transportation

WHAT ELSE ?????

Taxes and licenses... Don't know about everyone else, but I have to pay state sales tax on things I sell in my own state, have to have a business license for states where I go and physically sell things including of course my own state.

Show fees - entry fees, jury fees etc. that you have to pay for booth space, the jury fee to get in the show in the first place, electricity for your display etc.

That's all I can think of on this small amount of coffee...

[CitizenKate]

Hi Ed,

The built-in tutorials are the best place to start. Those were pretty much all I needed.

Kate

I just got QB Mfr and Wholesale Edition 8.0. Can you recommend a good book to help me learn how to use it?

[esantoro]

Taxes and licenses... Don't know about everyone else, but I have to pay state sales tax on things I sell in my own state, have to have a business license for states where I go and physically sell things including of course my own state.

Show fees - entry fees, jury fees etc. that you have to pay for booth space, the jury fee to get in the show in the first place, electricity for your display etc.

That's all I can think of on this small amount of coffee...

Can you choose whether to pay your state sales taxes quarterly or annually?

[Art]

Hi Ed,

No, the State makes that determination using your past sales performance as a criteria. Different States, different criteria. I pay Maryland quarterly at their direction, probably because I do most of my sales in the last quarter, almost all of the rest of the year is out of state.

Art

Can you choose whether to pay your state sales taxes quarterly or annually?

[David Genadek]

Hi Kate,

I just got QB Mfr and Wholesale Edition 8.0. Can you recommend a good book to help me learn how to use it?

Thanks,

Ed

Using it is easy setting it up is the hard part. The notion of perpetual inventory is real nice but the program doesn't handle the world of leather real well so still count on doing physical inventory and making adjustments. Although They do say the recent edition will handle conversions. Such as I buy skirting by the pound but I cost it out by the side. Paying the money to a CPA to set it up for you would be money well spent. I have stretched the program beyond what it is designed to do but we can make it work with lots of adjusting on the part of my accountant. I do mass customization and that is pretty complicated stuff so I doubt you will go through the hell I did but I would strongly urge you to get professional help on the set up. They can help you put into perspective what is worth the worry and what is not. If your a one man shop you can pretty much just go eye ball things and know where your at.

David Genadek

[CitizenKate]

Same here. Dealing with piece-parts is one thing, but dealing with raw material is another. So far, I've been able to set up my program to keep pretty close track of things like leather. Dyes are a little less cut-and-dry.

I told my accountant that the amount of dye I use not only varies from one identical piece to another, but for some pieces, I portion it out not in ounces, but in drops. Her response was, then you need to track your dyes by the number of drops. I asked her if she was out of her mind. No way am I going to sit around counting drops of dye all day long - I'd never have time to make anything. (Maybe that's where the term "bean-counter" comes from.)

So what I do is estimate as closely as possible, how many ounces of dye I use for each item, and I set up the system to deduct that amount automatically whenever I make the item. Then periodically, I do cycle counts on the dyes I've been using the most, and make inventory adjustments.

Kate

Using it is easy setting it up is the hard part. The notion of perpetual inventory is real nice but the program doesn't handle the world of leather real well so still count on doing physical inventory and making adjustments. Although They do say the recent edition will handle conversions. Such as I buy skirting by the pound but I cost it out by the side. Paying the money to a CPA to set it up for you would be money well spent. I have stretched the program beyond what it is designed to do but we can make it work with lots of adjusting on the part of my accountant. I do mass customization and that is pretty complicated stuff so I doubt you will go through the hell I did but I would strongly urge you to get professional help on the set up. They can help you put into perspective what is worth the worry and what is not. If your a one man shop you can pretty much just go eye ball things and know where your at.

David Genadek

[David Genadek]

Same here. Dealing with piece-parts is one thing, but dealing with raw material is another. So far, I've been able to set up my program to keep pretty close track of things like leather. Dyes are a little less cut-and-dry.

I told my accountant that the amount of dye I use not only varies from one identical piece to another, but for some pieces, I portion it out not in ounces, but in drops. Her response was, then you need to track your dyes by the number of drops. I asked her if she was out of her mind. No way am I going to sit around counting drops of dye all day long - I'd never have time to make anything. (Maybe that's where the term "bean-counter" comes from.)

So what I do is estimate as closely as possible, how many ounces of dye I use for each item, and I set up the system to deduct that amount automatically whenever I make the item. Then periodically, I do cycle counts on the dyes I've been using the most, and make inventory adjustments.

Kate

I count dyes as a supply I don't inventory them. There is a point where it is ridiculouse. An once of dye covers about a square foot so it costs more to track them than it is worthe. It won't help your ordering becasue your just going to look at the bottle and say oh I better order some more dye anyway. The dollars you have tied up are pretty small in relation to the other materials and frankly it would be hard to sell them so they really are not much of an assett anyway.

The program is great for doing estimates and doing billing and things and does make communications pretty easy but unless your doing some real simple assemblies for COGS it falls short. I use the inventory portion but we still do all that seperate on speadsheets and then just make adjustments.

If I were you I would look for different accountant. You want someone that thinks along the lines of Lady J Keep it simple so you have time to make money and not just spend your time doing books.

David Genadek

[bruce johnson]

I learned a lot about computer kept inventory and automatic item subtraction at work. We were test monkeys for a veterinary software package several years ago. What I learned is you are always out. There is no accounting for the pills you dropped in the sink, the 3.2 ml you gave and it took 3.0 off the inventory (after a while it adds up), or the bottle the other clinic borrowed and hasn't returned. David is right, you need to do physical counts. It really shouldn't matter how you do them, as long as it is consistant. What finally worked the best for us was to have an 'inventory side" and a "using side". When a bottle was taken from the inventory and opened, the whole bottle was immediately removed from the inventory. Easier to count bottles than pills. We have pretty much abandoned it now, and look at the shelves to decide what to order.

What I do with the leather business has evolved. I set up some templates in my spreadsheet program that do the calculations. I have a monthly expense report I keep. When I get an order in, I break it down into sections for a monthly expense sheet - office items and expenses, tools, shipping in, shipping out, inventoried supplies, and non-inventoried supplies. Most of these categories are pretty self explanatory. The non-inventoried supplies are the things like sponges, nails, screws, little tedious to count things that are not higher dollar items. Inventoried items are bigger volume things that are mostly used up and turned over several times a year, but accounted for. When I total these up for the month it gives me an idea of that month's expenses - less overhead, travel, and a few others accounted for elsewhere.

I also keep inventory sheets (files) for each item. I start with a Jan 1st count of how much, average cost for the last year, and dollar value. It is transferred over from the EOY for the previous year. Each time that item comes in, the date/supplier/quantity and cost per unit are entered. The spreadsheet totals the value and adds it to the running total at the bottom. At the end of the year it gives me a total for on-hand plus orders for the year, the average cost, and a final value based on that average cost. I total these files up, add the shipping in and out, the non-inventoried supplies, subtract the EOY inventory value, and it gives me a COGS. At the bottom of the inventory sheets is a place for EOY counts. It multiplies the amount by the year's average cost to get a final EOY inventory value. This is carried over to be the beinning inventory for the next year.

A few things I do by convention. I estimate bottles by fourths - one fourth, half, or 3/4. I estimate leather by eye, if my sides of a certain leather average 23 sg ft, and I have about a half, then I have 11-1/2 sg ft. I don't figure the scrap bins at all. I estimate small hardware (things I want to keep track of casts) by eye, I don't hard count rivets, Chicago screws, or the like. Buckles, rigging hardware, and that kind of stuff are hard counted. Thread is by half or whole spool.

There are places where I could short myself. Sometimes I have a big amount of a special buy leather and the price is low. I carry it over, use it up, and over the course of a year, I order a couple more at a higher price. At EOY, the cheap initial inventory has diluted the cost of the orders through the year. What I am carrying over is actually less value than replacement. One of thse actual cost vs. average cost accounting things that could bite you carried over for a long time. On those I watch myself and try to use it up before year's end and not carry a value over. There is a reason that suppliers have an end of period inventory sale. They don't want to carry it over either.

Another thing this does do is force me to monitor inventory costs. If a new order of leather is higher, then I need to refigure prices on those items that use it now. I used to get nibbled on there. If I have a big order coming up, I need to get with my supplier and make sure they are stocked with what I need and aren't planning a price increase. I got bit bad there once too. All this paperwork seems like a hassle, but once I got it set up, it isn't too bad. It takes a little time, but beats the first couple years I didn't keep it up as well. Totaled up, maybe two hours a month on paperwork now.

[esantoro]

This has all been very helpful.

I have had to download and install the free version of Quickbooks startup to get things rolling so that I can convert my data file later to a more advanced program, if needed.

Thanks,

Ed