Hopefully at this point in the year, you've finished reveling in your tax refund or you've quit bellyaching about the hefty bill you had to fork over. Now, it's time to do the unthinkable and start planning for next tax season.
It may seem like a vicious cycle, but remember, the more you prepare now, the less headaches and gray hairs you'll accumulate come April. That goes without mentioning the amount of money you'll have to pay your accountant to weed through a year's worth of disorganized invoices, bank statements and receipts.
'The more homework [business owners] can do themselves, the more savings they can make as far as paying tax preparers for their time,' says Adam Spiegel, a Miami-based certified public accountant and partner with Morrison, Brown, Argiz & Farra.
To get a head start on your taxes, Spiegel suggests using the word 'plan' as a guiding acronym for the year.
P stands for 'prepare your records ahead of time.'
L stands for 'list your issues and questions.'
A stands for 'analyze your financial statements for accuracy.
N stands for 'note the changes in laws during the year and discuss them with your tax advisor.'
We've broken down the steps you'll need to take to make sure you P.L.A.N. properly for next year.
How to Prepare for Next Tax Season Now: Preparing Your Records
Having an accounting system to keep things accurate and organized does you no good if you're waiting until the last minute to put your records in the system.
'Many small business owners, especially single owners who are the chief cook and bottle washer, don't have the time to keep their books on an ongoing basis, but if they can, they should,' says Lynn Conover, tax partner at The Curchin Group, based in Red Bank, NJ. 'If they can't, they should employ someone who can. They should always keep a pulse on their business.'
You should keep organized, detailed records of any invoices, bank statements and receipts you receive. Especially, says Spiegel, any receipts for travel and entertainment-related expenses, as they are often subject to the most IRS scrutiny. Spiegel suggests, 'Document the business purpose on the receipt and who attended the event.'
Make sure you can produce an updated record of both your accounts receivable and your accounts payable.
If you hire any subcontractors, realize that you must file a 1099 form for anyone you pay more than $600 in a given year. Kelly Phillips Erb, a Philadelphia-based blogger and tax attorney with Erb Law, says this is what gives many small business owners trouble.
'In terms of issuing 1099s, you need to take care of that in January, not in April,' she says. 'It's really important that you have the tax ID numbers and the proper address of your vendors that you've paid, so you can make sure you're in compliance come January.'
Even if you have not yet paid vendors the full $600, by June you can predict the amount you're likely to have paid them by the end of the year and collect all the necessary information from them in advance.
Conover adds that it's important, when dealing with subcontractors, to have documents proving the individual is a subcontractor and not, in fact, an employee. You don't want the government to accuse you of misclassifying an employee. Documents of proof could include the vendor's yellow page ad, business card, letterhead or invoices he or she gave you.
Conversely, if you have been a subcontractor for another business that paid you more than $600, remember to include that revenue when you're predicting your taxable income. June is also a good time to consider year-end bonuses and seasonal hires. Erb says both can influence your payroll tax obligations.
If you have organized documentation of every expense and bit of income, Conover says, 'you shouldn't have a problem' if you ever face an IRS audit. Remember that the IRS can perform an audit within three years of the date you file your taxes. If they believe there's tax fraud involved, that deadline gets extended to six years. That's why Spiegel says you should always make sure your last six to seven years worth of records are in order.
Dig Deeper: How to Create a Personal Financial Statement
How to Prepare for Next Tax Season Now: Analyzing for Accuracy
Don't worry. We haven't forgotten how to spell 'plan,' but before you can list your issues and questions with your accountant, you really should analyze the records you've just compiled.
Spiegel says you will need at least a balance sheet and an income statement when it comes time to file your taxes. A balance sheet should list your assets (cash, accounts receivable, inventory, equipment, etc.), liabilities (accounts payable, loans, etc.) and equity.
To verify your cash assets, as in, what's in the bank, you should take this time to prepare a bank reconciliation, which is essentially a comparison between what's in your bank statements and what's in your accounting system.
'You don't know how many times we say, ‘When was the last time you reconciled your bank account?' and a lot of times we get the answer, ‘Never,'' Conover says. A bank reconciliation will help you catch any errors that have been made on either end early on.
'You're basically verifying that what you recorded in your set of books is what cleared the bank,' Spiegel says.
You also need to take a close look at the accounts payable and accounts receivable records you have organized and ask yourself if those balances are accurate.
As for your income statement, Spiegel says it's 'much more difficult to reconcile.' But one thing you can do is compare the activity for that year to the activity the year before.
'Look at percentages of income and ask, ‘Has my wages expense gone up in relation to my income going up or down?'' he suggests. 'If the percentages are not consistent or you can't understand why the percentages are what they are, then dig down deeper and try to understand what makes up those balances.'
Taking a look at your general ledger, which details all the transactions that make up each balance, should help you pinpoint any mistakes that were made.
Dig Deeper: Sample Bank Reconciliation
How to Prepare for Next Tax Season Now: Listing Issues and Questions
After you've checked and double-checked your books and your bank statement, you probably have some idea of what your profits look like, meaning it's time to ask your accountant or tax preparer how much you can expect to be billed based on where your business stands this year.
'Neither the client nor I like surprises,' Conover says. 'The worst thing to do is get all the books closed in February, and tell our clients they owe a lot of taxes because they had this huge profit. Even if they have money in the bank, they're always so surprised.'
According to Bob Fouratt, a managing partner also with The Curchin Group, the number one question you should ask your accountant is: what am I currently not doing that I could be doing to reduce my tax bill?
'It's so much easier to tax plan prior to the close of the year than it is after the close of the year,' Fouratt says. 'Your options become more limited."
As you go through your accounts receivable, you may want to pinpoint what Spiegel calls 'doubtful accounts.' 'Let's say I have $1 million in receivables. Am I going to collect $1 million or am I only going to collect $900,000?' he asks. Ask your accountant if it would be wise for you to set aside money to cover those doubtful accounts.
Another issue you should broach with your accountant is whether or not you should try to spend money on big expenses like equipment, before the end of the year to reduce your profits, thereby reducing your tax bill.
'If you've been putting off buying a printer, because you've been worried about what your financials might look like, but it looks like you'll come out with a profit, it may be time to buy that printer,' Erb says.
On the other hand, Erb warns that you should have some money set aside to cover your tax bill. 'One of the reasons a lot of small business owners get behind in their taxes is because, when the tax bill comes, they haven't budgeted for [it],' she says. Ask your accountant if you should consider putting money aside or taking out a short-term Certificate of Deposit to cover the cost.
Dig Deeper: Smart Questions for Your Accountant
How to Prepare for Next Tax Season Now: Noting Changes in Tax Laws
The answers to many of the questions you pose to your accountant may be dependent on the particular tax laws for that year, so you need to stay as up-to-date as possible on the tax breaks that are available to you that year. Your accountant should be able to inform you.
'If you're going in [to meet your accountant] with some interim numbers to do some tax planning, that's the time to say, ‘What is going on and how is it affecting me?'' Fouratt says.
For instance, 2010 may very well be the right year to make that big purchase. 'Right now, a company can expense up to $250,000 of equipment purchases, as opposed to depreciating it over five, seven, maybe even fifteen years,' Conover explains. 'Take advantage of this expensing. Generally those limits go down to $25,000 if they don't extend them.'
This year business owners will also be subject to the new HIRE Act that passed in March of this year. It offers tax breaks to any employer who hires someone who was unemployed for a certain period of time. It provides an additional tax incentive for employers who keep those employees for at least a year.
In addition to addressing your current options, Fouratt says your accountant should have his or her finger on the pulse of what tax laws may look like in the future. One change Spiegel predicts, due to the current economic climate, is that income tax rates will rise in 2011.
'As a result, you want to accelerate income into 2010 to potentially benefit from the lower tax rate in 2010 versus 2011,' he explains. 'You're going to sell something? You may want to sell it in 2010. You may want to give people a discount to receive the most receivables in 2010.'
Talking over these future tax trends will make you even more informed when you start your P.L.A.N. all over again next June.
Dig Deeper: How to Reduce Your Small Business Tax Bill