After owning my own accounting business for over 18 years, when it comes to payroll I have one critical piece of advice for business owners:

OUTSOURCE YOUR PAYROLL – DO NOT DO IT YOURSELF!  Seriously. 
 
Payroll is a true headache. There are so many rules, regulations, rates, insurances, and deadlines that can cost you a small fortune if you make even the smallest error.
 
You must withhold taxes from your employees’ gross pay. You, as the employer, match some of those withheld taxes. You also pay some taxes that the employee doesn’t. At very specific intervals, with very strict deadlines, you must forward these taxes to the proper federal and state agencies; the payments are called “payroll tax deposits”. The penalties for not correctly calculating and/or not depositing  these on time are stiff.
 
You also need to file reports, called “payroll tax returns”, every quarter. These reports reconcile the employees’ earnings with the deposited payroll taxes. At the end of each year, you have to also file annual reports which must reconcile exactly to the quarterly reports. In addition, you must give each employee a form W-2 which provides them with the totals of the wages earned and the amount of taxes withheld during the year, and allows them to file their personal individual tax returns.
 
For a very modest fee, payroll outsourcing firms can take all of the agony of payroll processing from you. Your only job is calling in the hours and making sure there is money in your bank account to cover the payroll!
 
Over the years I have worked with many various payroll processing companies – some good, some pretty bad. My advice is to go with a company that payroll is their business, instead of a bank or big box store that does payroll as a side market. A good payroll company can handle all of your HR needs, as well as offering 401K management.

You can reach me at tina@tinamarino.com

Choosing the type of organizational entity your business will be is a very important decision.  It should be made with the advice of an accountant and a business tax savvy attorney. 

Sole Proprietorship

Most small businesses start out as sole proprietorships.  It is one owner, one person in charge with all responsibility.  The government and other entities do not recognize any real difference between a sole proprietorship and its owner.  The income and expenses from the business are included on a separate schedule in the owner’s personal individual tax return.  The net profit of the business is used to calculate self-employment tax which sole proprietors pay in addition to income tax. 

Partnership

Two or more people who share ownership of a business are considered partners and need to have a partnership agreement to prevent issues down the road.  This agreement should also include an exit strategy for each partner and a buy-sell agreement.  The income and expenses from the partnership are reported on a partnership tax return, with each partner receiving a form showing his or her share of the profit or loss.  Each partner then reports their share on their personal individual tax return.  Each partner’s share of net profit of the business is used to calculate self-employment tax which partners pay in addition to income tax. 

Corporation

Corporations afford liability protection to a certain extent for each of its shareholders. Normally, the shareholders are not held personally responsible for the liabilities of the corporation as only the corporation’s assets may be looked to for restitution. These shareholders have some type of investment in the business in exchange for a percentage of corporate stock ownership.  The income and expenses of the corporation are reported on a corporation tax return.  Taxes are paid by the corporation.  If any dividends are paid to the shareholders, they also pay tax on the dividends – thus the term “double taxation”.  Shareholders are usually treated as employees of the corporation and they do not pay self-employment tax in addition to income tax. 

S Corporation

An S corporation is a corporation that elects to be treated as a partnership for tax purposes.  There are certain limitations as to how many and who can be shareholders in an S corporation.  The income and expenses of the S corporation are reported on an S corporation tax return.  As with a partnership, each shareholder receives a form showing his or her share of the profit and loss, and reports their share on their personal individual tax return.  Shareholders are usually treated as employees and they do not pay self-employment tax in addition to income tax.

LLC (Limited Liability Company)

Contrary to popular belief, LLCs are not corporations, although they do provide limited liability protection to the members.  Not officially recognized by the IRS, LLCs are regulated by the states, and are a hybrid of a partnership and a corporation.  Instead of stock, LLC members hold membership interests.  The income and expenses of the LLC are reported on a partnership return for the IRS and on a partnership or individual personal tax return depending on each state’s requirements.  Depending on the type of business, members may pay self-employment tax in addition to income tax.

Remember, please consult your accountant before you choose your business’ organizational type.

There are two types of accounting methods the IRS recognizes for most businesses – Cash and Accrual.  You choose the method you are going to use when you file your first business tax return.  If you later decide to change the method, you must get approval from the IRS.  Therefore, it is very important you consult with an accountant well-versed in business to help you make this decision. 

Cash Basis

Income is recognized when it is received.

Expenses are recognized when they are paid. 

If you bill someone in December and receive payment for it in January, you record the income in January. 

If you incur an expense in December and pay it in January, you record the expense in January. 

Example:  If you sell someone a product and they pay you for it in 60 days, you record the income on the day you receive the payment. 

Accrual Basis 

Income is recognized when it is earned.

Expenses are recognized when they are incurred. 

If you bill someone in December and receive payment for it in January, you record the income in December. 

If you incur an expense in December and pay it in January, you record the expense in December. 

Example:  If you sell someone a product and they pay you in 60 days, you still record the income on the day you made the sale. 

It is very common for businesses to keep the books on an accrual basis and prepare the tax returns on a cash basis.  It allows the owner to keep track of how much is owed to him (accounts receivable) and how much he owes others (accounts payable), yet still allows for filing tax returns on a cash basis. 

The good news is that accounting programs such as Quickbooks will switch back and forth between cash basis and accrual basis at the touch of a button.

As a professional, you would expect me to say “Yes!  You should use professionals.” and you would be right.  But maybe not for the reasons you may think. 

A good accountant will help you decide which business entity is best for you.  While you may use an attorney to set up your partnership, LLC or corporation, you definitely will want to consult an accountant first.  Not to disparage lawyers, but my experience has shown that very few of them understand the tax ramifications of their business entity choices. 

The bookkeeping software packages that are on the market all tend to brag about being an “accountant in a box”.  While they are definitely timesavers compared to the good old manual systems, you still have to have the knowledge to know where to code the transactions.  

Some of the biggest “messes” I encountered in my practice were also the most common ones.  Business owners trust the accounting program, not aware transactions are not being properly recorded.  They make decisions based on this incomplete or erroneous information which end up costing them unnecessarily. 

Some examples: 

Some business owners are confused about draws they take out of their business account; they assume it is payroll and code the withdrawals to “salaries”.  

While some business owners know that health insurance for themselves is deductible, they don’t realize it is done as an adjustment to income on their personal 1040 return, not in the business books.  

Many business owners make car payments out of the business account, which is fine if the vehicle is used for business purposes.  However, only the interest portion of the payment is deductible as an expense; the principal portion is a reduction in principal not an expense. 

What happens when these errors are made in the business books is net profit is understated.  The business owner does his tax planning and his forecasting based on the wrong information! 

Let’s say John is the sole-proprietor of ABC Laundry.  Based on his records, using the above examples, he has a net profit of $40,000 and has made his estimated tax payments to the IRS and state accordingly.  He is in for a rude awakening when he sees his accountant in April and the professional tells John, “Sorry.  We have to add back in the $3,000 a month you drew out, the $4,800 you spent on your own health insurance, and the $3,200 principal portion of your car payments.  You actually have a net profit of $84,000, not $40,000. 

            John’s Erroneous Net Profit                     $40,000                  

            Add in Draws                                            36,000

            Add in Health Insurance                             4,800

            Add in Principal Portion Car Pymts             3,200           

            ACTUAL Net Profit                                  $84,000 

That is more than double what he had assumed, and it can have disastrous consequences. 

Since he is seeing his accountant in April, the prior year is already closed out and it is too late to do much of anything to reduce his tax liability. 

This is one of the reasons why I recommend that, even if you are going to do your own bookkeeping, you should see an accountant with business expertise to set up your books at the beginning and have them give you some basic instruction.  An hour or two of an experienced accountant’s time to properly install your system will pay off in the long run. 

Another reason I recommend using professionals is simple:  You should do what you do best and hire out the rest! 

I hire a plumber to fix my leaky pipes, an auto mechanic to give my car a tune-up, and a housekeeper to keep my house clean.  This frees me up to earn money doing the things I do best and is, in the end, more profitable – and that makes me happy!

When I taught the Small Business Tax & Accounting Workshops at the SBA’s Small Business Development Center, the one thing I was emphatic about is the need to keep good records.  I must’ve sounded like a broken record to the attendees!  But, it is true.  While you may groan about it and even hate it, recordkeeping is vital to the heartbeat of a business.

Benjamin Franklin said that there is nothing certain but death and taxes.  The bible says that we should render unto Caesar what is Caesar’s.  Both are true statements.  However, though we must pay taxes, we need to be sure to not pay one shekel more than we have to! 

Good recordkeeping will:

      Help you pay only the taxes you actually owe.  By having an up-to-date and accurate set of books, you will be able to do very precise tax planning which will allow you to keep more of your hard-earned money in your own pocket.

      Give you all the information you need to make sound business decisions.  It can track cycles in your sales, tell you which products or services you should keep and which you should stop selling, allow you to decide whether to hire new employees or let some go, and more.

      Allow you to prepare detailed budgets and forecasts.  If you know where you’ve been and what it cost, you are able to project more accurately.

      Provide you a historical record of your business.  The longer you are in business, the more important and informative looking back on your progress will be.

      Assist you in obtaining bank loans, lines of credit, vendor credit, and more.  Lenders always require complete and detailed financial statements and projections before they will show you the money.

      Help you easily keep compliant with federal, state, county and local governing agencies.

      Make tax season a breeze!  Since you will have done tax planning throughout the year, you will already know your tax bill.  Your records can be easily sent, complete and accurate, to your accountant for tax preparation.  You will make his or her life (and your invoice from them) much easier.

      Allow you to sleep like a baby at night!  You won’t be tossing and turning in turmoil because you will always know where you stand.

Think about this:  Every $100 you do not keep track of will cost you between $15 and $60 in taxes!