As this year's tax time dust settles you continue to oversee those books for business purposes to ensure the future success of your business.
As we all know, was the season for paying Uncle Sam. And for business owners, this month had been an especially delicate time as business owners are juggling with running a business and meeting with their tax professional regularly (sometimes daily) to ensure they do not pay any unnecessary income taxes.
Most business owners who file as an S Corporation have, most likely, filed their tax returns already for the year and consider their “accounting” work done as a result. However, this thinking is both dangerous to the functionality of the business’ operations and detrimental to the business’ future. While tax planning and reducing the payment of unnecessary taxes is important, knowing how the business is doing is equally important, if not more important, and necessary for business to thrive and succeed. As a result, a business should have two sets of records: one for tax and one for the business.
Most business owners, and individuals alike, understand this set of books and why they would primarily exist… to reduce tax liability. However, there is more to it than just reducing tax liability.
In some cases, businesses, such as startups may already be functioning at loss.
Consequently, reducing tax liability has already been achieved by the mere situation of the business. Under these circumstances, tax records take a new role and that is to possibly take advantage of losses to benefit prior year tax positions or even carry the loss forward to benefit future tax years. Depending on how your business is structured, a business owner incurring a business operating loss has the potential offset tax liability for prior tax years where the business was profitable or even the business owner’s own personal income tax where a tax was due.
Additionally, if carrying back is unavailable, the business owner could elect to carry the loss forward to use as another deduction for tax purposes. However, the rules regarding how this will be applied or function is directly dependent on the structure and tax treatment of the entity.
Another record of vital importance to most business owners is the capital account of the business owners. For owners of companies treated as S Corporations or partnerships for tax purposes, you know, should know, that you must keep records of the amount of a business owner’s investment in the business and any additional increases and decreases on this amount. The reasoning behind this account for tax purposes is two-fold: to know the limit of losses you can deduct and determination of profit allocation for tax purposes.
First, your capital account is an account that is increased or decreased depending on a business owner’s actions within the business.
For instance, if a business has a profit, the profit allocable to a business owner will increase the business owner’s account. Conversely, if the business suffers a loss and the business owner elects to report the loss on his/her tax return, it will decrease the capital account of the business owner.
Keep in mind, the amount of loss a business owner may deduct is limited to the amount listed within the owner’s capital account. The amount listed in the capital account must not go below zero (0). Should a business owner take a deduction for a loss that is greater than the amount in the business owner’s capital account, the business owner would be liable for capital gains tax on the negative amount in the capital account as it would be seen as a divestiture of the business by the owner.
This, of course, could create certain legal issues if there are multiple owners and one of the owners is seen to have divested his/her interest in the business.
Would that owner be out of the business? Would that owner automatically lose voting rights? These are important matters one should not take lightly when analyzing their tax positions.
Therefore, keep these factors in mind when considering your tax records. On a side note, remember that while a goal may be to reduce tax liability you may be hurting your business’ future (discussed further below).
Next Accounting Records and Planning ahead
About the author
Senen Garcia operates SG Law Group LLP a thriving law practice in multiple states assisting clients with their corporate, real estate, estate planning, and property insurance claim needs. Additionally, Mr. Garcia has accounting practice assisting small businesses with tax and accounting needs. Along with his work with SCORE, Mr. Garcia has also provided assistance with the local Small Claims Clinic that provides assistance to individuals filing small claims cases. Mr. Garcia has spoken on a variety of topics such as: How to start a business, Communication within your organization, Importance of Capital Accounts, What’s in Business Name Anyway?, and Stock Purchase Agreements vs. Asset Purchase Agreements.Website