THE VIRTUAL OFFICE GODDESS, LLC Bookkeeping and Office Support Services. Accounting Basics for a new Limited Liability Company

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1 THE VIRTUAL OFFICE GODDESS, LLC Bookkeeping and Office Support Services Accounting Basics for a new Limited Liability Company RECEIPTS FOR PURCHASES: Keep all receipts. Write on the back of the receipt what the receipt is for (supplies, marketing, etc.) and what job (if applicable). PAYMENTS FROM CLIENTS: photocopy the client check(s) and attach the deposit slip to the copies. TIME TRACKING: Keep track of your time spent to assist in job costing. Job specific (job name) and non-job specific (admin, marketing, etc.) QUARTERLY NET INCOME TAX DEPOSITS: Deposit 30% of your NET (income less expenses) income no later than the 15 th of the month following each quarter (Jan-Mar/April 15, Apr-Jun/July 15, Jul-Sep/October 15, Oct-Dec/January 15) Deposits are made through Beginning January 1, 2006, certain employment tax filers will be able to file the new Form 944 (Employer s Annual Federal Tax Return) once a year rather than filing Form 941 (Employer s Quarterly Federal Tax Return) four times a year New employers who expect to owe $1,000 or less in total annual employment tax (approximately $4,000 or less in annual wages) also are eligible to file Form 944. These employers can indicate their estimated tax amount when applying for their EIN (Employer s Identification Number) on Form SS-4. The IRS will notify the employer to file either Form 944 or Form 941 in the same notice indicating the taxpayer s new EIN Employers who do not receive a letter and believe they are eligible to file the new Form 944 can call the IRS at to find out if they qualify. LLC Taxes Unlike a corporation, an LLC is not considered separate from its owners for tax purposes. Instead, it is what the IRS calls a "pass-through entity," like a partnership or sole proprietorship. This means that business income passes through the business to the LLC members, who report their share of profits -- or losses -- on their individual income tax returns. Each LLC member must make quarterly estimated tax payments to the IRS. While an LLC itself doesn't pay taxes, co-owned LLCs must file Form 1065, an informational return, with the IRS each year. This form, the same one that a partnership files, sets out each LLC member's share of the LLC's profits (or losses), which the IRS reviews to make sure LLC members are correctly reporting their income. P.O. BOX BOULDER, CO

2 Understanding Small Business Tax Deductions You can reduce your business taxes by deducting most of what you spend. How tax savvy a businessperson you are has a great effect on how much money is in your pocket at the end of the year. You probably know that the tax code allows you to deduct costs of doing business from your gross income. What you are left with is your net business profit. This is the amount that gets taxed. So knowing how to maximize your deductible business expenses lowers your taxable profit. To boot, you may enjoy a personal benefit from a business expenditure -- a nice car to drive, a combination business trip/vacation, a retirement savings plan -- if you follow the myriad tax rules. The balance of this article deals with how the IRS decides when an expense is deductible. Ordinary and Necessary Expenses We won't burden you with a lot of tax code sections, but hear us out on this one. Section 162 is the cornerstone for determining the tax deductibility of every business expenditure. Here are the first 35 or so words: Internal Revenue Code 162. Trade or business expenses. (a) In general. There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business... Section 162 goes on -- and on -- but the important part is that expenses must be "ordinary and necessary" or they can't be deducted. However, the tax code doesn't define either "ordinary" or "necessary." Luckily, in many cases a legitimate business expense under Section 162 is obvious (for instance, office equipment and supplies are clearly deductible). Pubs and regs. In some cases, such as outlays for travel, the IRS provides specific instructions for determining whether or not an expense is "ordinary and necessary." This is often done through various IRS publications ("pubs") and regulations ("regs"). Court decisions. When a specific expense hasn't been mentioned in Section 162 or in publications or regulations, federal courts have tried to figure out what Congress intended and apply it to a particular set of facts. The legal consensus is that "ordinary and necessary" refers to the purpose for which an expense is made. For instance, renting office space is ordinary and necessary for many business folks, but it is neither unless it is actually used in running a business. "Ordinary" has been held by courts to mean "normal, common, and accepted under the circumstances by the business community." "Necessary" has been taken to mean "appropriate and helpful." Given these broad legal guidelines, it is not surprising that some folks have tried to push the envelope on "ordinary and necessary" business expenses, and the IRS has pushed back. Sometimes a compromise is reached, and sometimes the issue is thrown into a court's lap.

3 Example Mr. Henry, an accountant, deducted his yacht expenses, contending that because the boat flew a pennant with the numbers "1040," it brought him professional recognition and clients. The matter ended up before the tax court. The court ruled that the yacht wasn't a normal business expense for a tax professional, and so it wasn't "ordinary" or "necessary." In short, the yacht expense was personal and thus nondeductible. (Henry v. CIR, 36 TC 879 (1961).) The laugh test. Tax professionals frequently rely on the "laugh test": Can you put down an expense for business without laughing about putting one over on the IRS? In the example above, the tax court laughed the accountant and his yacht out of court. Large Expenses Because the IRS knows that people don't intentionally overpay for anything, amounts paid aren't usually questioned. However, IRS auditors sometimes object to expenditures deemed unreasonably large under the circumstances. While the tax code itself contains no "too big" limitation, courts have ruled that it is inherent in Section 162. For example, it might be reasonable for a multi-state apparel company to lease a jet for travel between manufacturing plants, but not for a corner deli owner to fly to New York to meet with her pickle supplier. Personal Expenses The number one concern of the IRS when auditing business deductions is whether purely personal expenditures are being claimed as business expenses. For instance, you can't deduct the cost of commuting to work, because the tax code specifically says this is a personal, not a business, expense. Ditto with using the business credit card for a vacation or cruising the beach in the company car. Because such shenanigans are common, IRS auditors are ever watchful. Fortunately, you can often arrange your affairs -- legally -- in a way that lets you derive considerable personal benefit and enjoyment from business expenditures. Be careful if you deal with relatives. An IRS auditor will look askance at payments to a family member or to another business in which your relatives have an ownership interest (in tax code parlance, these are termed "related parties"). An auditor may suspect that taxable profits are being taken out of your business for direct or indirect personal benefit in the guise of deductible expenses. For example, paying your spouse's father, who is in prison, $5,000 as a consultant's fee for your restaurant business would smell bad to an auditor.

4 Deductions Your Small Business Shouldn't Miss Keep an eye out for these often-overlooked ways to cut your tax bill. It's simple: The more tax deductions your business can legitimately take, the lower its taxable profit will be. And in addition to putting more money into your pocket at the end of the year, the tax code provisions that govern deductions can also yield a personal benefit: a nice car to drive at a small cost, or a combination business trip and vacation. It all depends on paying careful attention to IRS rules on just what is, and isn't, deductible. When you're totaling up your business's expenses at the end of the year, don't overlook these 14 common business deductions. 1. Auto Expenses Operating a car is expensive. The good news is that if you use your car for business, or your business owns its own vehicle, you can deduct some of the costs of keeping it on the road. Mastering the rules of car expense deductions can be tricky, but well worth your while. There are two methods of claiming expenses: You can either keep track of and deduct all of your actual business-related expenses, or you can deduct a certain amount for each mile driven (the "standard mileage amount," which is 48.5 cents per mile in 2007) plus all business-related tolls and parking fees. As a rule, if you use a newer car primarily for business, the actual expense method provides a larger deduction at tax time. If you use the actual expense method, you can also deduct depreciation on the vehicle. To qualify for the standard mileage rate, you must use it the first year you use a car for your business activity. Moreover, you can't use the standard mileage rate if you have claimed accelerated depreciation deductions in prior years, or have taken a Section 179 deduction for the vehicle. (For more on Section 179, see "New Equipment," below.) If your auto is used for both business and pleasure, only the business portion produces a tax deduction. That means you must keep track of how often you use the vehicle for business, and add it all up at the end of the year. Certainly, if you own just one car or truck, no IRS auditor will let you get away with claiming that 100% of its use is related to your business. 2. Expenses of Going Into Business Once you're running a business, expenses such as advertising, utilities, office supplies, and repairs can be deducted as current business expenses. But not before you open your doors for business. The costs of getting a business started are capital expenses -- $5,000 of which you may deduct the first year you're in business. Any remainder must be deducted in equal amounts over the next 15 years. If you expect your business to make a profit immediately, you may be able to work around this rule by delaying paying some bills until after you're in business, or by doing a small amount of business just to officially start. But if, like many businesses, you will suffer losses

5 during the first few years of operation, you might be better off taking the deduction over five years, so you'll have some profits to offset. 3. Education Expenses You can deduct education expenses if they are related to your current business, trade, or occupation. The expense must be to maintain or improve skills required in your present employment, or be required by your employer or as a legal requirement of your job. The cost of education that qualifies you for a new job isn't deductible. 4. Legal and Professional Fees Fees that you pay lawyers, tax professionals, or consultants generally can be deducted in the year incurred. But if the work clearly relates to future years, they must be deducted over the life of the benefit you get from the lawyer or other professional. Business books, including those that help you do without legal and tax professionals, are fully deductible as a cost of doing business. 5. Bad Debts If someone stiffs your business, the bad debt may or may not be deductible -- it depends on the kind of product your business sells. If your business sells goods, you can deduct the cost of goods that you sell but aren't paid for. If, however, your business provides services, no deduction is allowed for time you devoted to a client or customer who doesn't pay. The rationale behind this rule is that it would be too easy for businesses to inflate bills and claim large deductions for bad debts. 6. Business Entertaining If you pick up the tab for entertaining present or prospective customers, you may deduct 50% of the cost if it is either: "directly related" to the business and business is discussed at the event -- for example, a catered meeting at your office, or "associated with" the business, and the entertainment takes place immediately before or after a business discussion. Make notes. On the receipt or bill, always make a note of the specific business purpose -- for example, "Lunch with Joyce Slater of Ace Manufacturing Co. to discuss widget contract." 7. Travel When you travel for business, you can deduct many expenses, including the cost of plane fare, costs of operating your car, taxis, lodging, meals, shipping business materials, clothes cleaning, telephone calls, faxes, and tips.

6 What about combining business and pleasure? It's okay, as long as business is the primary purpose of the trip. But if you take your family along, you can deduct only your own expenses, just as if you had traveled alone. 8. New Equipment Some small businesses can write off the full cost of some assets in the year they buy them, rather than "capitalizing" them -- deducting their cost over a number of years. Section 179 of the Internal Revenue Code allows you to deduct up to $112,000 of the cost of new equipment or other assets in 2007 (subject to a phase-out if you place more than $450,000 of equipment in service that year). Some assets don't qualify for this Section 179 deduction, including real estate, inventory bought for resale, and property bought from a close relative. 9. Interest If, like many folks, you use credit to finance business purchases, the interest and carrying charges are fully tax-deductible. The same is true if you take out a personal loan and use the proceeds for your business. But be sure to keep good records showing that the money was really put into your business. Otherwise, if you're audited later, the interest expense deduction could be disallowed because it's considered a personal expense. 10. Moving Expenses If you move because of your business or job, you may be able to deduct certain moving costs that would otherwise be nondeductible personal living expenses. To qualify, you must have moved in connection with your business (or job, if you're an employee of your own corporation or someone else's business). The new workplace must be at least 50 miles farther from your old home than your old workplace was. (Technically, moving expenses aren't business expenses; there's a special place to list them on your Form 1040 tax return.) 11. Software As a general rule, software bought for business use must be depreciated over a 36-month period. But there are some important exceptions: Computer software placed in service from 1/1/2003 to 12/31/2007 is eligible for a Section 179 deduction, which means that 100% of the cost of software can be deducted in the year purchased. Starting in 2008, you will no longer be able to use Section 179 to deduct off-the-shelf software. When software comes with a computer, and its cost is not separately stated, it's treated as part of the hardware and is depreciated over five years. However, under Section 179, you can write off a whole computer system (including bundled software) in the first year if the total cost is less than a certain amount ($112,000 in 2007). See IRS Publication 946, How to Depreciate Property.

7 12. Charitable Contributions If your business is a partnership, a limited liability company, or an S corporation (a corporation that has chosen to be taxed like a partnership), your business can make a charitable contribution and pass the deduction through to you, to claim on your individual tax return. If you own a regular (C) corporation, the corporation can deduct the charitable contributions. If you've got some old computers or office furniture, giving it to a school or nonprofit organization can yield goodwill plus a tax benefit. But if the equipment has been fully depreciated (written off), you can't claim a deduction. 13. Taxes Taxes incurred in operating your business are generally deductible. How and when they are deducted depends on the type of tax. Sales tax on items you buy for your business's day-to-day operations is deductible as part of the cost of the items; it's not deducted separately. But tax on a big business asset, such as a car, must be added to the car's cost basis; it isn't deductible entirely in the year the car was bought. Excise and fuel taxes are separately deductible expenses. If your business pays employment taxes, the employer's share is deductible as a business expense. Self-employment tax is paid by individuals, not their businesses, and so isn't a business expense. Federal income tax paid on business income is never deductible. State income tax can be deducted on your federal return as an itemized deduction, not as a business expense. Real estate tax on property used for business is deductible, along with any special local assessments for repairs or maintenance. If the assessment is for an improvement -- for example, to build a sidewalk -- it isn't immediately deductible; instead, it is deducted over a period of years. 14. Advertising and Promotion The cost of ordinary advertising of your goods or services -- business cards, yellow page ads, and so on -- is deductible as a current expense. Promotional costs that create business goodwill -- for example, sponsoring a peewee football team -- are also deductible as long as there is a clear connection between the sponsorship and your business. For example, naming the team the "Southwest Auto Parts Blues" or listing the business name in the program is evidence of the promotion effort.

8 Easily Overlooked Business Expenses Here are some additional routine deductions that many business owners miss. Keep your eye out for them. audiotapes and videotapes related to business skills bank service charges business association dues business gifts business-related magazines and books casual labor and tips casualty and theft losses coffee and beverage service commissions consultant fees credit bureau fees office supplies online computer services related to business parking and meters petty cash funds postage promotion and publicity seminars and trade shows taxi and bus fare telephone calls away from the business