The Risk of Fraud in Small Businesses

As small business owners, we wear many hats. For example, a restaurant owner can also be the procurer of supplies, chef, maitre d’, waiter, and bottle washer. One hat many small business owners tend to not wear is the bookkeeper’s, and therein lies the risk of fraud. To many, the lack of bookkeeping knowledge, hatred or fear of numbers, the need to focus on growing the business, or lack of time, drives the need for employing a bookkeeper.

In the accounting world, there’s a term called “segregation of duties”. In a nutshell, this refers to having different people do different accounting functions. For example, the person receiving customer payments isn’t also the person writing (or signing) checks. The problem in many small businesses is that they can’t afford to have an entire accounting department (such as accounts receivable, accounts payable, payroll), so all the functions are performed by the one bookkeeper. The danger here is that you’re entrusting someone with your money (i.e. your checkbook), and if that person isn’t honest, embezzlement can be the result. It’s beyond the scope of this article to get into the numerous ways a bookkeeper can “rob you blind”, but the point is that regardless of how busy the small business owner is, she/he needs to pay very close attention to what the bookkeeper is doing with deposits and payments, as it’s possible for both money coming in and money going out to be diverted. Bank statements should be reviewed for irregularities when received, blank checks should never be pre-signed, internal financial statements (such as a balance sheet and profit & loss printed from QuickBooks) should be reviewed, and payroll needs to be monitored, both for false employees and for pay rates. There are too many ways of misdirecting company funds, and the small business owner needs to be mindful of the possibilities.

I hope you’ve found this article helpful, and that it’s got you thinking. Please contact me if you have any questions, and if you know of any real life “horror stories” involving employee fraud, please leave a comment.

How Long Do I Have To Keep This Stuff?!

Now that the April 18th tax filing deadline has passed (and your returns are filed…hopefully), you may have a pile of W-2s, 1099s, and all sorts of other papers sitting in a stack, and you’re wondering whether you need to keep it all. The short answer is yes! You’re probably also thinking about the papers sitting in your filing cabinet/boxes/closet/attic/storage, gathering dust over the last five or twenty years. Is it really necessary to schlep this stuff around every time you move? Unfortunately, there’s no short answer to this question.

IRS recently issued Tax Tip 2011-71 “Tips for Managing Your Tax Records”. Unlike me, they don’t use the word ‘schlep’ in a sentence, but, like me, they do give some good advice. The first tip is one that you may have heard before, that is, tax records should be kept for three years. The reason for this is that IRS generally has a three year statute of limitations to audit a tax return. This is three years from the due date of the return, or when you file the return, whichever is later. It would follow, then, that if there’s a chance that your 2010 return could be audited within the next three years, keep your supporting papers for the next three years.

Now before you go tossing all your 2010 stuff out three years from now (or tossing out all of your 2007 papers now), check out IRS’s second tip, which is “some documents-such as records relating to a home purchase or sale, stock transactions, IRA and business or rental property-should be kept longer”. This article would be way too long if I gave you examples for every one of these things, but the idea here is that you need to keep any documents that will help you compute a gain/loss claimed on a tax return (such as a capital loss on a sale of stock, or gain on the sale of a home). So while you’re in the heat of spring cleaning, before you toss out those boxes of papers, make sure they don’t contain something you’ll need in the future.

As far as the types of records you need to keep, IRS’s tip says “…bills, credit card and other receipts, invoices, mileage logs, canceled/imaged/substitute checks, proof of payment, and any other records to support deductions or credits you claim on your return”. For this, personally, I like to work backwards. If I have an accordion file full of papers, I’ll toss out anything that had absolutely nothing to do with either my business or personal taxes. And when I say ‘toss out’ I mean shred… you can’t be too careful these days. Whatever’s left I’ll keep for at least three years.

There are other tips that IRS has, but we’ve run out of time. I’d be happy to tell you about them; just contact me for more information. And please, leave a comment, to let others know how you deal with your records.

Tax Refunds

Everybody who wants an interest free loan, raise your hand. While that hand is raised, those of you who got a big tax refund, use that hand to smack yourself over the head! Why, you ask? It’s because you just gave the government an interest free loan. Let me ask you this; would you give a complete stranger a loan, and not expect to get at least some sort of market rate interest on that money? I didn’t think so, but why are you so quick to give the government your money for free? Even having that money in a savings account earning .25% (you know how low rates are these days) is better than earning zero.

For years I’ve heard clients tell me that they look forward to that big check at tax time, and how they have too much tax withheld on purpose, and it’s ‘forced savings’, blah blah blah. My reply has always been “if you want to force yourself into saving money, why not just cut a check (or set up an automatic debit) every month to invest in a mutual fund, or fund an IRA”? It’s such a no brainer that can only help people, which is why it’s confounded me for years. Obviously my job is to advise my clients, and of course they’ll do whatever the heck they want anyway (much the same way as I ignore advice!).

With proper tax planning/projecting, it’s possible to get to the end of the tax year at close to a breakeven (i.e. either very small refund or very small balance due), without incurring penalties, and having more money saved (and no interest free loans to Uncle Sam or Uncle Governor-of-your-state). By changing your withholding exemptions, you’ll have more money in your pocket each paycheck, and won’t have to wait until tax time to get your loan money back from the government.

I have a challenge; allow me to bug you on a monthly basis, to send me a check, payable to the mutual fund/investment of your choice, and I’ll make sure that check gets deposited to your account, so you can earn something on your money…more than the zero percent the government’s giving you. Better yet, you can loan me the money interest free, I’ll invest it, keep the income, and then pay back your loan at the end of the year! Just kidding, but you understand my point.

With that raised hand, give yourself one more smack over head. O.K., you can put your hand down now! Now that your hand is down, please leave a comment. I’m interested in hearing your thoughts on this.

Love and Taxes

It’s spring, and love is in the air. You may be planning for the big June wedding right now. All the details; what caterer to choose, what color are the bridesmaid’s dresses, who sits next to whom, filing joint or separate tax returns, where to honeymoon, where to live. Whoa, back up…did I just say ‘filing joint or separate tax returns’? I sure did, and I bet you haven’t given that as much thought as you have about who gets stuck sitting next to Aunt Sophie! Well, as they say (whoever they are), there’s no time better than the present. So while you’re stressing out about which band to pick, add this to the list, and get the valium ready!

I thought this would be an interesting topic to write about, because over the years I’ve had to explain to countless newlyweds why they now owe taxes, when, in their single days, they always got refunds.

First thing to understand; when you’re married, you cannot file your tax return with the ‘single’ filing status. To quote IRS “If you are considered married for the whole year, you and your spouse can file a joint return, or you can file separate returns. There are a few examples that IRS gives for what’s considered ‘married for the whole year’, all of which pertain to the last day of the year. To simplify it, if you were married on December 31, you’re considered married for the whole year. This article isn’t meant to be political, so I would like to recognize all the same-sex partners reading this, and please don’t shoot the messenger; IRS makes the tax laws, not me.

Being a numbers guy, I threw together a very simple Excel worksheet, to compare the tax bite between single, married filing jointly (MFJ), and married filing separately (MFS). Even though you can only file jointly or separately if you’re married, I imagine there are people out there who might put off getting married if it’ll save them taxes, which is why I’m including single in this comparison.

Our love struck couple (let’s call them Bristol and Levi) each earn $100K/year in wages, each receives $3K/yr in interest and dividend income, and each have a rental property that generates $5K/yr net rental income. On single returns, they both have adjusted gross income (AGI) of $108K. On a MFJ return, their AGI will be $216K, since all of their respective income items will be on one return. On the MFS returns, they’ll each have AGI of $108K, same as single. Both claim a standard deduction, which will be $5,700 apiece, for either single or MFS. For MFJ, the standard deduction will be double, $11,400. They will each get one exemption of $3,650 on the single and MFS returns, and the MFJ return will have two exemptions (one for each) for a total of $7,300. When standard deductions and exemptions are subtracted, on the single and MFS returns, our lovebirds will each have taxable income of $98,650. On the MFJ return, the taxable income will be $197,300. Now comes the fun part!

Going to the tax charts/tables, the tax on taxable income of $98,650 will be $21,338 for single taxpayers. For MFJ, the tax on taxable income of $197,300 will be $43,488. Let’s summarize; two single returns will generate a total tax of $42,676, compared to a joint tax return which will generate a tax of $43,488. So being married and filing a joint return costs $812 more in federal tax! But wait, it gets worse. When filing separately, each return will generate a tax of $21,751, for a total of $43,502 for the two returns, or $14 more than filing jointly. Now if that isn’t a kick in the pants!

For all my unsuspecting newlywed clients, I’ve had to explain the “phenomenon” of the marriage penalty. Regardless of any attempts or claims by congress to mitigate this, it’s still there. The reason for this is that tax brackets for MFJ aren’t exactly double the brackets for single. What winds up happening is that on a joint return, more dollars wind up being taxed at a higher bracket than on a single return. And MFS is even more, which is why it comes out with the highest tax.

The moral of this story is, Bristol and Levi got scared off by the taxes, and decided to not get married! For all the “real” people out there; obviously there are a lot of other factors to consider when getting married, but when tax time comes, at least you’ll understand better why you just got smacked with taxes. Now go and enjoy that wedding. I’ll be here to talk taxes when you return.

Can You Review My Tax Return?

I’ve recently been contacted by a couple of people, asking me to review the tax returns they prepared themselves with TurboTax. They’re just part of a long list of people over the years to contact me about this, which is what prompted me to write this article.

Having been in public accounting for about thirty years, I’ve always used professional tax preparation software that’s meant for people who know their way around tax returns. The difference between the software I use and TurboTax is sort of like the difference between a Viking and EZ-Bake oven. You’ve heard the line “kids, don’t try this at home”, right? Well, when it comes to taxes, it’s the same thing. You shouldn’t be doing it yourself. I must confess, though, that for a very simple tax return (with one W-2 and one 1099 for bank interest, for example), you probably can get away with using TurboTax.

I have a problem with Intuit, the company that makes TurboTax. They’re trying to convince the world that all you need to do is pay $49 (or whatever the cost is) for ‘The Box’, and ‘The Box’ will guarantee your biggest tax refund, will support you in case of an audit, will guarantee its calculations, and will answer all your questions (wow, maybe I should use TurboTax!). The problem is, taxes are just not that easy, regardless of what Intuit is trying to brainwash the masses into thinking. Neither is bookkeeping, and Intuit has the same tactic with QuickBooks, but that’s a subject for another day.

The question I have for all those people who have contacted me to review their self-prepared TurboTax returns is “if Intuit is giving you all this support, and making these guarantees, and you think you know enough to do the return yourself, then why are you contacting me?” It seems to me that there’s some sort of doubt in the minds of these people; that maybe placing so much faith in ‘The Box’ isn’t enough assurance that the job is being done correctly. I’ve had many people come to me over the years, who have found out the hard way that putting blind faith in ‘The Box’ has led them to notices from IRS, and paying hundreds or thousands of dollars in tax and penalties and interest that could’ve been avoided by spending a little more than $49, to have a real person/tax professional, advise them.

I recommend that you think long and hard about whether you’re really qualified to prepare your own tax returns, or if it’s a better use of your time and hard-earned money to have a knowledgeable tax professional help you instead.

I Started a Nonprofit, and Now I Have to Do What??

You just formed a nonprofit organization. Congratulations on your altruism, and your chutzpah! Most people would’ve just made a donation to the charity of their choice, and considered that to be doing their part to help humanity, or the environment, or the planet, or something else. You’ve taken a step past that; a BIG step. You’re going to personally help further a cause that’s near and dear to you, and that’s beyond commendable, because you’re about to sacrifice yourself in ways that you may not have considered.

This is a brief discussion of some things that you’ve hopefully thought of, when you decided to form your nonprofit. For those of you considering starting your own nonprofit, think about these things before you take the big leap. The following issues have all arisen in discussions with clients, over the years.

I’m in business for myself?

In a word, yes! Starting a nonprofit is the same as starting your own for-profit business, except you’re using the public’s money. Until you’re large enough to have your own staff, you’re going to be the program director, development director/fundraiser, bookkeeper, and other positions, all rolled into one. Taking into consideration other ‘adult’ duties (i.e. spouse, parent, ”real job”, soccer practices, etc), when you add the responsibilities of managing a nonprofit business, you may run out of hours in a day.

I have to file what with IRS?

Just because you filed with the Virginia State Corporation Commission (SCC) to be a non-stock corporation, doesn’t mean that you’re done with the formation. When most people think of forming a ‘nonprofit’, they’re thinking of a 501(c)(3) public charity, as recognized by IRS. That doesn’t come automatically with your SCC filing. To be recognized as a public charity, Form 1023 “Application for Recognition of Exemption…” must be filed with (and approved by) IRS. The application is fairly rigorous, and is not rubber stamped, so make sure all the information is completely and accurately filled out, before submitting.

I need to be a bookkeeper too?

For us CPAs, this part is a breeze, but for the general public, maintaining accounting records can be a real drag. If you’re going to be a public charity using public funds (contributions), you will be accountable to the public as to how you used their money. By some means (yourself, a bookkeeper, etc) you will need to keep books and records of the organization’s finances, for different purposes, one of which follows, next.

I have to file what with IRS?

I know, you’ve heard that already. The issue is, filing that original application for tax exemption with IRS doesn’t fulfill your obligations to them forever. A report of one length or another must be filed with IRS annually. It can be as detailed and complicated as the Form 990 (Return of Organization Exempt From Income Tax), which is the “long form” 990, or can be the 990-EZ “short form”, or even the 990-N “e-postcard”. Which form you file is dependent on how much your gross receipts and total assets were for each tax year.

This article barely scratches the surface of things that you need to consider when you form a nonprofit organization (or think of forming one). Remember, you’ll be using other peoples’ money, and will be held to a higher standard than if you were in business for yourself. Be prepared!