Publication 583 |
2003 Tax Year |
Publication 583 Main Contents
This is archived information that pertains only to the 2003 Tax Year. If you are looking for information for the current tax year, go to the Tax Prep Help Area.
What New Business Owners Need To Know
As a new business owner, you need to know your federal tax responsibilities. Table 1, below, can help you learn what those
responsibilities are. Ask yourself each question listed in the table, then see the related discussion to find the answer.
In addition to knowing about federal taxes, you need to make some basic business decisions. Ask yourself:
-
What are my financial resources?
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What products and services will I sell?
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How will I market my products and services?
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How will I develop a strategic business plan?
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How will I manage my business on a day-to-day basis?
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How will I recruit employees?
The Small Business Administration (SBA) is a federal agency that can help you answer these types of questions. For information
on how to
contact the SBA, see page 26.
Forms of Business
The most common forms of business are the sole proprietorship, partnership, and corporation. When beginning a business, you
must decide which form
of business to use. Legal and tax considerations enter into this decision. Only tax considerations are discussed in this publication.
Your form of business determines which income tax return form you have to file. See Table 2 on page 6 to find out which form
you have to
file.
Sole proprietorships.
A sole proprietorship is an unincorporated business that is owned by one individual. It is the simplest form of business
organization to start and
maintain. The business has no existence apart from you, the owner. Its liabilities are your personal liabilities. You undertake
the risks of the
business for all assets owned, whether or not used in the business. You include the income and expenses of the business on
your personal tax return.
More information.
For more information on sole proprietorships, see Publication 334, Tax Guide for Small Business. If you are a farmer, see Publication
225, Farmer's Tax Guide.
Partnerships.
A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each
person contributes money,
property, labor, or skill, and expects to share in the profits and losses of the business.
A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its
operations, but it does not
pay income tax. Instead, it “ passes through” any profits or losses to its partners. Each partner includes his or her share of the partnership's
items on his or her tax return.
More information.
For more information on partnerships, see Publication 541, Partnerships.
Corporations.
In forming a corporation, prospective shareholders exchange money, property, or both, for the corporation's capital
stock. A corporation generally
takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions.
The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed
as dividends. However,
shareholders cannot deduct any loss of the corporation.
More information.
For more information on corporations, see Publication 542, Corporations.
S corporations.
An eligible domestic corporation can avoid double taxation (once to the corporation and again to the shareholders)
by electing to be treated as an
S corporation. Generally, an S corporation is exempt from federal income tax other than tax on certain capital gains and passive
income. On their tax
returns, the S corporation's shareholders include their share of the corporation's separately stated items of income, deduction,
loss, and credit, and
their share of nonseparately stated income or loss.
More information.
For more information on S corporations, see the instructions for Form 2553, Election by a Small Business Corporation, and Form 1120S,
U.S. Income Tax Return for an S Corporation.
Limited liability company.
A limited liability company (LLC) is an entity formed under state law by filing articles of organization as an LLC.
None of the members of an LLC
are personally liable for its debts. An LLC may be classified for federal income tax purposes as either a partnership, a corporation,
or an entity
disregarded as an entity separate from its owner by applying the rules in regulations section 301.7701–3. For more information,
see the
instructions for Form 8832, Entity Classification Election.
Identification Numbers
You must have a taxpayer identification number so the IRS can process your returns. The two most common kinds of taxpayer
identification numbers
are the social security number (SSN) and the employer identification number (EIN).
-
An SSN is issued to individuals by the Social Security Administration (SSA) and is in the following format:
000–00–0000.
-
An EIN is issued to individuals (sole proprietors), partnerships, corporations, and other entities by the IRS and is in the
following
format: 00–0000000.
You must include your taxpayer identification number (SSN or EIN) on all returns and other documents you send to the IRS.
You must also furnish
your number to other persons who use your identification number on any returns or documents they send to the IRS. This includes
returns or documents
filed to report the following information.
-
Interest, dividends, royalties, etc., paid to you.
-
Any amount paid to you as a dependent care provider.
-
Certain other amounts paid to you that total $600 or more for the year.
If you do not furnish your identification number as required, you may be subject to penalties. See Penalties, later.
Employer Identification Number (EIN)
EINs are used to identify the tax accounts of employers, certain sole proprietors, corporations, partnerships, estates, trusts,
and other entities.
If you don't already have an EIN, you need to get one if you:
-
Have employees,
-
Have a qualified retirement plan,
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Operate your business as a corporation or partnership, or
-
File returns for:
-
Employment taxes, or
-
Excise taxes.
Applying for an EIN.
You may apply for an EIN:
-
Online—Click on the EIN link at www.irs.gov/businesses/small. The EIN is issued immediately once the application
information is validated.
-
By telephone at 1–800–829–4933 from 7:30 a.m. to 5:30 p.m. in the applicant's local time zone.
-
By mailing or faxing Form SS–4, Application for Employer Identification Number.
When to apply.
You should apply for an EIN early enough to receive the number by the time you must file a return or statement or
make a tax deposit. If you apply
by mail, file Form SS–4 at least 4 to 5 weeks before you need an EIN. If you apply by telephone or through the IRS website,
you can get an EIN
immediately. If you apply by fax, you can get an EIN within 4 business days.
If you do not receive your EIN by the time a return is due, file your return anyway. Write “ Applied for” and the date you applied for the
number in the space for the EIN. Do not use your social security number as a substitute for an EIN on your tax returns.
More than one EIN.
You should have only one EIN. If you have more than one EIN and are not sure which to use, contact the Internal Revenue
Service Center where you
file your return. Give the numbers you have, the name and address to which each was assigned, and the address of your main
place of business. The IRS
will tell you which number to use.
More information.
For more information about EINs, see Publication 1635, Understanding Your EIN.
Payee's Identification Number
In the operation of a business, you will probably make certain payments you must report on information returns (discussed
later under
Information Returns). The forms used to report these payments must include the payee's identification number.
Employee.
If you have employees, you must get an SSN from each of them. Record the name and SSN of each employee exactly as
they are shown on the employee's
social security card. If the employee's name is not correct as shown on the card, the employee should request a new card from
the SSA. This may occur,
for example, if the employee's name has changed due to marriage or divorce.
If your employee does not have an SSN, he or she should file Form SS–5, Application for a Social Security Card, with the SSA. This
form is available at SSA offices or by calling 1–800–772–1213. It is also available from the SSA website at
www.ssa.gov.
Other payee.
If you make payments to someone who is not your employee and you must report the payments on an information return,
get that person's SSN. If you
make reportable payments to an organization, such as a corporation or partnership, you must get its EIN.
To get the payee's SSN or EIN, use Form W–9,
Request for Taxpayer Identification Number and Certification. This form is available from IRS offices
or by calling 1–800–829–3676. It is also available from the IRS website at www.irs.gov.
If the payee does not provide you with an identification number, you may have to withhold part of the payments as
backup withholding. For
information on backup withholding, see the Form W–9 instructions and the General Instructions for Forms 1099, 1098, 5498,
and
W–2G.
Tax Year
You must figure your taxable income and file an income tax return based on an annual accounting period called a tax year.
A tax year is usually 12
consecutive months. There are two kinds of tax years.
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Calendar tax year. A calendar tax year is 12 consecutive months beginning January 1 and ending December 31.
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Fiscal tax year. A fiscal tax year is 12 consecutive months ending on the last day of any month except December. A 52-53-week tax
year is a fiscal tax year that varies from 52 to 53 weeks but does not have to end on the last day of a month.
If you file your first tax return using the calendar tax year and you later begin business as a sole proprietor, become a
partner in a partnership,
or become a shareholder in an S corporation, you must continue to use the calendar year unless you get IRS approval to change
it or are otherwise
allowed to change it without IRS approval.
You must use a calendar tax year if:
-
You keep no books.
-
You have no annual accounting period.
-
Your present tax year does not qualify as a fiscal year.
-
You are required to use a calendar year by a provision of the Internal Revenue Code or the Income Tax Regulations.
For more information, see Publication 538, Accounting Periods and Methods.
First-time filer.
If you have never filed an income tax return, you adopt either a calendar tax year or a fiscal tax year. You adopt
a tax year by filing your first
income tax return using that tax year. You have not adopted a tax year if you merely did any of the following.
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Filed an application for an extension of time to file an income tax return.
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Filed an application for an employer identification number.
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Paid estimated taxes for that tax year.
Changing your tax year.
Once you have adopted your tax year, you may have to get IRS approval to change it. To get approval, you must file
Form 1128,
Application To Adopt, Change, or Retain a Tax Year. You may have to pay a fee. For more information, see
Publication 538.
Accounting Method
An accounting method is a set of rules used to determine when and how income and expenses are reported. You choose an accounting
method for your
business when you file your first income tax return. There are two basic accounting methods.
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Cash method. Under the cash method, you report income in the tax year you receive it. You usually deduct or capitalize expenses
in the tax year you pay them.
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Accrual method. Under an accrual method, you generally report income in the tax year you earn it, even though you may receive
payment in a later year. You deduct or capitalize expenses in the tax year you incur them, whether or not you pay them that
year.
For other methods, see Publication 538.
If you need inventories to show income correctly, you must generally use an accrual method of accounting for purchases and
sales.
Inventories
include goods held for sale in the normal course of business. They also include raw materials and supplies that will
physically become a part of merchandise intended for sale. Inventories are explained in Publication 538.
Certain small business taxpayers can use the cash method of accounting and can also account for inventoriable items as materials
and supplies that
are not incidental. For more information, see Publication 538.
You must use the same accounting method to figure your taxable income and to keep your books. Also, you must use an accounting
method that clearly
shows your income. In general, any accounting method that consistently uses accounting principles suitable for your trade
or business clearly shows
income. An accounting method clearly shows income only if it treats all items of gross income and expense the same from year
to year.
More than one business.
When you own more than one business, you can use a different accounting method for each business if the method you
use for each clearly shows your
income. You must keep a complete and separate set of books and records for each business.
Changing your method of accounting.
Once you have set up your accounting method, you must generally get IRS approval before you can change to another
method. A change in accounting
method not only includes a change in your overall system of accounting, but also a change in the treatment of any material
item. For examples of
changes that require approval and information on how to get approval for the change, see Publication 538.
Business Taxes
The form of business you operate determines what taxes you must pay and how you pay them. The following are the four general
kinds of business
taxes.
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Income tax.
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Self-employment tax.
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Employment taxes.
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Excise taxes.
See Table 2 on page 6 for the forms you file to report these taxes.
You may want to get Publication 509. It has tax calendars that tell you when to file returns and make tax payments.
Income Tax
All businesses except partnerships must file an annual income tax return. Partnerships file an information return. Which form
you use depends on
how your business is organized. See Table 2 on page 6 to find out which return you have to file.
The federal income tax is a pay-as-you-go tax. You must pay the tax as you earn or receive income during the year. An employee
usually has income
tax withheld from his or her pay. If you do not pay your tax through withholding, or do not pay enough tax that way, you might
have to pay estimated
tax. If you are not required to make estimated tax payments, you may pay any tax due when you file your return.
Table 2. Which Forms Must I File?
IF you are a... |
|
THEN you may be liable for... |
|
Use Form... |
Sole proprietor |
|
Income tax |
|
1040 and Schedule C
1 or C–EZ (Schedule F
1 for farm business)
|
|
|
Self-employment tax |
|
1040 and Schedule SE |
|
|
Estimated tax |
|
1040–ES |
|
|
Employment taxes: |
|
|
|
|
• Social security and Medicare
taxes and income tax
withholding
|
|
941 (943 for farm employees) |
|
|
• Federal unemployment (FUTA)
tax
|
|
940 or 940–EZ |
|
|
• Depositing employment taxes |
|
8109
2 |
|
|
Excise taxes |
|
See Excise Taxes |
Partnership |
|
Annual return of income |
|
1065 |
|
|
Employment taxes |
|
Same as sole proprietor |
|
|
Excise taxes |
|
See Excise Taxes |
Partner in a partnership (individual) |
|
Income tax |
|
1040 and Schedule E
3 |
|
|
Self-employment tax |
|
1040 and Schedule SE |
|
|
Estimated tax |
|
1040–ES |
Corporation or S corporation |
|
Income tax |
|
1120 or 1120–A (corporation)
3 1120S (S corporation)
3 |
|
|
Estimated tax |
|
1120–W (corporation only) and 8109
2 |
|
|
Employment taxes |
|
Same as sole proprietor |
|
|
Excise taxes |
|
See Excise Taxes |
S corporation shareholder |
|
Income tax |
|
1040 and Schedule E
3 |
|
|
Estimated tax |
|
1040–ES |
1 File a separate schedule for each business.
|
2 Do not use if you deposit taxes electronically.
|
3 Various other schedules may be needed.
|
Estimated tax.
Generally, you must pay taxes on income, including self-employment tax (discussed next), by making regular payments
of estimated tax during the
year.
Sole proprietors, partners, and S corporation shareholders.
You generally have to make estimated tax payments if you expect to owe tax of $1,000 or more when you file your return.
Use Form 1040–ES,
Estimated Tax for Individuals, to figure and pay your estimated tax. For more information, see Publication 505, Tax Withholding and
Estimated Tax.
Corporations.
You generally have to make estimated tax payments for your corporation if you expect it to owe tax of $500 or more
when you file its return. Use
Form 1120–W, Estimated Tax for Corporations, to figure the estimated tax. You must deposit the payments as explained on page 8 under
Depositing Taxes. For more information, see Publication 542.
Self-Employment Tax
Self-employment tax (SE tax) is a social security and Medicare tax primarily for individuals who work for themselves. Your
payments of SE tax
contribute to your coverage under the social security system. Social security coverage provides you with retirement benefits,
disability benefits,
survivor benefits, and hospital insurance (Medicare) benefits.
You must pay SE tax and file Schedule SE (Form 1040) if either of the following applies.
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Your net earnings from self-employment were $400 or more.
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You had church employee income of $108.28 or more.
Use Schedule SE (Form 1040) to figure your SE tax. For more information, see Publication 533, Self-Employment Tax.
You can deduct one-half of your SE tax as an adjustment to income on your Form 1040.
The Social Security Administration (SSA) time limit for posting self-employment income.
Generally, the SSA will give you credit only for self-employment income reported on a tax return filed within 3 years,
3 months, and 15 days after
the tax year you earned the income. If you file your tax return or report a change in your self-employment income after this
time limit, the SSA may
change its records, but only to remove or reduce the amount. The SSA will not change its records to increase your self-employment
income.
Employment Taxes
This section briefly discusses the employment taxes you must pay, the forms you must file to report them, and other forms
that must be filed when
you have employees.
Employment taxes include the following.
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Social security and Medicare taxes.
-
Federal income tax withholding.
-
Federal unemployment (FUTA) tax.
If you have employees, you will need to get Publication 15, Circular E, Employer's Tax Guide. If you have agricultural employees, get
Publication 51, Circular A, Agricultural Employer's Tax Guide. These publications explain your tax responsibilities as an employer.
If you are not sure whether the people working for you are your employees, see Publication 15–A, Employer's Supplemental Tax Guide.
That publication has information to help you determine whether an individual is an employee or an independent contractor.
If you classify an
employee as an independent contractor, you can be held liable for employment taxes for that worker plus a penalty. An independent
contractor is
someone who is self-employed. Generally, you do not have to withhold or pay any taxes on payments to an independent contractor.
Federal Income, Social Security, and Medicare Taxes
You generally must withhold federal income tax from your employee's wages. To figure how much federal income tax to withhold
from each wage
payment, use the employee's Form W–4 (discussed later under Hiring Employees) and the methods described in Publication 15.
Social security and Medicare taxes pay for benefits that workers and their families receive under the Federal Insurance Contributions
Act (FICA).
Social security tax pays for benefits under the old-age, survivors, and disability insurance part of FICA. Medicare tax pays
for benefits under the
hospital insurance part of FICA. You withhold part of these taxes from your employee's wages and you pay a matching amount
yourself. To find out how
much social security and Medicare tax to withhold and to pay, see Publication 15.
Which form do I file?
Report these taxes on Form 941, Employer's Quarterly Federal Tax Return. (Farm employers use Form 943, Employer's Annual Federal
Tax Return for Agricultural Employees.)
Federal Unemployment (FUTA) Tax
The federal unemployment tax is part of the federal and state program under the Federal Unemployment Tax Act (FUTA) that pays
unemployment
compensation to workers who lose their jobs. You report and pay FUTA tax separately from social security and Medicare taxes
and withheld income tax.
You pay FUTA tax only from your own funds. Employees do not pay this tax or have it withheld from their pay.
Which form do I file?
Report federal unemployment tax on Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return. Or, if you qualify, you can use
the simpler Form 940–EZ instead. See Publication 15 to find out if you can use this form.
Hiring Employees
Have the employees you hire fill out Form I–9 and Form W–4. If your employees qualify for and want to receive advanced earned
income
credit payments, they must give you a completed Form W–5.
Form I–9.
You must verify that each new employee is legally eligible to work in the United States. Both you and the employee
must complete the U.S.
Citizenship and Immigration Services (USCIS) Form I–9, Employment Eligibility Verification. You can get the form from USCIS offices
or from the USCIS website at http://uscis.gov. Call the USCIS at 1–800–375–5283 for more information about
your responsibilities.
Form W–4.
Each employee must fill out Form W–4, Employee's Withholding Allowance Certificate. You will use the filing status and withholding
allowances shown on this form to figure the amount of income tax to withhold from your employee's wages.
In certain circumstances, you may be required to send a copy of an employee's Form W–4 to the IRS. If you have an
employee who submits a
Form W–4 claiming more than 10 withholding allowances, or claiming an exemption from withholding when the employee's wages
are normally more
that $200 a week, see Publication 15.
Form W–5.
An eligible employee who has a qualifying child is entitled to receive advance earned income credit (EIC) payments
with his or her pay during the
year. To get these payments, the employee must give you a properly completed Form W–5, Earned Income Credit Advance Payment
Certificate. You are required to make advance EIC payments to employees who give you a completed and signed Form W–5. For more
information, see Publication 15.
Form W–2 Wage Reporting
After the calendar year is over, you must furnish copies of Form W–2, Wage and Tax Statement, to each employee to whom you paid
wages during the year. You must also send copies to the Social Security Administration. See Information Returns, later, for more
information on Form W–2.
Excise Taxes
This section describes the excise taxes you may have to pay and the forms you have to file if you do any of the following.
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Manufacture or sell certain products.
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Operate certain kinds of businesses.
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Use various kinds of equipment, facilities, or products.
-
Receive payment for certain services.
For more information on excise taxes, see Publication 510.
Form 720.
The federal excise taxes reported on Form 720, Quarterly Federal Excise Tax Return, consist of several broad categories of taxes,
including the following.
-
Environmental taxes.
-
Communications and air transportation taxes.
-
Fuel taxes.
-
Tax on the first retail sale of heavy trucks, trailers, and tractors.
-
Manufacturers taxes on the sale or use of a variety of different articles.
Form 2290.
There is a federal excise tax on certain trucks, truck tractors, and buses used on public highways. The tax applies
to vehicles having a taxable
gross weight of 55,000 pounds or more. Report the tax on Form 2290, Heavy Highway Vehicle Use Tax Return. For more information, see the
instructions for Form 2290.
Form 730.
If you are in the business of accepting wagers or conducting a wagering pool or lottery, you may be liable for the
federal excise tax on wagering.
Use Form 730, Monthly Tax Return for Wagers, to figure the tax on the wagers you receive.
Form 11–C.
Use Form 11–C, Occupational Tax and Registration Return for Wagering, to register for any wagering activity and to pay the federal
occupational tax on wagering.
Depositing Taxes
You generally have to deposit employment taxes, certain excise taxes, corporate income tax, and S corporation taxes before
you file your return.
Electronic deposit of taxes.
Generally, taxpayers whose total deposits of social security and Medicare taxes and withheld income tax during previous
years exceeded certain
amounts are required to deposit taxes through the Electronic Federal Tax Payment System (EFTPS).
Starting in January 2004, any business that has a federal tax obligation and requests a new EIN will automatically
be enrolled in EFTPS. Through
the mail, the business will receive an EFTPS PIN package that contains instructions for activating its EFTPS enrollment.
If a business is not required to use EFTPS, it can make deposits with an authorized financial institution. These deposits
must be accompanied by a
deposit coupon. See Deposit coupons, later.
Taxpayers not required to make deposits by EFTPS may enroll in the system, which will allow tax deposits without coupons,
paper checks, or visits
to an authorized depositary. For more information, see Publication 15.
Making deposits with coupons.
Mail or deliver deposits with completed deposit coupons to an authorized financial institution unless you make the deposits
electronically, as discussed earlier.
Generally, a mailed deposit will be considered timely if the taxpayer establishes that it was mailed in the United
States at least 2 days before
the due date. You may be charged a penalty for not making deposits when due, unless you have reasonable cause. See Penalties, later.
To help ensure proper crediting of your account, include the following on your check or money order.
Deposit coupons.
Use Form 8109,
Federal Tax Deposit Coupon, to deposit taxes. On each coupon, you must show the deposit amount, the type of
tax, the period for which you are making a deposit, and your telephone number. Use a separate coupon for each tax and period.
You must include a
coupon with each deposit you make.
If you apply for a new EIN and have a federal tax obligation, you will be mailed one deposit coupon. If you want to
order a coupon book, call
1–800–829–4933. You should receive the coupon book within 4 to 6 weeks of ordering.
If you have a deposit due and there is not enough time to obtain a coupon book, you can get a blank coupon (Form 8109–B)
by calling
1–800–829–4933.
If you have not received your EIN and must make a deposit, mail your payment with an explanation to the Internal Revenue
Service Center where you
file your return. Make your check or money order payable to the United States Treasury. On the payment, write your name (exactly
as shown on Form
SS–4), your address, the kind of tax, the period covered, and the date you applied for an EIN. Do not use Form 8109–B in this
situation.
Information Returns
If you make or receive payments in your business, you may have to report them to the IRS on information returns. The IRS compares
the payments
shown on the information returns with each person's income tax return to see if the payments were included in income. You
must give a copy of each
information return you are required to file to the recipient or payer. In addition to the forms described below, you may have
to use other returns to
report certain kinds of payments or transactions. For more details on information returns and when you have to file them,
see the General
Instructions for Forms 1099, 1098, 5498, and W–2G.
Form 1099–MISC.
Use Form 1099–MISC, Miscellaneous Income, to report certain payments you make in your trade or business. These payments include
the following items.
-
Payments of $600 or more for services performed for your business by people not treated as your employees, such as subcontractors,
attorneys, accountants, or directors.
-
Rent payments of $600 or more, other than rents paid to real estate agents.
-
Prizes and awards of $600 or more that are not for services, such as winnings on TV or radio shows.
-
Royalty payments of $10 or more.
-
Payments to certain crew members by operators of fishing boats.
You also use Form 1099–MISC to report your sales of $5,000 or more of consumer goods to a person for resale anywhere other
than in a
permanent retail establishment.
Form W–2.
You must file Form W–2, Wage and Tax Statement, to report payments to your employees, such as wages, tips, and other compensation,
withheld income, social security, and Medicare taxes, and advance earned income credit payments. For more information on what
to report on Form
W–2, see the Instructions for Forms W–2 and W–3.
Form 8300.
You must file Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business, if you receive more than $10,000 in cash
in one transaction or two or more related business transactions. Cash includes U.S. and foreign coin and currency. It also
includes certain monetary
instruments such as cashier's and traveler's checks and money orders. For more information, see Publication 1544, Reporting Cash Payments of Over
$10,000 (Received in a Trade or Business).
Penalties
The law provides penalties for not filing returns or paying taxes as required. Criminal penalties may be imposed for willful
failure to file, tax
evasion, or making a false statement.
Failure to file tax returns.
If you do not file your tax return by the due date, you may have to pay a penalty. The penalty is based on the tax
not paid by the due date. See
your tax return instructions for more information about this penalty.
Failure to pay tax.
If you do not pay your taxes by the due date, you will have to pay a penalty for each month, or part of a month, that
your taxes are not paid. For
more information, see your tax return instructions.
Failure to withhold, deposit, or pay taxes.
If you do not withhold income, social security, or Medicare taxes from employees, or if you withhold taxes but do
not deposit them or pay them to
the IRS, you may be subject to a penalty of the unpaid tax, plus interest. You may also be subject to penalties if you deposit
the taxes late. For
more information, see Publication 15.
Failure to follow information reporting requirements.
The following penalties apply if you are required to file information returns. For more information, see the General Instructions for Forms
1099, 1098, 5498, and W–2G.
-
Failure to file information returns. A penalty applies if you do not file information returns by the due date, if you do not
include all required information, or if you report incorrect information.
-
Failure to furnish correct payee statements. A penalty applies if you do not furnish a required statement to a payee by the
required date, if you do not include all required information, or if you report incorrect information.
Waiver of penalty.
These penalties will not apply if you can show that the failures were due to reasonable cause and not willful neglect.
In addition, there is no penalty for failure to include all the required information, or for including incorrect information,
on a de minimis
number of information returns if you correct the errors by August 1 of the year the returns are due. (To be considered de
minimis, the number of
returns cannot exceed the greater of 10 or ½ of 1% of the total number of returns you are required to file for the year.)
Failure to supply taxpayer identification number.
If you do not include your taxpayer identification number (SSN or EIN) or the taxpayer identification number of another
person where required on a
return, statement, or other document, you may be subject to a penalty of $50 for each failure. You may also be subject to
the $50 penalty if you do
not give your taxpayer identification number to another person when it is required on a return, statement, or other document.
Business Expenses
You can deduct business expenses on your income tax return. These are the current operating costs of running your business.
To be deductible, a
business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your field of business,
trade, or profession. A necessary expense is one that is helpful and appropriate for your business, trade, or profession. An expense does
not have to be indispensable to be considered necessary.
The following are brief explanations of some expenses that are of interest to people starting a business. There are many other
expenses that you
may be able to deduct. See your form instructions and Publication 535, Business Expenses.
Business Start-Up Costs
Business start-up costs are the expenses you incur before you actually begin business operations. Your business start-up costs will
depend on the type of business you are starting. They may include costs for advertising, travel, surveys, and training. These
costs are capital
expenses.
You usually recover costs for a particular asset (such as machinery or office equipment) through depreciation (discussed next).
Other qualifying
start-up costs can be recovered through amortization. This means you deduct them in equal amounts over a period of 60 months
or more. If you do not
choose to amortize these start-up costs, you generally cannot recover them until you sell the business or otherwise go out
of business.
For more information on business start-up costs, see chapter 9 in Publication 535.
Depreciation
If property you acquire to use in your business has a useful life that extends substantially beyond the year it is placed
in service, you generally
cannot deduct the entire cost as a business expense in the year you acquire it. You must spread the cost over more than one
tax year and deduct part
of it each year. This method of deducting the cost of business property is called depreciation.
Business property you must depreciate includes the following items.
-
Office furniture.
-
Buildings.
-
Machinery and equipment.
You can choose to deduct a limited amount of the cost of certain depreciable property in the year you place the property in
service. This deduction
is known as the “section 179 deduction.” You can take a special depreciation allowance for certain property you acquire and place in service
before January 1, 2005. For more information about depreciation, the section 179 deduction, and the special depreciation allowance,
see Publication
946, How To Depreciate Property.
Depreciation must be taken in the year it is allowable. Allowable depreciation not taken in a prior year cannot be taken in
the current year. If
you do not deduct the correct depreciation, you may be able to make a correction by filing Form 1040X, Amended U.S. Individual
Income Tax
Return, or by changing your accounting method. For more information on how to correct an incorrect depreciation deduction,
see chapter 1 in
Publication 946.
Business Use of Your Home
To deduct expenses related to the business use of part of your home, you must meet specific requirements. Even then, your
deduction may be limited.
To qualify to claim expenses for business use of your home, you must meet both the following tests.
-
Your use of the business part of your home must be:
-
Exclusive (however, see Exceptions to exclusive use, later),
-
Regular,
-
For your trade or business, AND
-
The business part of your home must be one of the following:
-
Your principal place of business (defined later),
-
A place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, or
-
A separate structure (not attached to your home) you use in connection with your trade or business.
Exclusive use.
To qualify under the exclusive use test, you must use a specific area of your home only for your trade or business. The area used for
business can be a room or other separately identifiable space. The space does not need to be marked off by a permanent partition.
You do not meet the requirements of the exclusive use test if you use the area in question both for business and for personal purposes.
Exceptions to exclusive use.
You do not have to meet the exclusive use test if either of the following applies.
-
You use part of your home for the storage of inventory or product samples.
-
You use part of your home as a daycare facility.
For an explanation of these exceptions, see Publication 587, Business Use of Your Home (Including Use by Daycare Providers).
Principal place of business.
Your home office will qualify as your principal place of business for deducting expenses for its use if you meet the
following requirements.
-
You use it exclusively and regularly for administrative or management activities of your trade or business.
-
You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.
Alternatively, if you use your home exclusively and regularly for your business, but your home office does not qualify
as your principal place of
business based on the previous rules, you determine your principal place of business based on the following factors.
-
The relative importance of the activities performed at each location.
-
If the relative importance factor does not determine your principal place of business, the time spent at each location.
If, after considering your business locations, your home cannot be identified as your principal place of business,
you cannot deduct home office
expenses. However, for other ways to qualify to deduct home office expenses, see Publication 587.
Which form do I file?
If you file Schedule C (Form 1040), use Form 8829,
Expenses for Business Use of Your Home, to figure your deduction. If you file Schedule F (Form 1040) or you
are a partner, you can use the worksheet in Publication 587.
More information.
For more information about business use of your home, see Publication 587.
Car and Truck Expenses
If you use your car or truck in your business, you can deduct the costs of operating and maintaining it. You generally can
deduct either your
actual expenses or the standard mileage rate.
Actual expenses.
If you deduct actual expenses, you can deduct the cost of the following items:
Depreciation |
Lease payments |
Registration |
Garage rent |
Licenses |
Repairs |
Gas |
Oil |
Tires |
Insurance |
Parking fees |
Tolls |
If you use your vehicle for both business and personal purposes, you must divide your expenses between business and
personal use. You can divide
your expenses based on the miles driven for each purpose.
Example.
You are the sole proprietor of a flower shop. You drove your van 20,000 miles during the year. 16,000 miles were for delivering
flowers to
customers and 4,000 miles were for personal use. You can claim only 80% (16,000 ÷ 20,000) of the cost of operating your van
as a business
expense.
Standard mileage rate.
Instead of figuring actual expenses, you may be able to use the standard mileage rate to figure the deductible costs
of operating your car, van,
pickup, or panel truck for business purposes. You can use the standard mileage rate for a vehicle you own or lease. The standard
mileage rate is a
specified amount of money you can deduct for each business mile you drive. It is announced annually by the IRS. To figure
your deduction, multiply
your business miles by the standard mileage rate for the year.
Generally, if you use the standard mileage rate, you cannot deduct your actual expenses. However, you may be able to deduct
business-related parking fees, tolls, interest on your car loan, and certain state and local taxes.
Choosing the standard mileage rate.
If you want to use the standard mileage rate for a car you own, you must choose to use it in the first year the car
is available for use in your
business. In later years, you can choose to use either the standard mileage rate or actual expenses.
If you use the standard mileage rate for a car you lease, you must choose to use it for the entire lease period (including
renewals).
Additional information.
For more information about the rules for claiming car and truck expenses, see Publication 463, Travel, Entertainment, Gift, and Car
Expenses.
Recordkeeping
This part explains why you must keep records, what kinds of records you must keep, and how to keep them. It also explains
how long you must keep
your records for federal tax purposes. A sample recordkeeping system is illustrated at the end of this part.
Why Keep Records?
Everyone in business must keep records. Good records will help you do the following.
Monitor the progress of your business.
You need good records to monitor the progress of your business. Records can show whether your business is improving,
which items are selling, or
what changes you need to make. Good records can increase the likelihood of business success.
Prepare your financial statements.
You need good records to prepare accurate financial statements. These include income (profit and loss) statements
and balance sheets. These
statements can help you in dealing with your bank or creditors and help you manage your business.
-
An income statement shows the income and expenses of the business for a given period of time.
-
A balance sheet shows the assets, liabilities, and your equity in the business on a given date.
Identify source of receipts.
You will receive money or property from many sources. Your records can identify the source of your receipts. You need
this information to separate
business from nonbusiness receipts and taxable from nontaxable income.
Keep track of deductible expenses.
You may forget expenses when you prepare your tax return unless you record them when they occur.
Prepare your tax returns.
You need good records to prepare your tax returns. These records must support the income, expenses, and credits you
report. Generally, these are
the same records you use to monitor your business and prepare your financial statements.
Support items reported on tax returns.
You must keep your business records available at all times for inspection by the IRS. If the IRS examines any of your
tax returns, you may be asked
to explain the items reported. A complete set of records will speed up the examination.
Kinds of Records To Keep
Except in a few cases, the law does not require any specific kind of records. You can choose any recordkeeping system suited
to your business that
clearly shows your income and expenses.
The business you are in affects the type of records you need to keep for federal tax purposes. You should set up your recordkeeping
system using an
accounting method that clearly shows your income for your tax year. See Accounting Method, earlier. If you are in more than one business,
you should keep a complete and separate set of records for each business. A corporation should keep minutes of board of directors'
meetings.
Your recordkeeping system should include a summary of your business transactions. This summary is ordinarily made in your
books (for example,
accounting journals and ledgers). Your books must show your gross income, as well as your deductions and credits. For most
small businesses, the
business checkbook (discussed later) is the main source for entries in the business books. In addition, you must keep supporting
documents, explained
next.
Supporting Documents
Purchases, sales, payroll, and other transactions you have in your business generate supporting documents. Supporting documents
include sales
slips, paid bills, invoices, receipts, deposit slips, and canceled checks. These documents contain information you need to
record in your books.
It is important to keep these documents because they support the entries in your books and on your tax return. Keep them in
an orderly fashion and
in a safe place. For instance, organize them by year and type of income or expense.
Gross receipts.
Gross receipts are the income you receive from your business. You should keep supporting documents that show the amounts
and sources of your gross
receipts. Documents that show gross receipts include the following.
Purchases.
Purchases are the items you buy and resell to customers. If you are a manufacturer or producer, this includes the
cost of all raw materials or
parts purchased for manufacture into finished products. Your supporting documents should show the amount paid and that the
amount was for purchases.
Documents for purchases include the following.
These records will help you determine the value of your inventory at the end of the year. See Publication 538 for information
on methods for
valuing inventory.
Expenses.
Expenses are the costs you incur (other than purchases) to carry on your business. Your supporting documents should
show the amount paid and that
the amount was for a business expense. Documents for expenses include the following.
A petty cash fund allows you to make small payments without having to write checks for small amounts. Each time you
make a payment from this fund,
you should make out a petty cash slip and attach it to your receipt as proof of payment.
Travel, transportation, entertainment, and gift expenses.
Specific recordkeeping rules apply to these expenses. For more information, see Publication 463.
Employment taxes.
There are specific employment tax records you must keep. For a list, see Publication 15.
Assets.
Assets are the property, such as machinery and furniture you own and use in your business. You must keep records to
verify certain information
about your business assets. You need records to figure the annual depreciation and the gain or loss when you sell the assets.
Your records should show
the following information.
-
When and how you acquired the asset.
-
Purchase price.
-
Cost of any improvements.
-
Section 179 deduction taken.
-
Deductions taken for depreciation.
-
Deductions taken for casualty losses, such as losses resulting from fires or storms.
-
How you used the asset.
-
When and how you disposed of the asset.
-
Selling price.
-
Expenses of sale.
The following documents may show this information.
What if I don't have a canceled check?
If you do not have a canceled check, you may be able to prove payment with certain financial account statements prepared
by financial institutions.
These include account statements prepared for the financial institution by a third party. These account statements must be
highly legible. The
following table lists acceptable account statements.
IF payment is by... |
THEN the statement must show the... |
Check |
|
Electronic funds transfer |
|
Credit card |
-
Amount charged.
-
Payee's name.
-
Transaction date.
|
Proof of payment of an amount, by itself, does not establish you are entitled to a tax deduction. You should also
keep other documents, such as
credit card sales slips and invoices, to show that you also incurred the cost.
Recording Business Transactions
A good recordkeeping system includes a summary of your business transactions. (Your business transactions are shown on the
supporting documents
just discussed.) Business transactions are ordinarily summarized in books called journals and ledgers. You can buy them at
your local stationery or
office supply store.
A journal is a book where you record each business transaction shown on your supporting documents. You may have to keep separate
journals for transactions that occur frequently.
A ledger is a book that contains the totals from all of your journals. It is organized into different accounts.
Whether you keep journals and ledgers and how you keep them depends on the type of business you are in. For example, a recordkeeping
system for a
small business might include the following items.
-
Business checkbook.
-
Daily summary of cash receipts.
-
Monthly summary of cash receipts.
-
Check disbursements journal.
-
Depreciation worksheet.
-
Employee compensation record.
The business checkbook is explained next. The other items are illustrated later under Sample Record System.
The system you use to record business transactions will be more effective if you follow good recordkeeping practices. For
example, record expenses
when they occur, and identify the source of recorded receipts. Generally, it is best to record transactions on a daily basis.
Business checkbook.
One of the first things you should do when you start a business is open a business checking account. You should keep
your business account separate
from your personal checking account.
The business checkbook is your basic source of information for recording your business expenses. You should deposit
all daily receipts in your
business checking account. You should check your account for errors by reconciling it. See Reconciling the checking account, later.
Consider using a checkbook that allows enough space to identify the source of deposits as business income, personal
funds, or loans. You should
also note on the deposit slip the source of the deposit and keep copies of all slips.
You should make all payments by check to document business expenses. Write checks payable to yourself only when making
withdrawals from your
business for personal use. Avoid writing checks payable to cash. If you must write a check for cash to pay a business expense,
include the receipt for
the cash payment in your records. If you cannot get a receipt for a cash payment, you should make an adequate explanation
in your records at the time
of payment.
Use the business account for business purposes only. Indicate the source of deposits and the type of expense in the
checkbook.
Reconciling the checking account.
When you receive your bank statement, make sure the statement, your checkbook, and your books agree. The statement
balance may not agree with the
balance in your checkbook and books if the statement:
-
Includes bank charges you did not enter in your books and subtract from your checkbook balance, or
-
Does not include deposits made after the statement date or checks that did not clear your account before the statement date.
By reconciling your checking account, you will:
-
Verify how much money you have in the account,
-
Make sure that your checkbook and books reflect all bank charges and the correct balance in the checking account, and
-
Correct any errors in your bank statement, checkbook, and books.
You should reconcile your checking account each month.
Before you reconcile your monthly bank statement, check your own figures. Begin with the balance shown in your checkbook
at the end of the previous
month. To this balance, add the total cash deposited during the month and subtract the total cash disbursements.
After checking your figures, the result should agree with your checkbook balance at the end of the month. If the result
does not agree, you may
have made an error in recording a check or deposit. You can find the error by doing the following.
-
Adding the amounts on your check stubs and comparing that total with the total in the “amount of check” column in your check
disbursements journal. If the totals do not agree, check the individual amounts to see if an error was made in your check
stub record or in the
related entry in your check disbursements journal.
-
Adding the deposit amounts in your checkbook. Compare that total with the monthly total in your cash receipt book, if you
have one. If the
totals do not agree, check the individual amounts to find any errors.
If your checkbook and journal entries still disagree, then refigure the running balance in your checkbook to make
sure additions and subtractions
are correct.
When your checkbook balance agrees with the balance figured from the journal entries, you may begin reconciling your
checkbook with the bank
statement. Many banks print a reconciliation worksheet on the back of the statement.
To reconcile your account, follow these steps.
-
Compare the deposits listed on the bank statement with the deposits shown in your checkbook. Note all differences in the dollar
amounts.
-
Compare each canceled check, including both check number and dollar amount, with the entry in your checkbook. Note all differences
in the
dollar amounts. Mark the check number in the checkbook as having cleared the bank. After accounting for all checks returned
by the bank, those not
marked in your checkbook are your outstanding checks.
-
Prepare a bank reconciliation. One is illustrated later under Sample Record System.
-
Update your checkbook and journals for items shown on the reconciliation as not recorded (such as service charges) or recorded
incorrectly.
At this point, the adjusted bank statement balance should equal your adjusted checkbook balance. If you still have differences,
check the
previous steps to find the errors.
Table 3. Period of Limitations
IF you... |
|
THEN the period is... |
1. Owe additional tax and situations (2), (3), and (4), below, do not apply to you |
|
3 years |
2. Do not report income that you should report and it is more than 25% of the gross income shown on the
return
|
|
6 years |
3. File a fraudulent return |
|
Not limited |
4. Do not file a return |
|
Not limited |
5. File a claim for credit or refund after you filed your return |
|
Later of: 3 years or
2 years after tax
was paid
|
6. File a claim for a loss from worthless securities or a bad debt deduction |
|
7 years |
Bookkeeping System
You must decide whether to use a single-entry or a double-entry bookkeeping system. The single-entry system of bookkeeping
is the simplest to
maintain, but it may not be suitable for everyone. You may find the double-entry system better because it has built-in checks
and balances to assure
accuracy and control.
Single-entry.
A single-entry system is based on the income statement (profit or loss statement). It can be a simple and practical
system if you are starting a
small business. The system records the flow of income and expenses through the use of:
-
A daily summary of cash receipts, and
-
Monthly summaries of cash receipts and disbursements.
Double-entry.
A double-entry bookkeeping system uses journals and ledgers. Transactions are first entered in a journal and then
posted to ledger accounts. These
accounts show income, expenses, assets (property a business owns), liabilities (debts of a business), and net worth (excess
of assets over
liabilities). You close income and expense accounts at the end of each tax year. You keep asset, liability, and net worth
accounts open on a permanent
basis.
In the double-entry system, each account has a left side for debits and a right side for credits. It is self-balancing
because you record every
transaction as a debit entry in one account and as a credit entry in another.
Under this system, the total debits must equal the total credits after you post the journal entries to the ledger
accounts. If the amounts do not
balance, you have made an error and you must find and correct it.
An example of a journal entry exhibiting a payment of rent in October is shown next.
General Journal
Date |
Description of Entry |
Debit |
Credit |
Oct. 5 |
Rent expense |
780.00 |
|
|
Cash |
|
780.00 |
|
|
|
|
|
|
|
|
Computerized System
There are computer software packages you can use for recordkeeping. They can be purchased in many retail stores. These packages
are very helpful
and relatively easy to use; they require very little knowledge of bookkeeping and accounting.
If you use a computerized system, you must be able to produce sufficient legible records to support and verify entries made
on your return and
determine your correct tax liability. To meet this qualification, the machine-sensible records must reconcile with your books
and return. These
records must provide enough detail to identify the underlying source documents.
You must also keep all machine-sensible records and a complete description of the computerized portion of your recordkeeping
system. This
documentation must be sufficiently detailed to show all of the following items.
-
Functions being performed as the data flows through the system.
-
Controls used to ensure accurate and reliable processing.
-
Controls used to prevent the unauthorized addition, alteration, or deletion of retained records.
-
Charts of accounts and detailed account descriptions.
See Revenue Procedure 98–25 in Cumulative Bulletin 1998–1 for more information.
Microfilm
Microfilm and microfiche reproductions of general books of accounts, such as cash books, journals, voucher registers, and
ledgers, are accepted for
recordkeeping purposes if they comply with Revenue Procedure 81–46 in Cumulative Bulletin 1981–2.
Electronic Storage System
Records maintained in an electronic storage system are accepted for recordkeeping purposes if the system complies with Revenue
Procedure
97–22 in Cumulative Bulletin 1997–1.
An electronic storage system is one that either images hardcopy (paper) books and records or transfers computerized books
and records to an
electronic storage media, such as an optical disk.
How Long To Keep Records
You must keep your records as long as they may be needed for the administration of any provision of the Internal Revenue Code.
Generally, this
means you must keep records that support an item of income or deduction on a return until the period of limitations for that
return runs out.
The period of limitations is the period of time in which you can amend your return to claim a credit or refund, or the IRS
can assess additional
tax. Table 3 below contains the periods of limitations that apply to income tax returns. Unless otherwise stated, the years refer to the
period after the return was filed. Returns filed before the due date are treated as filed on the due date.
Keep copies of your filed tax returns. They help in preparing future tax returns and making computations if you file an amended
return.
Employment taxes.
If you have employees, you must keep all employment tax records for at least 4 years after the date the tax becomes
due or is paid, whichever is
later. For more information about recordkeeping for employment taxes, see Publication 15.
Assets.
Keep records relating to property until the period of limitations expires for the year in which you dispose of the
property in a taxable
disposition. You must keep these records to figure any depreciation, amortization, or depletion deduction, and to figure your
basis for computing gain
or loss when you sell or otherwise dispose of the property.
Generally, if you received property in a nontaxable exchange, your basis in that property is the same as the basis
of the property you gave up,
increased by any money you paid. You must keep the records on the old property, as well as on the new property, until the
period of limitations
expires for the year in which you dispose of the new property in a taxable disposition.
Records for nontax purposes.
When your records are no longer needed for tax purposes, do not discard them until you check to see if you have to
keep them longer for other
purposes. For example, your insurance company or creditors may require you to keep them longer than the IRS does.
Sample Record System
This example illustrates a single-entry system used by Henry Brown, who is the sole proprietor of a small automobile body
shop. Henry uses
part-time help, has no inventory of items held for sale, and uses the cash method of accounting.
These sample records should not be viewed as a recommendation of how to keep your records. They are intended only to show how one
business keeps its records.
1. Daily Summary of Cash Receipts
(Page 18)
This summary is a record of cash sales for the day. It accounts for cash at the end of the day over the amount in the Change
and Petty Cash Fund at
the beginning of the day.
Henry takes the cash sales entry from his cash register tape. If he had no cash register, he would simply total his cash sale
slips and any other
cash received that day.
He carries the total receipts shown in this summary for January 3 ($267.80), including cash sales ($263.60) and sales tax
($4.20), to the
Monthly Summary of Cash Receipts.
Petty cash fund.
Henry uses a petty cash fund to make small payments without having to write checks for small amounts. Each time he
makes a payment from this fund,
he makes out a petty cash slip and attaches it to his receipt as proof of payment. He sets up a fixed amount ($50) in his
petty cash fund. The total
of the unspent petty cash and the amounts on the petty cash slips should equal the fixed amount of the fund. When the totals
on the petty cash slips
approach the fixed amount, he brings the cash in the fund back to the fixed amount by writing a check to “ Petty Cash” for the total of the
outstanding slips. (See the Check Disbursements Journal entry for check number 92.) This restores the fund to its fixed amount of $50. He
then summarizes the slips and enters them in the proper columns in the monthly check disbursements journal.
2. Monthly Summary of Cash Receipts
(Page 19)
This shows the income activity for the month. Henry carries the total monthly net sales shown in this summary for January
($4,865.05) to his
Annual Summary.
To figure total monthly net sales, Henry reduces the total monthly receipts by the sales tax imposed on his customers and
turned over to the state.
He cannot take a deduction for sales tax turned over to the state because he only collected the tax. He does not include the
tax in his income.
3. Check Disbursements Journal (Pages 20 and 21)
Henry enters checks drawn on the business checking account in the Check Disbursements Journal each day. All checks are prenumbered and
each check number is listed and accounted for in the column provided in the journal.
Frequent expenses have their own headings across the sheet. He enters in a separate column expenses that require comparatively
numerous or large
payments each month, such as materials, gross payroll, and rent. Under the General Accounts column, he enters small expenses that normally
have only one or two monthly payments, such as licenses and postage.
Henry does not pay personal or nonbusiness expenses by checks drawn on the business account. If he did, he would record them
in the journal, even
though he could not deduct them as business expenses.
Henry carries the January total of expenses for materials ($1,083.50) to the Annual Summary. Similarly, he enters the monthly total of
expenses for telephone, truck/auto, etc., in the appropriate columns of that summary.
4. Employee Compensation Record
(Page 22)
This record shows the following information.
-
The number of hours Henry's employee worked in a pay period.
-
The employee's total pay for the period.
-
The deductions Henry withheld in figuring the employee's net pay.
-
The monthly gross payroll.
Henry carries the January gross payroll ($520) to the Annual Summary.
5. Annual Summary (Page 22)
This annual summary of monthly cash receipts and expense totals provides the final amounts to enter on Henry's tax return.
He figures the cash
receipts total from the total of monthly cash receipts shown in the Monthly Summary of Cash Receipts. He figures the expense totals from
the totals of monthly expense items shown in the Check Disbursements Journal. As in the journal, he keeps each major expense in a separate
column.
Henry carries the cash receipts total shown in the annual summary ($47,440.95) to Part I of Schedule C (not illustrated).
He carries the total for
materials ($10,001.00) to Part II of Schedule C.
A business that keeps materials and supplies on hand generally must complete the inventory lines in Part III of Schedule C.
However, there are no
inventories of materials and supplies in this example. Henry buys parts and supplies on a per-job basis; he does not keep
them on hand.
Henry enters annual totals for interest, rent, taxes, and wages on the appropriate lines in Part II of Schedule C. The total
for taxes and licenses
includes the employer's share of social security and Medicare taxes, and the business license fee. He enters the total of
other annual business
expenses on the “Other expenses” line of Schedule C.
6. Depreciation Worksheet (Page 22)
This worksheet shows the information used in figuring the depreciation allowed on assets used in Henry's business. Henry figures
the depreciation
using the modified accelerated cost recovery system (MACRS). He purchased and placed in service several used assets that do
not qualify for the
section 179 deduction or the special depreciation allowance. Depreciation, the section 179 deduction, and the special depreciation
allowance are
discussed in Publication 946. Henry uses the information in the worksheet to complete Form 4562, Depreciation and Amortization (not
illustrated).
7. Bank Reconciliation (Page 23)
Henry reconciles his checkbook with his bank statement and prepares a bank reconciliation for January as follows.
-
Henry begins by entering his bank statement balance.
-
Henry compares the deposits listed on the bank statement with deposits shown in his checkbook. Two deposits shown in his checkbook—
$701.33 and $516.08—were not on his bank statement. He enters these two amounts on the bank reconciliation. He adds them to
the bank statement
balance of $1,458.12 to arrive at a subtotal of $2,675.53.
-
After comparing each canceled check with his checkbook, Henry found four outstanding checks totaling $526.50. He subtracts
this amount from
the subtotal in (2). The result of $2,149.03 is the adjusted bank statement balance.
-
Henry enters his checkbook balance on the bank reconciliation.
-
Henry discovered that he mistakenly entered a deposit of $600.40 in his checkbook as $594.40. He adds the difference ($6.00)
to the
checkbook balance of $2,153.03. There was a $10.00 bank service charge on his bank statement that he subtracts from the checkbook
balance. The result
is the adjusted checkbook balance of $2,149.03. This equals his adjusted bank statement balance computed in (3).
The only book adjustment Henry needs to make is to the Check Disbursements Journal for the $10 bank service charge. He does not need to
adjust the Monthly Summary of Cash Receipts because he correctly entered the January 8 deposit of $600.40 in that record.
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