Monthly Archives: October 2015

My Customer/Tenant Didn’t Pay Me. Can I Deduct This on My Tax Return?

I get asked this question a lot, mostly from business owners. The answer to this question is that it depends. First a quick accounting lesson of cash vs. accrual. I promise not to keep it too technical!

If you are a cash basis taxpayer, then you record income or sales once you get paid, either by cash, check, or credit card. You also record expenses when you pay them, even if with a credit card.

For an accrual basis taxpayer, you record income when it is earned. For example, if you are a consultant and you sent an invoice to your client in January for December’s work, then you record the income from the invoice during December. The same goes for expenses, as it generally doesn’t matter when you paid your bill, but when you incurred the expense. This means that if you ordered supplies in December, but paid for them in January, you can deduct the expense in December.

Now to answer the original question: A cash basis taxpayer cannot deduct as an expense an outstanding invoice that was not paid by their customer, or tenant, if they are a landlord. Remember, the invoice was not included as income. On the other hand, an accrual basis taxpayer can deduct an expense for non-payment from a customer or tenant, as long as it is deemed uncollectible.

Most small business clients and landlords are on the cash basis method of accounting. It is much easier for record keeping purposes, and especially for income tax purposes.

What’s In Your Credit Report?

When we apply for loans, search for a job, or even take out an insurance policy, our credit report is used in the process. Your credit report shows all of your outstanding debts and lines of credit, including credit cards, mortgages, auto loans, and personal loans. Even accounts that have been closed or debts that have been paid off will be shown for years. All of this information is used to apply a credit score to you.

It is important to make sure that you pay all of your bills on time and don’t incur too much debt so that you maintain a healthy credit score. Sometimes, incorrect information may inadvertently be placed on your credit report, which will negatively impact your credit score. The higher your credit score generally means that you will pay a lower interest rate when applying for loans, which can save you hundreds or thousands of dollars each year.

Although there are a lot of companies that will provide you with your credit report for a fee, you are legally entitled to one free credit report per year by each of the three credit reporting companies. They are Equifax, Experian, and TransUnion. The website to obtain your free credit report is www.annualcreditreport.com, which is very user-friendly. I recommend obtaining one report every four months from a different credit reporting company so that you will never have to pay for them.

Once you have your report you should review it for accuracy. If there is a mistake, such as an account that shows that you have been late, you will need to contact the credit reporting company who issued the report to have it corrected. Most likely you will need to contact all three companies to have it straightened out.

One last note: According to the Federal Trade Commission (FTC), you should be skeptical of companies that claim they can repair your credit. Some of their business practices are fraudulent and many of the steps you can take yourself at little to no cost. You can go to this page: http://www.ftc.gov/bcp/edu/pubs/consumer/credit/cre13.shtm.

Keep It Separate

What should you keep separate? Business and personal expenses, of course! When you operate a business, including a sole-proprietorship, an LLC, corporation, or even as a realtor, your business activities need to be kept separate from your personal expenses. This is especially important in the case of an audit by the IRS. Here are some best practices and areas where it matters most:

Have Two Separate Checking Accounts: One for your business and one for your personal expenses. When you have to pay for a personal expense, make sure to use your personal checking account. If you pay personal expenses through your business accounts, you will need to separately record these as draws or distributions, otherwise it may look like you are trying to deduct personal expenses as business expenses. The same applies to business expenses. Even though business expenses that are paid personally may still be deductible, chances are that you will not keep track of these expenses and forget to include them on your tax return, thus you end up overpaying taxes.

Business Vehicles, Property, and Equipment: Make sure that you purchase any business property in the name of the business. If the assets are on the books of the business, they need to be owned by the business.

If a Vehicle is in Your Name Personally: Corporate owner-employees may be able to reimburse themselves for vehicle expenses.

The bottom line is to keep your records clean, separate, and simple.

Do You Want to Audit-Proof Your Return?

While certain taxpayers have a higher chance of being audited, such as small business owners with a schedule C, how can you audit-proof your return? Actually, there is no way of insuring that you never get audited, but just in case you do, to make sure that you come out unscathed, there is one secret to help you to survive an audit – organized, clean records and documentation!

The secret is not glamorous, but it will save your nerves, your hard-earned money, and will most likely help you to be more successful. Some techniques for individuals without a business to audit-proof their returns are as follows:

  • Make sure that you have received all of your W-2’s from every job during the last year, along with 1099’s for interest, dividends, and investment transactions. Leaving one of these off your return is sure to have the IRS send you a deficiency notice.
  • Keep copies of all receipts, documents, and cancelled checks for charitable contributions and other expenses you claim on your return.
  • Keep track of your cost-basis for your investments.
  • I also recommend keeping your tax returns and supporting documents for at least 7 years.

For business owners:

You have much more responsibility, because you may have income tax returns, payroll taxes, and sales taxes that need to be filed, to name a few.

  • Use a computerized bookkeeping program, such as QuickBooks. This will help you to run your business better as well.
  • Reconcile your bank and credit cards accounts to your statements to make sure that you have recorded all information, and keep your statements.
  • Keep all of your receipts and canceled checks to support your deductions.
  • Maintain a vehicle mileage log for your business vehicles to prove business use.
  • Document the business reason for your meals and entertainment expenses.
  • Separate your personal expenses from your business. Even if you account for your personal expenses as a draw, it is much cleaner to pay for them personally.
  • For sales that are not subject to sales taxes, make sure to be able to prove exemptions, with proper documentation for out-of-state sales for online retailers or tax-exempt certificates for contractors, for example.

The bottom line is that you need to be able to show proof for your expenses and deductions if you are audited or receive a notice from the IRS and state taxing agencies. Unfortunately, you are guilty unless proven otherwise.