J.K. Lasser's Small Business Taxes 2018. Barbara Weltman

you are subject to the uniform capitalization rules, you capitalize all direct costs of your production or resale activities. Direct costs for producers include direct material costs and direct labor costs. Direct costs for resellers mean acquisition costs.

      You also capitalize a portion of indirect costs. Indirect costs for producers and resellers include costs of purchasing, handling, and storage, as well as taxes, interest, rent, insurance, utilities, repairs, engineering and design costs, quality control, tools and equipment, licensing, and more.

Change in Accounting Method

      If you want to change your method of accounting (for example, from the accrual method to the cash method), you must file Form 3115, Application for Change in Accounting Method (Rev. Dec. 2015), during the year for which the change is to be effective. (Instructions on how and where to file this form are included in instructions to the form.) Some changes are automatic – just by filing you are ensured that your change is recognized; other changes require the consent of the IRS.

      Periodically, the IRS modifies its list of automatic changes (see Revenue Procedure 2017–30 for the latest list of automatic changes). These include changing to a required accounting method from an incorrect one, switching to the cash method by an eligible small inventory-based business, implementing depreciation changes pursuant to a cost segregation study, changing the treatment of repair and maintenance costs from capitalized to currently deductible, deducting the cost of “smallwares” (such as dishes and glassware) in the year they are first put to use by restaurants, and applying the de minimis rule for certain repairs.

      The IRS created a simplified change in accounting procedure to small businesses with respect to certain changes under the so-called repair regulations (explained in Chapter 10) that eliminates the need to file Form 3115 entirely. Revenue Procedure 2015–20 as updated in Revenue Procedure 2017–30, applies to small businesses (those with assets under $10 million or average annual gross receipts for the 3 prior years under $10 million). Those that qualified are able to simply make the change on the return without any special reporting or notification to the IRS. However, some tax experts advise small businesses to file Form 3115 even though not required in order to obtain audit protection for prior years in which expenses were covered by these regulations.

      CHAPTER 3

      Recordkeeping for Business Income and Deductions

      Alert

      At the time this book was completed, Congress was considering important tax changes that could affect 2017 tax returns and planning for 2018. Check the online Supplement in February 2018 at www.jklasser.com or www.barbaraweltman.com to see what changes have been enacted and when they are effective.

      Recordkeepingis a tiresome and time-consuming task. Still, you have little choice but to do it. Records show whether your business is producing a profit or a loss. The information in your records can enable you to prepare financial statements, such as profit and loss statements and balance sheets, which may be required by your lenders or investors. From a tax perspective, you need records to determine your gain or loss when you sell property. And as a general rule, you must be able to back up your deductions with certain clear proof, such as receipts, canceled checks, and other documentation. If you do not have this proof, your deductions may be disallowed or force you to litigate in order to win your position (a costly and time-consuming activity). Certain deductions require specific evidence. Other deductions are based on more general means of proof.

      For further information on recordkeeping, see IRS Publication 334, Tax Guide for Small Business (for Individuals Who File Schedule C or C-EZ); IRS Publication 552, Recordkeeping for Individuals; and IRS Publication 583, Starting a Business and Keeping Records.

      General Recordkeeping

      The tax law does not require you to maintain books and records in any particular way. It does, however, require you to keep an accurate and complete set of books for each business you operate. Statistics show that this can be an awesome task.

      According to the IRS, it takes a mere 3 hours and 36 minutes for recordkeeping to prepare a Schedule C for a sole proprietor. However, what “recordkeeping” means for this purpose is not explained. According to the House Small Business Committee, more than half of small businesses said they spent more than 40 hours each year dealing with taxes, and 40 % said they spent more than 80 hours (which is more than two 35-hour work weeks). The House Ways and Means Committee noted that tax compliance costs S corporations alone more than $46 billion each year (nearly $12,000 per company).

      Set up your books when you begin your business. Your books are based on your choice of tax year and accounting method, as explained in Chapter 2. In the past, when you kept your books in paper ledgers, you needed to choose a bookkeeping method – single-entry or double-entry. If you are a service business, single-entry bookkeeping may be sufficient. Today, with software and online accounting solutions, you don't need to know about bookkeeping methods; you merely input income and expense items, and the program does the rest.

      Your books should be set up with various accounts in order to group your income and expenses. The broad categories of accounts include income, expenses, assets, liabilities, and equity (or net worth). Within these accounts you can keep various subaccounts. For example, in an account called Expenses you can have subaccounts for advertising, bad debts, interest expense, taxes, rents, repairs, and more. In fact, your subaccounts should reflect the various income and deduction topics discussed throughout this book.

Technology for Recordkeeping

      More and more businesses are using computers, tablets, and smartphones to maintain books and records rather than having bookkeepers make handwritten entries. Computer-generated records save time – an important commodity for the small business owner – and generally are more accurate than handwritten entries.