Tough Tax Year? Here’s How To Prepare For A Painless 2021 Filing.
Interview: Steven Crighton, 29.05.2021
Most people think of tax season as a time of year where taxpayers offer a grudging assessment of their own finances, often after much hemming and hawing. My accountant, however, will never hesitate to remind me of the benefits of treating it instead as more of a state of mind.
Business-owning taxpayers have more things to consider than ever before, between new laws and recent trends in finance and technology, and there’s a number of new ways of doing business that function contrary to the way many might assume tax-wise.
I spoke with Armine Alajian, a Certified Public Accountant and founder of Alajian Group in Los Angeles, about the benefits of embracing a more holistic approach that puts minds and bank accounts at ease year-round. With the 2020 tax year freshly behind us, there’s no better time to get things started for 2021 and beyond.
The first step to a proper accounting? A proper account.
This may seem obvious. But, speaking from personal experience, it’s a daunting task for someone who’s put it off. The longer it goes neglected, Alajian said, the more problems it causes.
“Just like with anything else, there are rules determining how financial transactions should be recorded and reported, and tax and accounting guidelines vary based on each individual’s financial activity and intentions,” Alajian said.
For example, investor funding is not income for the company, it’s equity that sits on the balance sheet, and investors don’t get 1099s for this amount as income.
“I see this happen all the time, where financials include this funding portion as revenue,” Alajian said.
Not everything is an income or an expense, Alajian notes, so it’s very important for businesses to keep how they’re accounting things month-to-month in mind. You need an accountant to prepare financial statements in accordance with all of the above.
Truth, reconciliation, and PayPal
Once you have everything recorded, it’s time to reconcile those balance sheets. This includes bank accounts, credit cards accounts, loans, PayPal, Venmo, Cashapp, and merchant processors, just to name a few.
As Alajian explains, reconciliation is the act of merging two sets of data, tying together the beginning and ending balances and everything in between.
“It’s key to accounting and needs to be done monthly. The balance of your bank account needs to reflect the statement from the bank, for example, and if it doesn’t, then data is missing or duplicated,” Alajian said. “This process will ensure what you have on your books ties to the source.”
Bank statements are a common reconciliation item, but there are many others that get bypassed. PayPal and similar e-commerce services, which are exceptionally popular among the newer generations of business owners, provide a great example of a reconciliation item that often goes overlooked.
“I’ve been surprised by the number of people I’ve spoken to who assumed PayPal was some exception to the rule that allowed for some accounting shortcuts. They’ve been surprised to find that’s not the case,” said Alajian.
PayPal and others like it need to be treated like a bank account, Alajian said, and all transactions must be recorded. PayPal is a standalone service — you put money in, you spend from the account and money gets transferred out, just like a bank statement.
“In fact, these kinds of e-commerce companies might even make things a little more complicated, because they can be connected to your bank account, credit card, or just about anything that allows for the transfer of cash,” said Alajian. “Money flows in and flows out from all over.”
If not reconciled properly, income and expenses can be understated, and you may even have duplicate transactions. Similar providers like Venmo, CashApp, and Square can work in a similar way, but you can’t lump them together. They need to be treated as separate bank accounts and individual transactions need to be recorded.
Merchant processors are your customers, not the other way around.
Another thing Alajian says businesses often fail to reconcile and record properly are merchant accounts. Businesses use merchant processors like Stripe when they sell their product or service, using them as an intermediary to collect from customers.
While the business no doubt paid Stripe for the service, many business owners are shocked to find out they’re to be treated as a customer for accounting purposes. It’s a three-way reconciliation: sales have to be reported, and gross method, fees, returns deductions need to be recorded separately to determine the net amount of cash received from the merchant processor.
“Many people skip this part and record the money from Stripe as income,” Alajian said. “That means they’re not getting the right data for business decision-making purposes, and they’re not reporting the proper breakdown on taxes.”
Nor do they consider the fees associated with the service, which is understandable given, that may be by the merchant processor’s design.
“No one likes a fee, and they’ll do just about anything to get out of paying one. If they knew the amount merchant services take, they may make better decisions about which merchant processors to use, or change their collection process,” Alajian said.
And then there’s online retailers…
When you sell an item on Amazon, there’s a deluge of deductions before the money actually hits your account. Alajian says most people may not know about all the ins and outs when using a third party to sell products, not to mention the relevant state sales tax.
“It might be laborious, but all of these details need to be properly reflected in reports and booked and reconciled against the cash received,” Alajian said.
Your accountant exists year-round!
We’ve only really scratched the surface of the variables a business owning taxpayer must consider when tax season rolls around. Alajian suspects that may be a reason so many put it off.
“That’s why it’s always so strange to me that so many otherwise fiscally responsible people treat taxes like a big exam they’ve failed to study for but hope to ace with a last minute cramming session,” Alajian said. “Doesn’t that sound like a nightmare you’ve had at some point?”
This can be avoided by treating your accountant like a relatively good acquaintance, the kind you’ll reconnect with at least somewhat occasionally. Keep them in the loop, and don’t hesitate to reach out with any odd accounting question that comes to mind. Chances are you’re making their job easier in the long run.
In conclusion, find an accountant you’re comfortable with. If you’re in or near Los Angeles, you might want to start with The Alajian Group.