Special Earthquake Edition

Yesterday when the earth began trembling, I did what I do every time I am in a life threatening situation. I asked myself, “What would Jennifer Aniston do?” So I kicked off my high heeled pumps and ran screaming from the building. Then I went shopping. What really happened isn't as interesting. I was working at a client's office in Manassas when the building started shaking. I was entering a couple of journal entries into their accounting system and didn't see a need to interrupt that. One of the owners came by and remarked, “Wow, Frank didn't even stop working.” I replied, “Did you really want me to keep billing you as I ran screaming out of the building like a little girl?” When I was done at that client's office, I rushed back to my office to make certain none of our Jennifer Aniston pictures had fallen off the men's bathroom wall. That would have been a real tragedy. We can rebuild the Pentagon, but an autographed picture of Jen is irreplaceable. Thanks to all of you who expressed your concern for Jen's pictures on Facebook. I tried calling Jen on her cell phone to make certain she was unhurt, but all of you wussies were busy calling your families and prevented me from getting through. As I drove back to my office post-quake, I listened to WTOP news on the radio. They had someone from everywhere call in to share their experiences – even Woodbridge. Who gives a damn about how people in Woodbridge feel? The Loch Ness monster called in from Scotland to tell us his lake shook. Big Foot probably couldn't get through on his cell phone. AT&T service was down – as usual. If you've made it through my earthquake diatribe, you at least deserve some real business advice. I wish I had a good stock tip to pass on – say what to buy when the earth is shaking, but I don't. There is a punch line in there that eludes me. If I find one, I'll post it on Facebook. If you have a good one, let me know. I'll take the credit for it – but not the blame if it bombs. Last week, I was preparing a set of financial statements for a client. This was no big deal. I spent a few hours working on them and then send the owner a draft. After reviewing the draft, he called me, “Frank, I need you to make me look good for the bank.” You might reasonably inquire why he would make that statement. I might reasonably answer that his company's financial statements weren't very impressive. By that, I mean that he had small losses, not profits, for both years presented in the financial statements. He was hoping to get a new bank loan. The financial statements certainly would not look great to a bank. I hear this owner's plea about a dozen times per year. In each case, a company owner is looking for something from a bonding company or a bank and needs financial statements prepared by a CPA. I prepare the financial statements as requested and then get the phone call. “Frank, can you make my financial statements look better?” Apparently, there is some trick I missed in CPA school that will magically turn losses into profits. Jesus turned one loaf of bread into many. That is a miracle. I dare him to turn some of these ugly-assed profit and loss statements into something a banker might believe. Take a guess why banks and bonding companies want financial statements prepared by CPA's. No that isn't right. That isn't either. You get half credit if you guessed that banks just want someone to sue when the loan goes bad. The real reason is that banks trust CPA's to present financial statements that are truthful to the best of our abilities. That reason would seem to eliminate the possibility of my fudging the numbers to make the company owner happy. I should mention, however, that in the past I have had mortgage companies ask me to falsify financial amounts. We all know where that practice led the mortgage industry. In case you haven't guessed by now, my answer is “No.” My job isn't to make a company's financial statements look good. My job is to make them look accurate. The owner's job is to make the financial statements look good – by managing his company well. Now that you have accepted my plea not to ask me to commit fraud, let's discuss the types of financial statements a bank or a bonding company might request. There are three basic types of financial statements a CPA can issue. They are compiled financial statements, reviewed financial statements, and audited financial statements. These three types of statements differ in the amount of responsibility the CPA takes for the accuracy of the numbers and consequently the amount of work the CPA performs. A quick explanation of the three types of financial statements is as follows. If it looks like a duck, it is a duck. That describes compiled financial statements. If it looks like a duck and quacks like a duck, it is probably a duck. That describes reviewed financial statements. If it looks like a duck, quacks like a duck, and is genetically proven to be a duck, it is a duck. That describes audited financial statements. Let's look at the three types in a little more detail. When a CPA prepares a set of compiled financial statements, he takes no responsibility for the accuracy of the financial statements. The CPA is required to read the financial statements and gain an understanding of the company, but that is all. There is no assurance whatsoever that the financial statements are correct. This, obviously, is the lowest level of assurance a CPA can provide in that no assurance is provided at all. The only responsibility for correcting the financial statements arises when the CPA notes an obvious departure from accounting principles generally accepted in the United States. Then he can either correct the financial statements or note in his report the departure. From a practical standpoint, most CPA's including me, don't issue compiled financial statements without performing at least some work to determine that the numbers in the financial statements aren't total garbage. We will normally make certain the bank accounts and a few other important balance sheet accounts have been reconciled. But – we aren't required to do that. Compiled financial statements are the least expensive set of financial statements a CPA will issue. Compiled statements normally run from $500 to $2,000 depending on the complexity of the statements and the amount of work the CPA performs. Reviewed financial statements provide a higher level of assurance than compiled financial statements. A CPA is required to do at least a little more work before issuing reviewed financial statements. We have to perform all of the procedures for a compilation, but we must also make inquiries as to the balances in the financial statements. In other words,we might inquire as to whether the bank accounts have been reconciled and whether all accounts receivable are collectible. From a practical standpoint, most CPA's will prepare workpapers that support the balances of all the significant balance sheet accounts and some of the accounts on the income statement. We aren't required to actually test any of the transactions that make up the financial statements. In other words, we don't examine canceled checks or confirm accounts receivable balances with customers. We also do not do any testing for fraud. A set of reviewed financial statements gives some assurance that a company's financial statements are accurate, but certainly not absolute assurance. A set of reviewed financial statements will typically cost between $1,000 and $5,000 for a small business again depending on the complexity of the financial statements. The highest level of assurance that a CPA can provide comes with audited financial statements. An audit includes all of the compilation and review procedures but also includes testing on a sample basis the transactions in the accounting system. For example, in an audit, a CPA will test count year end inventory and confirm bank account balances with a company's bank. The CPA will also evaluate the risk that fraud may have occurred and perform some fraud testing. However, testing extensively for fraud isn't part of an audit. This surprises most people. The general public perception is that an audit is primarily about detecting fraud. It is not. An audit for a small business will typically start at not less than $15,000 and could run to over $100,000. Audits aren't for most small businesses. Audits are also risky for CPA firms from a liability standpoint. We don't perform them for that reason. They also aren't nearly as much fun as preparing tax returns. Yes, I take medication for this condition. What type of financial statements should you want for your small business? Banks and bonding companies love audits for obvious reasons. They also understand that most companies can't afford them. For companies with less than $10 million in annual revenue, most banks and bonding companies will accept reviewed financial statements. For very small companies with less than $1 million in annual revenue, banks will typically accept compiled financial statements. In most cases, I recommend selecting the least costly service that your bank or bonding company will accept. Yes, I would love to bill you for reviewed financial statements. However, if I ask myself what Jennifer Aniston would do, I realize that she would probably go shopping. So she is no help there. I try to put my clients' best interests first. I sleep better that way. I end up with plenty or work to do anyway. As always, if you want non-snarky tax and accounting advice, please visit our main S&K web site at HTTP://www.skcpas.com. In the meantime, make certain your life insurance bill is paid. With the next earthquake, we will all surely die!

Deduct Your Spouse

A friend from Facebook, Angelina J. writes, “Frank, I am taking a business trip in a month with my husband, Brad P. How can I make his travel expenses deductible?” That's a great question. I am in a similar situation. My future wife, Jen A., and I are opening a sex toys business. She needs to find a way to make my travel expenses deductible. In her new movie, “Horrible Bosses”, Jen demonstrates her knowledge of sex toys. She plays a cougar dentist, who enjoys seducing / torturing her dental assistant. I would have been great in that role.

The key to making spouse travel expenses or any other spouse related expenses is involvement in the business. In other words, your spouse must have some substantial, active role in your business. In my case, I plan on being Jen's sex toy model. She can test the toys on me.

Angelina J. runs an adoption agency. She has to find a way to make Brad P. a contributor to her business. She could have Brad fill any of a number of roles like bookkeeping, searching for orphans to adopt, or marketing foreign kids to rich, useless American actors. For Brad's expenses to be deductible, his role in the business must be essential. The I.R.S. has seen and rejected all sorts of schemes. The more Brad's arrangement in Angelina's business looks like something an unrelated employee might do, the better the changes of sustaining deductions related to Brad's involvement.

A second factor Angelina must consider is Brad's compensation. His compensation must be commensurate with his involvement, and his expenses must be reasonable based on his level of compensation. You wouldn't spend $10,000 in travel expenses on an unrelated employee making $15,000 per year. We CPA's say, “Pigs get fat. Hogs get slaughtered.” If you get greedy, the I.R.S. will disallow your deduction.

You have some choices in how you structure your spouse's involvement in your business. If you already have employees, putting your spouse on the payroll with a salary is a great idea. If you own a pass thru entity such as an LLC, partnership, or S corporation, your spouse's salary will increase your personal income but be offset by your business's deduction for his salary. There can be some Social Security tax and Medicare implications. So you have to actually work out the numbers to make certain the additional spouse travel deductions are worth the hassle.

If you don't have employees already, you can make your spouse your only employee. However, then you begin to incur the additional administrative expense of processing payroll. That expense eats into the benefit of deducting your spouse's travel. A way around having to process payroll is to make your spouse a minority owner. If you are the only owner of an LLC, now you have created a partnership for income tax purposes when you add your spouse as an owner. If your spouse is involved in your business, his / her expenses are deductible to the business since he / she is an owner.

There is a definite downside to making your spouse an owner in your business. If you get divorced, the consequences aren't happy. If you think your marriage isn't on solid ground, give up the deductions. I am only addressing deductions in this article. I ain't no Dr. Phil. Your marriage is your business. I was bad enough at my first one that I shouldn't be giving marriage advice.

There is a more aggressive way to make spouse travel deductible. If you have a legal entity such as an LLC or corporation, you can make your spouse a member of the board of directors. Corporations are required to have annual director meetings. Hold yours someplace nice like Hawaii.

The key to successfully defending your spouse travel deduction is documentation, documentation, and more documentation. If you go to Hawaii to hold a directors' meeting, meet every day of the trip for some substantial period each day and keep detailed meeting minutes. Don't think you can create the minutes after the fact. Your computer file creation dates had better be consistent with your trip dates. If your spouse is an employee, keep the same time records you would keep for any other employee.

Arranging your business affairs to make spouse travel deductible is definitely an aggressive income tax reduction technique. If you are audited, expect the I.R.S. to question the deductions. However, if you can prove through solid documentation that your spouse is actively involved in your business, you will be able to defend your deduction successfully. But, expect a fight. If you aren't willing to have the fight, pass on the deduction.

If you are looking for not so snarky tax and business advice, please visit our main S&K web site www.skcpas.com. Thanks for reading.

Blame Your Customers – Santa Closes Up Shop

Here's how you can tell the last recession was a severe one. Santa Claus closed his shop at the North Pole. The elves pension trust held the mortgage note on the workshop. They threw Santa out on his ass, when he fell six months behind on the mortgage. Santa applied for federal stimulus money to save the shop, but like most Americans, the loan to value ratio didn't work even with lower payments. What happened to the reindeer was just wrong. They didn't just lose their jobs. Wegman's told us they were selling bison, but we really know the truth. Make mine medium rare, please.

Santa fell on hard times in 2007 when he had a falling out with his main benefactor, Osama Bin Laden. Santa refused to deliver suicide-bomber Barbie dolls to girls in Israel. Santa packed up his tools and fixtures from his shop and moved to Danslowne, where he opened a retail toy shop in 2008. Danslowne is an affluent residential community twenty-five miles west of Washington, DC. Shortly after opening, Santa's toy shop won the prestigious small retailer of the year award presented annually by the Douloun County Chamber of Commerce. Santa was proud of his award and thought he was on the way to financial success.

Early in the summer of 2011, the president of the Douloun County Chamber of Commerce, Hony Toward, sent a message to past winners of the small business award. He asked each of the winners to provide a few words explaining how winning the award benefited their businesses. Hony was shocked when Santa replied that he couldn't provide a quote, because he didn't believe winning the award had helped his toy business at all. His business was struggling.

Santa explained that Douloun County residents had changed their buying behavior between 2008 and 2011. Residents ignored small local retailers, like Santa, in favor of big box stores like Wal-mart and Best Buy. He couldn't understand why consumers would forsake the incredible customer service he provided in favor of the rock bottom prices of Target and the other large discount chains. He told Hony that someone, presumably the Douloun County Chamber of Commerce, should start the fight for the little guy in Douloun County. Someone should convince county residents to buy local. Santa explained that he was too busy trying to save his business to participate in his proposed program, but that somebody should do it. Hony presented Santa's message to the small business committee of the chamber. One of the members was a stunningly handsome, young CPA, named Srank Ftitely. Srank brought Santa's message to my attention.

Santa thought winning the small retailer award validated his business expertise and anointed him a small business leader who would surely succeed. The award judges were forward thinkers, who understood the genius of his business model. That model was selling upscale toys to affluent consumers in Danslowne. A toy from his store would have your little Timmy solving Einstein's relativity equations by combining data from the Hubble telescope and the Large Hadron Collider. His toys would have your child graduating from Harvard by age twelve.

Here's the truth about the small retailer award. The award isn't judged based on the viability of a business's model or its financial results. The judges review packages submitted by award nominees. The best package wins. Santa had submitted a beautiful brochure featuring Stephen Hawking brand toys. The brochure was produced by an amazing printer, named Mave Dorey. Mave owned M & M Printing. Yes, I switched the M & M. You still get M & M. Santa won based on his package.

Let's take a look at Santa's actual business plan. This isn't how he would express the plan, but we will be closer to reality. Here is Santa's business model. Rich people are willing to pay too much for toys. The underlying assumption is that rich people are stupid. They are willing to pay more for a pedophile Ken doll or slutty Barbie to Santa than they are willing to pay Wal-mart. Santa thinks his outstanding service will be the difference. How much service do you need to buy toys?

To compete with big discount warehouses, small retail stores have to offer something the warehouses can't offer. That seems obvious. What wasn't obvious to Santa is that customers have to want that something. That something isn't service in the case of a toy store.

If I could retool Santa's business model, I would eliminate the retail part completely. Small retail toy stores can't exist any more than the Loch Ness monster can exist. Santa needs a niche market. Osama Bin Laden might have had the right idea. Santa could sell suicide bomber Barbie dolls over the internet to the children of Al Quaeda terrorists. The reason he can't do this with a brick and mortar location is that there aren't enough terrorist families in Danslowne. The market isn't big enough to support a store. However, an internet business with almost no inventory and overhead could work great selling internationally. He could have a customer loyalty program. If you buy suicide bomber Barbie, you get a free Taliban Ken.

What really offended me about Santa's message to the chamber of commerce was the implication of entitlement. He is a small business. Therefore, we owe him. If Santa had been at the meeting, Srank Ftitely would have told him Stitely's rule of seven billion. There are seven billion people on the planet,who don't give a damn about his business, and not a single one owes him anything. I quoted George Thorogood two weeks ago, but the quote applies to Santa as well. “Get a haircut and get a real job.”

A good friend and client, Ken Irish, passed away tragically in an accident this past week. Ken was a former military guy, who had created a really amazing business. Every moment I spent discussing business with Ken was a real joy. Ken was no Santa. He not only had a great business idea, but he knew how to make money with it. He will be sorely missed by all who knew him.

Thanks for reading. For real tax and accounting advice, please see the main S&K web site at http://www.skcpas.com.