Let’s chat today about how good practices for your bookkeeping benefit you and puts more money in your pocket. In case you are keeping count, this is item six in the series (see below).
Grab your cup of tea (Okay don't grab. Mind your manners and pick it up nicely.) ... sit back, take a sip. Now take a deep breath and relax. Focus here. Bring your mind on this page right now ...
I like to break good bookkeeping practices into seven categories:
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1. Get yourself organized. Enter your data regularly.
2. Use computer software so you can mine your business data.
3. Learn to create audit trails as you go. Some are super easy to implement.
4. Reconcile your bank statement, credit card and vendor statements regularly.
5. Comply with federal record retention requirements.
6. Learn to avoid what gets sole proprietors in trouble with the CRA/IRS.
7. Prepare and file your U.S. and Canadian government compliance reports (sales and use tax, employment and payroll tax, worker's compensation and income tax) on time. Remit the amounts owing. Don't have the money? Don't worry. I have a tip for you; just follow the country link you run your business from.
By law, every business owner must keep a complete and organized set of books and records.
A good bookkeeping practice to start your set of books is to keep your business expenses separate from your personal expenses. (See the audit trail article to find out how.)
It’s a financial catastrophe in a tax audit if you have inadequate supporting documentation. Don't even consider not filing your return every year. That leads to costly late filing penalty charges. That would definitely not be considered good bookkeeping!
For those of you who are interested in the why and how come ... you might like to know that good bookkeeping follows generally accepted accounting principles (GAAP).
As a business owner, you are also legally required to collect and remit payroll sources deductions and GST/HST collected (or any sales and use tax). These funds do not belong to the owner and/or the corporation and should not be used to finance your business.
See an excellent August 15, 2012 article by Greer Jacks at the Knowledge Bureau titled "Distinguished Advisor: “Due diligence” defence for directors is no sure defence" on due diligence and what the court had to say. Go to KnowledgeBureau.com> eTools> Knowledge Bureau Report> Breaking News Archives or Back Issues> August 15, 2012.
Skimming is not reporting part of a business activity.
Moonlighting is not reporting a business activity.
Need I say that neither is
considered good bookkeeping! ... in fact these activities are illegal ... and please don't tell me that all your buddies do it. Are you sure about that?
Most non-compliance issues are examples of what is NOT good bookkeeping practices and relate to:
Did you know there are only five ways to pay no taxes? If you are running a successful business, expect to pay some taxes.
Perhaps you are wondering if CRA/IRS looks at your personal bank deposits during an audit of your business. The answer is yes ... but it goes further, they can even look at your lifestyle ... keeping reading to learn more.
On the Revenue Canada website (see IRS sidebar), they are very open about how and why they conduct audits. Many of these audits are performed on the self-employed, unincorporated, work from home business owner as they are a high risk group. In fact, 98% of Canadian businesses have less than 100 employees.
Here is just a bit of information regarding the type of audits they may perform.
Generally, five different audits for occupations and industries that deal with a lot of cash transactions are performed each year.
The IRS use an income analysis that examines whether the unincorporated business owner's personal living expenses plus reported business expenses exceeds the reported income.
The IRS can use the Discriminate Index Function program to score audit potential of small closed corporations. It was updated in 2012.
A study of 2010 tax returns with corporate assets under a quarter of a million dollars is planned to assist in revising the Discriminate Index Function formulas to improve small business tax compliance.
CRA used to have 2007 publication RC4444, Making a Difference for Canadians, that explained their approach to tax administration, how they deter non-compliance and enforce legislation. However, since they have restructured their website, it seems to have gone by the wayside ... which is too bad.
So what is CRA's approach to tax administration? The publication stated that "our fundamental approach to tax administration is to enable individuals and businesses to comply with their obligations, without our direct intervention." As taxpayer non-compliance increases, so does CRA involvement.
They deter non-compliance by conducting reviews and audits.
CRA's current enforcement project, called Project Trident, targets and prosecutes individuals and companies involved in fraudulent tax schemes. You can find CRA tax alerts, leads, convictions (they name names), revoked charities, three types of fraud CRA is actively pursuing - tax preparer fraud, charity fraud and identity theft on their project page.
In 2014, CRA has proposed registration of tax preparers (the U.S. already has this already) so they can identify and help those submitting recurring errors when preparing small business returns.
... On Good Practices
If you keep your books solely for tax preparation purposes, tax experts suggest you establish this simple method to meet this requirement.
At the beginning of each calendar year, take an envelope (or file folder) and write on the front -- the year, the tax line number, and the expense name. Do this for every line you will be submitting a tax claim for.
Throughout the year, place all your corresponding business receipts in the appropriate envelope.
At the end of the year, run a tape listing every receipt for each envelope. Write the total expense for that line on the outside of the envelope. Insert the tape in theenvelope.
If you want to have access to your information in the future, you could use a program such as QuickBooks like a calculator. Then instead of running a tape listing, you would print out a report for each expense line and place it in the envelope ... just setup a bank account called cash and be sure to enter all your sales through Sales Receipt and all paid bills through the cash account using Write Cheques. You won't have a set of books prepared in accordance with GAAP or ASPE, but you should have all the information you need to file your tax return.
Keep all envelopes pertaining to one tax year together in a box. If you are audited, you've got everything you need to support your return. It's not however the best way to implement good bookkeeping practices in your business.
Find other filing organization options if you want to use your records to help you run your business too.
Earlier I laid out what I think constitutes good bookkeeping practices. Let’s look at some of the benefits to you when good bookkeeping processes are in place. I’ll follow that up with a peek at the consequences of poor bookkeeping practices.
I'm here to tell you ... ALL of the above scenarios are achievable if you have good accounting practices in place. Now ...
Many small business owners run into trouble because they do not keep adequate books and records. This can be expensive in the long term. It is for this reason that this group of taxpayer is most likely to get audited by the Canada Revenue Agency (CRA) or the Internal Revenue Service (IRS).
The CRA and IRS have developed their own databases to select returns to be audited. They will compare your tax return against known filers who have a verified history of non-compliance and against filers who have a proven history of compliance. If your return falls within the appropriate parameters, it will be flagged for an audit.
The CBC reports that in 2014, CRA will be auditing waiters/waitresses, sub-contractors and freelancers looking for unclaimed income. On their radar are:
✔ selling used cars on Craigslist
✔ day labor on construction sites
✔ home renovations subcontracted by the retail stores
✔ flipping houses
✔ driving trucks and hot shot couriers
✔ freelance articles income
“You participate in the underground economy when you fail to declare income that would generally be taxable if you reported it to the tax authorities" (Definitely not good bookkeeping! I might even go so far as to say this would definitely be an example of very bad bookkeeping practices.) ...
"When you help others to avoid paying taxes, you support the underground economy" …
"The underground economy undermines the competitiveness of businesses and individuals because it offers an unfair, illegal advantage to those who fail to comply with Canada's tax laws."
"It undermines the integrity of our tax system.”
In September 2012, Stats Can released their study of the underground economy for the years 1992 - 2009. The three most significant industries with underground activity were construction, retail trade, and accommodation and food services; accounting for 61% of the total estimate.
The information from the study will be used by CRA to further develop compliance strategies for the underground economy. See CRA newsroom> Fact Sheets> 2012> Statistics Canada Study on the Underground Economy in Canada for more information.
During the 2010-2011 reporting period, CRA performed 834 underground economy audits, resulting in $87 million taxes owing. (see source note below) It only takes one audit to change your life forever ... there is no going back ... you may want to check out the convictions posted on the CRA website where they name names for a reality check.
CRA has a voluntary disclosure program to encourage you to self-correct past returns ... or if you haven't filed past returns ... with no prosecution or penalties. You must apply before CRA has makes a demand request.
Dealing in cash thrives in the underground economy. Here is a bookkeeper's tip about cash and GST/HST. GST/HST must still be collected by registrants on cash sales. This also means that you need a receipt for expenses paid by cash if you want to claim your input tax credit.
Source: CRA website> About the CRA> Tax Alert> Special enforcement audits
If your customer wants to hire you with "cash under the table" ... read that as pay no sales tax ... take the business.
You can still be honest and prepare an accurate set of books. Having integrity let's you sleep better at night.
Good bookkeeping practices require you to make the following bookkeeping entries:
If you aren't a sales tax registrant, ignore step two and modify step three to book the entire amount to your sales account.
You can also use this method if you are asking, "What happens if I didn't know I had to collect GST/HST... now who will pay the sales tax?" You probably already know the answer to this ... but you, the business owner, pay for it. Think of it as an expensive lesson in learning the rules. If you had an experienced bookkeeper working on your books, the problem would have been diverted.
Be honest. Avoid possible criminal charges of tax evasion. Pay your fair share of income taxes (nobody likes a freeloader). Learn good bookkeeping practices.
Avoid these "deals" as the expense is NOT deductible. Why give him a business advantage and a tax break?
“It is a myth that operating in cash and failing to keep records makes you immune to taxes.
If your lifestyle is not in line with the income you report, and you cannot explain the difference, the CRA can assess taxes based on indirect or alternate methods of calculating your income.”
You can read about a recent CRA 2010 conviction in the area that I live in ... to see the consequences of tax evasion.
I think it is just a lot less work topractice good bookkeeping and keep an honest set of books ... with the added benefit that you sleep better at night.
If CRA (or IRS for that matter) ever decides, during a tax audit of your business, to do an independent verification of income on your tax return, they can look at all of your family's personal bank and credit card accounts.
A blog by Mark Feldstein, CA explains a good bookkeeping practice. He recommends that you formally record a detailed list of all the cash and cheques (even photocopy) you receive as wedding gifts. Also keep on file your guest list, wedding venue contract, and proof of your wedding date. Mr. Felstein recommends this procedure for any life event that results in large deposits such as casino winnings or lump sums from relatives.
For example, one way to audit proof yourself is to keep your source documentation (or a log) of all deposits and transfers made between family member accounts ... this is especially important if you or other family members like cash transactions.
Remember to log any cash gifts that your children received from their grandparents, aunts or uncles ... or the money from friends finally repaying amounts owed to you.
Why go to all this trouble? Under audit, CRA considers any unsupported deposits as income. You must have proof that the deposit being questioned is not income. Without proof, you will be assessed tax on the amounts in question.
It is in your best interest to always create an audit trail for these types of transactions by doing an electronic transfer of funds or writing a cheque whenever possible. This is a good bookkeeping practice too!
Also, consider starting a file (paper or electronic) for each family member that contains their bank statements, credit card statements, RRSP contributions, and investments made. It will avoid you having to pay the bank for copies during a tax audit.
Because we have a self-assessing tax system, the burden of proof lies with the taxpayer not with the CRA ... in other words, you are guilty until you can prove you are innocent. Audit trails and original, readable source documents go along way to proving this.
Source: MarkFeldstein.ca and TaxDetective.ca
As a taxpayer, you have the right to legally arrange your affairs to pay the least amount of tax but you do not have the right to illegally avoid or evade tax.
If you are suspected of tax avoidance, CRA may challenge some of your business transactions. If the suspected transactions were made solely to avoid tax and were not legitimate business transactions, the CRA can ignore them. Interest on unpaid tax balances will be assessed but no penalties will be charged.
CRA's publication IC88-2 General Anti-Avoidance Rule - Section 245 of the I.T. discusses tax avoidance and gives specific examples of what is and is not anti-avoidance.
Once you deliberately understate your taxes, you have crossed the line and committed tax evasion. Tax evasion is a criminal offense and the CRA does prosecute.
Gross negligence (making a false statement or omission on your tax return through “willful blindness”) is assessed very expensive penalties and interest charges. What is willful blindness you ask? Wikipedia describes it as willful ignorance or contrived ignorance.
At the very least, if you are disorganized in your record keeping, it is very likely you are overpaying your taxes due to missed tax deductions and lost receipts. In this case, hiring a bookkeeper to do a task you never get around to actually saves you money in the long term.
In the end, bad bookkeeping practices are very expensive and result in additional expenses and / or losses to your business. It could lead to years of financial problems, headaches and increased monitoring by CRA.
On the other hand, good bookkeeping practices can help ensure that future tax audits go smoothly.
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