Tax Season Helper: 4 Overlooked Areas to Review

Most small business owners overlook how deferred revenue and prepaid expenses should be handled, yet they can significantly impact taxable income if not properly accounted for.

Why It’s Important:

• Accurate Revenue Recognition: Deferred revenue (money received for goods or services not yet delivered) must be properly allocated to the period when it’s earned, not when it’s received.

• Expense Matching: Prepaid expenses, such as annual software subscriptions or insurance premiums, should be amortized over the coverage period, ensuring they’re matched to the correct fiscal year.

What to Look For:

• Deferred Revenue Balances: Ensure they’re not prematurely recognized as income. For example, service retainers should remain in deferred revenue until the service is provided.

• Expense Amortization: Review prepaid expenses to confirm proper allocation across months. Look for any lump-sum entries that should be spread over multiple periods.

Pro Tip:

If clients routinely mismanage deferred revenue, set up automated rules in their accounting software to track these balances accurately.

2. Fixed Asset Register and Depreciation Schedules

Fixed assets like equipment, vehicles, and property are often neglected until year-end, when depreciation is hastily applied. This can lead to missed deductions or inaccurate reporting.

Why It’s Important:

• Maximized Deductions: Depreciation schedules help allocate the cost of assets over their useful life, ensuring clients take all eligible deductions.

• Accurate Asset Tracking: A clean fixed asset register ensures businesses aren’t depreciating disposed assets or underreporting their net worth.

What to Look For:

• Unrecorded Disposals: Ensure assets no longer in use are removed from the register, along with their associated depreciation.

• Improperly Classified Assets: Verify that assets are correctly categorized (e.g., equipment vs. leasehold improvements) to apply the appropriate depreciation method.

• Bonus Depreciation or Section 179: Evaluate whether clients are eligible to accelerate depreciation for specific assets.

Pro Tip:

Conduct a physical asset audit with your clients annually. This not only ensures accuracy but also helps them make strategic decisions about replacing outdated equipment.

3. Owner Draws and Contributions

For businesses structured as partnerships, LLCs, or sole proprietorships, owner draws and contributions are common but frequently mishandled in the books. Misclassification of these transactions can create confusion when determining taxable income.

Why It’s Important:

• Avoid Taxable Income Misstatements: Owner draws are not deductible expenses, and contributions are not taxable income, yet they often get recorded as such by mistake.

• Clean Equity Accounts: Properly tracking these transactions ensures equity accounts reflect the correct balance for tax filings and financial analysis.

What to Look For:

• Misclassified Transactions: Check for draws recorded as wages or contributions recorded as revenue.

• Loans to/from Owners: Ensure any loans are documented with formal agreements and properly recorded to avoid IRS scrutiny.

• Equity Tracking: Confirm the equity section accurately reflects owner contributions, retained earnings, and distributions.

Pro Tip:

If clients regularly struggle with these distinctions, suggest creating specific accounts in their chart of accounts labeled clearly as “Owner Draws” and “Owner Contributions.”

4. Unrecorded Liabilities and Contingent Liabilities

While accounts payable tracks current liabilities, many businesses fail to account for unrecorded or contingent liabilities, which can lead to incomplete financial reporting and tax complications.

Why It’s Important:

• Compliance with Accrual Accounting: Businesses using accrual accounting must record liabilities when incurred, not when paid. Missing these liabilities distorts financial statements.

• Tax Timing: Properly recording liabilities ensures expenses are deducted in the correct year, particularly for large, infrequent costs like legal fees or bonuses.

What to Look For:

• Unrecorded Obligations: Check for pending bills, warranties, or customer refunds that should be accrued but aren’t reflected in the books.

• Contingent Liabilities: Identify potential liabilities (e.g., pending lawsuits or performance guarantees) that need disclosure or accrual under certain conditions.

• Year-End Accruals: Scrutinize year-end activities for liabilities incurred but not yet invoiced, such as employee bonuses or utility bills.

Pro Tip:

Work with clients to establish a liability review process at least quarterly. This habit reduces surprises at year-end and ensures financial statements remain accurate.