Help me, Mr. Wizard!

[Openfire]

I have a return that carries an inventory of vehicles. LLC that files as a Schedule C. I have two questions that involve accounting:

1. The business had a loss last year and paid no taxes. This year the TP owes 57K to Federal. He about choked. So did I. When doing a comparison of the B.S and P & L to make sure no one had changed any numbers that I used last year on the return, I see that his accountant adjusted Retained Earnings, putting depreciation into that category. I try not to ever adjust Retained Earnings, as a bookkeeper. Maybe I need some education on this. Can anyone think of a good reason to do this? The accountant told me he meant to do this.

2. TP takes regular payroll. It is filed as a Sole Prop and not an 1120S. Is there a benefit for doing this? He deducts from PR on return, and adds back in as income.

[Burke]

A sole proprietorship is not supposed to pay himself as an employee. Does he have other employees for whom he does payroll? It sounds as if he might be deducting the self-employment taxes from the Sche C, when they would otherwise not be a deduction.

[Openfire]

Yes, he does pay other employees.

[Burke]

But he does not include himself in that group as a disregarded entity (filing Sche C.)

[BOB W]

You could have several issues. Prior year the purchased vehicles could of been expensed off instead of being kept in inventory. This year the sale of the vehicles happened with no COGS because it was already expensed in the prior year.

If that is the case, an amended return needs to be done to even out the 2 years income.

That big of a difference usually means inventory problems.

[Openfire]

Do you have any idea why the accountant would have adjusted Retained earnings instead of expensing Depreciation? I'm wondering what the purpose of this would be, and would it be appropriate for me to expense it on the return regardless?

[Openfire]

Burke, he pays himself as a regular employee. He deducts and pays SS and Medicare just like he does for the employees. So, he ends up paying both sides of Medicare and SS, and then claims the deduction and the gain in the form of a W-2. I am trying to see what purpose this might have. He ends up paying the 15.4% of SS/Medicare as an employer and an employee, writes it off then claims it again. This was all in place before I came on the scene. He was working with a CPA. I am an EA with marginal accounting skills--not up to the par of a CPA, so I am thinking I am missing something.

[geekgirldany]

Do you have any idea why the accountant would have adjusted Retained earnings instead of expensing Depreciation? I'm wondering what the purpose of this would be, and would it be appropriate for me to expense it on the return regardless?

I can tell you when I do it, it is on S-Corp returns, for Section 179 expense. This is because it flows through to the shareholder and is not on the P&L. So that it the only time I put depreciation(section 179) into retained earnings. Maybe he did the same thing??

You say he carries an inventory of vehicles, is he a used car lot or a buy not pay here car lot? As Bob said, inventory and cogs might be incorrect. He also should not be paying himself as a W-2 employee filing a Schedule C.

[Openfire]

He is not a used car lot, he sells big work trucks, as well as has a maintenance division. Believing that the Inventory has some errors, would it be acceptable for me to amend last year's return to off-set some of the losses? Would I have any risk in doing this?

[BOB W]

If inventory is the problem, it is what it is. Your client may be better off with the amended return. Their accountant may be the problem and owing 57,000 is no joke. The amended return would be MY only choice. In both cases there will be penalties and interest but in the end the total taxes will (should) be less.

Dig into the inventory issue with the accountant to see where it went wrong. Run a test amended return and a current this year return to see where total taxes end up. Reviewing last years return will be a good start and look at the COGS in particular.

[Zee]

Somethings Amiss

I’m confused by this post.

A sole-proprietor isn’t an employee of the company and cannot deduct wages he has paid to himself. They are recorded as Owner’s draws which are recorded as a debit to the capital account. I’m not sure why a sole-proprietor would choose to treat himself as an employee and issue a W2. Assuming the taxpayer is deducting the wages and payroll taxes, on Schedule C, the net impact on the tax return should be the same since he is reporting the wages as income and paying federal, state, and other taxes. This also assumes the SE tax isn’t be duplicated with a Schedule SE. This is just bad tax reporting and could raise questions on the non-inclusion of a Schedule SE. Perhaps there is a fringe benefit motivation, or long-term social security benefit increase possible by allocating wages if the spouse is also considered an employee (of course you can also deduct spouse wages).

You’ve indicated the taxpayer is in the business of selling big work trucks. As such, those trucks represent inventory which isn’t depreciable property. The cost is recorded as inventory and reported as Cost of Goods Sales when sold.

A sole-proprietorship doesn’t generally utilize a retained earnings account since they don’t pay dividends. Retained earnings are simply a part of the owner’s equity account.

It isn’t clear what you mean when you indicate, “the prior accountant adjusted Retained Earnings, putting depreciation into that category”. What accounting entry was made? Was it the entry recorded as a Debit to Retained Earnings and a Credit to Depreciation? If so, the others responding are probably correct it would appear that an error was made in the prior year and Section 179 depreciation may have been taken for inventory that shouldn’t have been depreciated.

If that’s the situation, an Amended return should be filed correcting the inventory error and any errors resulting from deducting his wages. You’ve noted the prior accountant (a CPA) made these errors? Have you talked to him? What else do the comparative financial statements show? Have you compared the depreciation schedules? If you cannot obtain satisfactory explanations to these answers, it might be best to simply decline this client.

[BOB W]

THE WAGES ARE A DONE DEAL........ NO ADJUSTMENT SHOULD BE DONE regarding owner's payroll without making a real problem for 2013 payroll reports. Going froward is another issue.... Just a note: No harm was really done, but the proceedure is wrong.

[Burke]

It sounds to me as if he is acting as a SCorp, and probably should have elected that status when applying for the LLC.

[JON]

If he

is reporting tHis W-2 on page 1 of the 1040 it should be deducted on his Schedule C. You sound like this may be a little out of your ball park. Tough to understand how you got there. Any questrions with the previous year's filing sahould be questioned by who prepared it. If client left with paying previous then get the the workpapers from the old preparer. Based on what you said - there should be a new probably substantial year end inventory, and floor plan loans to finance it - that should have been handled at the end of the year. Big maintenance departement probably means invenoty, work-in-process, supplies and equiptment. A revew of the previous year's financials and return should give you a good idea of last year's ending balance sheet which is this years beginning. Retaining earnings adjustment strange unless it was a book to tax difference, but that should be relected in the previous years return and balance sheet.

Good luck..

[BOB W]

Do you have any idea why the accountant would have adjusted Retained earnings instead of expensing Depreciation? I'm wondering what the purpose of this would be, and would it be appropriate for me to expense it on the return regardless?

For a Schedule C there is no Retained Earnings, Just a Capital Account. Operating income (or loss) and owner withdrawal get posted to the Capital Account at the end of the year while doing a turnaround to the new year. Since depreciation effects profit or loss it ends up in the capital account. Retained Earnings and Capital account serve the same function but for different types of business structures. The only difference with Retained Earnings is that it does not get posted to a corporation's Capital Account, it stands on its own as an account, with required Financial Statement reporting.