S-Corp Books

[barzillai]

Last Year I did the taxes for a friend who is the sole owner of an S-Corp. She had someone else set it up for her several years ago; however, they never told her how to keep the books. She doesn't use double entry bookkeeping; she just tracks expenses, like you would for a Sole Prop. She also paid personal expenses out of her business accounts. I was able to sort everything out, and am confident the return I prepared is accurate. I told her at the time she would need to change her bookkeeping methods. She said she was going out of business, so I let it go. Now here we are in 2008, and guess what, she is not going out of business, and she wants me to do her taxes again. With the new preparer penalties, I am thinking about telling her I will not do them unless she first pays me to do her books correctly for 2007. Am I being justifiably cautious or going overboard in trying to follow the rules? Any thoughts or experience anyone has will be appreciated.

[Golden Rocket]

Barzilli

I would hate to defend my following suggestion on the basis of accuracy or good taste (for that matter). But sometimes customers dump stuff on you that has no solution in any textbook or carefully crafted seminar question/answer session. It's what I commonly call the "real world."

The corporation, of course, requires a balance sheet, which means there has to be double-entry accountability whether the books are a double-entry system or not. I have a couple customers which give me a pile of records every year NOT in double-entry format. I tell them up front that the amount unaccountable will be charged to their drawing account. Some of the accounts have natural offsets such as prepaid insurance or accrued expenses. But the money that ends up being "unaccounted" for, debit or credit, is applied against the shareholder draw.

As you might suspect, I have never had a case where unaccountable credits exceeded debits. This means for all unaccountable money, the assumption is that the owner simply just took the money for his own personal purposes. (By the way, that is the most likely fate, truth be known) So it is charged to his drawing account.

There have been a few sobering moments with the client, that go something like this:

CLIENT: I just KNOW I didn't take $18,000 out of the company.
ROCKET: I don't dispute that. Take a couple of days, go through your
paperwork, and tell me what else you spent it on, other than
what you've already told me.
CLIENT: O.K. I just KNOW I didn't take that much money.
ROCKET: I don't dispute that. I'll give you until Thursday, and if I don't
hear from you, I will go ahead and prepare your 1120 on the basis
of what we have now.
CLIENT: I may need more time than that.
ROCKET: I understand, but today is March 2, and your return is due on
March 15.
CLIENT: How can I avoid this in the future?
ROCKET: Get a double-entry system. At some point, this distribution will
have to be paid back or else treated as a constructive dividend.

Invariably, the result is predictable. Fact is, client has most likely taken out
$18,000 in bits and pieces during the year. He may not realize he did it,
or he may really know and not want to tell me.

And next year? Same thing.

No way would I prescribe this as being good accounting, or acceptable tax
accounting, or within the scope of Cir. 230. But I have lots of clients who are
not accountants, and if they were, then they wouldn't need me. And it places
the onus square on the shoulders of the party which should bear the responsibility.

[Bees Knees]

I won't do a corporation or partnership return without a balanced set of books.

The client thus has several options:

1) Learn how to do double entry bookkeeping.
2) Hire someone to do double entry bookkeeping.
3) Hire someone else to do the tax return.

[WhiteOleander]

I could be wrong, but I thought that not keeping proper double entry books for a S-Corp was grounds for automatic termination. ?????

[Golden Rocket]

Clarification

Whoops! I can see from the responses already that I have put the wrong spin on my message.

Essentially, what happens in this cigar-box scenario, IS in fact a double-entry update to their prior year balance sheet. That's all that happens in any accounting system, no matter how sophisticated.

The taxpayer has no double-entry system, so he effectively pays me to make the necessary journal entries. The prior year balances are set up, and debit/credit entries are made to update all accounts. This is classic double-entry accounting, and, at a minimum, cash is supported by bank statements. If it were not double-entry accounting, the ending balance sheet would not balance or the retained earnings reconciliation would not balance -- or both.

Where the Gods of Accounting frown, is when I bring the balances to year-end, and then charge his drawing account for items that do not agree with year-end if the taxpayer has no other logical explanation. This includes the cash balance which has an overage because of unsupported charges to the bank statements. The taxpayer is thus penalized for his cigar-box approach - and if there is any party treated unfairly, it is he.

I would say that most CPAs doing write-up work have performed this same function in a real world environment, or a variation of same -- it's just a matter of extent. If it is very extensive, he certainly wouldn't issue an opinion on it, or a favorable audit review.

Having elaborated on this, and knowing Bees Knees as we do, he probably would still not accept a customer where this had to be done. Maybe some of the rest of you wouldn't either - that's O.K., I never claimed this methodology was anything better than rag-tag. But the party holding the bag is the party who failed to lock-down his own accounting system. The treatment is not much better than had the return been prepared by the IRS.

[Zee]

Golden Rocket - Right on. I agree.

Of course, a double-entry accounting system is the most preferable system for most businesses. However, I'm not aware of an IRS requirement that a double-entry accounting system must be used by all Corporations, or others. It's a PITA, but many clients including those operating as S-Corporations have little to offer except their bank statements, cancelled checks, and credit card information, etc. If the preparer is required to reconstruct financial statements, the client should be billed accordingly.

Is there too much risk in doing this any longer? I'm not sure. But, I wouldn't send a client packing without trying to help and educate them.

[sea-tax]

Of course, a double-entry accounting system is the most preferable system for most businesses. However, I'm not aware of an IRS requirement that a double-entry accounting system must be used by all Corporations, or others. It's a PITA, but many clients including those operating as S-Corporations have little to offer except their bank statements, cancelled checks, and credit card information, etc. If the preparer is required to reconstruct financial statements, the client should be billed accordingly.
Is there too much risk in doing this any longer? I'm not sure. But, I wouldn't send a client packing without trying to help and educate them.

Zee I could not agree more. While I think that Publicly held corps must have these types of accounting requirements , I know of no requirement for closely held companies. I would not turn a client down simply because they had a modified bookkeeping system. Double entry while ideal is not required as far as I am aware.

My only concern is that the information that is provided is accurate and complete and that I can easily make the adjusting entries as needed.

[Bees Knees]

Having elaborated on this, and knowing Bees Knees as we do, he probably would still not accept a customer where this had to be done. Maybe some of the rest of you wouldn't either - that's O.K., I never claimed this methodology was anything better than rag-tag. But the party holding the bag is the party who failed to lock-down his own accounting system. The treatment is not much better than had the return been prepared by the IRS.

Been there, done that many times.

That was covered in my #2, "Hire someone to do double entry bookkeeping."

If I'm the one that has to translate their mess into something I can use to fill out their tax return, then they have to pay for that.

That doesn't necessarily mean I have to perform a debit credit entry for every silly transaction. But they are going to pay for it, as if I had to perfomr a debit credit entry for every silly transation.

[dsi]

Without a complete financial statement, which includes a balance sheet how can one possibly determine the SH basis upon sale of the stock or dissolution of the corp?

[les grans]

Didn't the IRS stir this controversy once, already, years ago?

My impression was that - many years ago - the IRS at least poured fuel onto this fire when they eliminated the requirement for a balance sheet on page 4 of Form 1120/1120S. But I've been away from it so long .. I don't even know if that's still the case today...!! I haven't *touched* a Form 1120 in seven years!! And I konw it's seven years because today's the anniversary of my retirement!!!!!

[taxxcpa]

Balance sheet

My impression was that - many years ago - the IRS at least poured fuel onto this fire when they eliminated the requirement for a balance sheet on page 4 of Form 1120/1120S. But I've been away from it so long .. I don't even know if that's still the case today...!! I haven't *touched* a Form 1120 in seven years!! And I konw it's seven years because today's the anniversary of my retirement!!!!!

They still allow omission of balance sheets for small corporations. I generally include the balance sheet anyway even if the corp qualifies for omitting it.

[Zee]

Without a complete financial statement, which includes a balance sheet how can one possibly determine the SH basis upon sale of the stock or dissolution of the corp?

Very good question. My guess is SH Basis is very complicated and confusing to most accountants & tax preparers (including me). Calculating the basis can be almost impossible unless you can be confident in the beginning balance for each shareholder. If none is available, the only choice is to calculate the basis as best you can with the current and past financial information and tax returns available. Of course, that would require a disclosure under the new reporting rules. I don't know of any better answer, but look forward to reading the responses of others.

[Golden Rocket]

Unknown beginning balances

Much in this thread has referred to "hit and miss" accounting/reporting methods (my posts included). Whether it is the cigar-box scenario, or simply a client whose prior year records are not available, suffice it to say that we ALL have been confronted with these situations. The client is still under obligation to properly report, and SOMEONE will have to help him. This "someone" should be able to charge decent money to assuage his otherwise-benevolent spirit.

Here's one I've had many times. A client sells 675.228 shares of LongHaul mutual funds for $14,000. He bought LongHaul in 1988. He remembers putting $5000 into LongHaul at the time, but of course has no idea how many shares. Almost every year since the beginning, LongHaul has paid dividends in the form of ordinary and CG distributions, but has reinvested these dividends.

I have worked behind some tax preparers who would file a $9000 gain. But I hope most of us know better than that, as a portion (if not all) of the "gain" is attributable to reinvested dividends.

He has the last 2-3 years brokerage statements, showing activity for that length of time. He has no record of dividends, reinvestments, 1099-DIV, nothing of the sort dating back to 1988. Long story short, we don't know what the basis is. LongHaul may have such records, but will not divulge them in a timely manner.

So what do you do? Send him packing? File an extension until LongHaul furnishes records (probably the "best" option, but I've done this and you will not get satisfactory results from the institution)? Make assumptions as to what the basis was 3 years ago, then work with the last 2-3 years of investor statements?