A Preferred Tax Rate

There is much said and written in the news about the long-term capital gains rate, that it is preferential and biased toward the uber wealthy. That is a political and philosophical call, but I would point out it is also preferential toward plain folk too, but only if you own and sell a capital asset for a gain. If you have recently sold or are contemplating the sale of property and expect to realize a gain, to determine if you might qualify for a lower and preferential tax rate on the sale of your property, you first need to understand what a capital asset is, the way you calculate the gain, and when it qualifies as long-term. First let’s understand what is meant by the sale of a “capital asset.”

Tax law doesn’t define what a capital asset is, it defines what it isn’t. The Internal Revenue Code states, “…the term “capital asset” means property held by the taxpayer (whether or not connected with his trade or business), but does not include—“

Here is a short list of what is not considered a capital asset.

  • Inventory or property primarily for sale to customers in the ordinary course of a trade or business;
  • Property used in a trade or business that can be depreciated. This is generally personal property like automobiles, office furniture, equipment and real estate;
  • A copyright, a literary, musical, or artistic composition, a letter or memorandum, or similar property that the taxpayer’s personal efforts created;
  • Accounts or notes receivable acquired in the ordinary course of a trade or business for services;
  • Any commodities derivative financial instrument held by a commodities derivatives dealer (with some exceptions);
  • Certain hedging transactions;
  • Supplies used or consumed by the taxpayer in the ordinary course of a trade or business of the taxpayer.

If it’s not listed above, then there is a good chance your property is a capital asset. However, I modified and shortened the list and therefore, when in doubt, you should do your own due diligence or ask a CPA if your property might qualify as a capital asset.

Keep in mind that to qualify for a preferred long-term capital gain rate, there are a few more rules where compliance is required. Next I will discuss the rules you need to know to correctly calculate your capital gain…or loss.

T. David

Why Journal Entries are a Bad Idea

You should never use journal entries!

In QuickBooks, everything is transaction based. Meaning, there are two sides to every transaction. When you write a check, you post that check to an expense. The other side of that transaction shows it coming out of your bank account. When you use journal entries to enter these expenses, you lose some of the detail that goes along with a transaction and the ability for some reporting features. For instance, was this check to pay a bill? Maybe it’s a customer refund?

Without good documentation, we as accountants are not sure of the nature of the entry. That’s why you should leave the journal entries to the professionals.

That being said, there are some exceptions to the rule. There are times when we will provide you a list of journal entries to make. We would appreciate if you actually make these entries into your books. If you are uncertain, call us! Depreciation is an example of an entry we would ask you to do a journal entry for. This is a unique item that does not have a natural transaction. Other times might be after the tax return is complete. We need your ending balance to match the tax return. If you fail to enter the entries into your software, then your balance sheet will show incorrect figures.



The Accounting Cycle

I was browsing an accounting book a while back and came across the description and a diagram of “the accounting cycle.” Having started my CPA career in the “old days”, I could understand the cycle part of the term. Accounting really had a cycle of steps that went like this:

Step 1: Create source document. A source document was and still is your basic invoice, check, receipt, etc.

Step 2: You would take the source document and analyze the transaction then determine where to record the specific transaction. It might be the cash journal or the purchases journal depending on the transaction. Whatever the transaction represented, it was recorded by a bookkeeper using pen and paper with a calculator and eraser within arm’s reach.

Step 3: Record the transaction in a journal. A journal was a specific type of book with lined pages and several columns across the pages where you would record every transaction, generally in date order, then at the end of the month, add all the numerical entries and summarize the totals of each column, and “balance the totals.” This was the start of a monthly ritual, a cycle, of “closing the books.” Steps 4 through 7 below is the process known as closing the books.

Accounting Ledger

Step 4: Next the summary totals of each journal were entered into another book with paper sheets with printed lines and columns called a general ledger. Normally each page of the general ledger was “indexed” with an account number where the summary total for each category of columns in the different journals were posted at the end of each month. The indexed accounts were titled to represent either an asset, liability, equity, income or expense account such as “sales”, “cost of goods sold” or “rent expense.” The general ledger was then balanced to make sure the debits equaled the credits.

Step 5: The bookkeeper would then take the general ledger totals and prepare a “trial balance”. The trial balance was the beginning stages of the preparation for the monthly or annual financial statement. However, there was generally one more step needed before the bookkeeper would use trial balance to prepare the balance sheet and income statement.

Step 6: Before a financial statement could be prepared, certain final items needed to be recorded or transactions reclassified. These adjustments were made by preparing final “adjusting journal entries”. These adjusting journal entries would be necessary to record accounting entries like depreciation of assets. The bookkeeper would then balance the trial balance to make sure the debits equaled the credits. Bookkeeping took quite a lot of balancing at the end of each month.

Step 7: Finally the bookkeeper would prepare a financial statement so the owners and managers knew how much profit or loss the business generated the previous month.

The above described the accounting cycle using a manual bookkeeping system.

Today, with computers and accounting software, this is the equivalent of the accounting cycle.

Step 1: Create the transaction document in QuickBooks.

Step 2: Immediately print financial statement on demand.

That describes what most people believe the accounting cycle is today when using computers. How wrong they are! But that is why inaccurate financial statements and accounting records proliferate the business environment.

Although computers and accounting software have eliminated, or at least compressed the mechanics of creating a source document (like a check or invoice) and simultaneously posting that transaction through the system to a financial statement format, it did not remove the need for training in bookkeeping or accounting to produce accurate accounting records. The accounting cycle in the computer age still requires training to correctly analyze the business transaction and the understanding of how financial statements are created and the why of adjusting journal entries. Without this knowledge and understanding and skill, bad business decisions are made and loans are denied and business value is decimated.

If you don’t understand bookkeeping, or if your bookkeeper doesn’t understand bookkeeping, you need help. There is a lot more to preparing useful and accurate financial statements backed by a well-organized and correct set of books than installing QuickBooks or some other accounting software on your computer. That belief really is a myth.