You may have heard a bookkeeper or accountant say that your business should have “tax-ready books.”
But what does that actually mean?
Does it mean everything has been entered into QuickBooks?
Does it mean your bank feed is empty?
Does it mean you can print a Profit and Loss Statement?
Tax-ready books are financial records that have been properly recorded, reconciled, reviewed, and organized so your tax professional can use them as a reliable starting point for preparing your tax return.
That doesn’t mean your books and your tax return will be identical. Your tax professional may still need to make tax-specific adjustments.
But they should not have to reconstruct your bookkeeping before they can begin preparing your return.
Tax-Ready Starts With Complete Books
The first requirement is fairly simple: the year’s financial activity needs to be recorded.
That includes more than the transactions that happened to download through your bank feed.
Depending on your business, your books may need to include:
- Bank transactions
- Credit card transactions
- Customer invoices and payments
- Vendor bills and payments
- Payroll
- Sales tax
- Loan activity
- Equipment and other asset purchases
- Owner contributions and distributions
- Business expenses paid personally by an owner
- Merchant processor activity
- Other business income and expenses
If significant activity is missing, the books are not ready for tax preparation.
Bank Accounts Should Be Reconciled
This is one of the most important parts of getting books tax-ready.
Every business bank account should be reconciled through the end of the year.
Reconciliation compares the transactions recorded in your accounting system with the actual bank statement.
It can help identify:
- Missing transactions
- Duplicate transactions
- Incorrect amounts
- Old outstanding checks
- Old outstanding deposits
- Bank fees that were not recorded
- Interest that was not recorded
- Transactions posted to the wrong account
And remember: a connected bank feed is not the same thing as a bank reconciliation.
Having no transactions waiting in the QuickBooks bank feed does not prove that your books are accurate.
Credit Card Accounts Should Be Reconciled, Too
Business credit cards should also be reconciled to the actual credit card statements.
This is an area that is sometimes overlooked.
A credit card account may contain:
- Missing charges
- Duplicate transactions
- Credits
- Refunds
- Interest
- Fees
- Payments recorded incorrectly
The ending balance in QuickBooks should be supported by the credit card statement.
The Balance Sheet Should Be Reviewed
If someone is trying to determine whether books are tax-ready, I don’t look only at the Profit and Loss Statement. In fact, I usually start with the balance sheet.
Many bookkeeping problems show up on the balance sheet.
Accounts that may need to be reviewed include:
- Bank accounts
- Accounts Receivable
- Accounts Payable
- Credit cards
- Loans
- Fixed assets
- Payroll liabilities
- Sales tax liabilities
- Undeposited Funds
- Owner or shareholder equity accounts
- Other assets and liabilities
Every Balance Sheet account should have a reason for the balance that is there.
A strange balance does not automatically mean something is wrong, but it should be explainable. And every line item on the balance sheet should agree to a source document. The loan balance should agree to the loan statement. Checking should agree to the checking account bank statement. Fixed assets should agree to the fixed asset listing used for depreciation expense. Payroll liabilities should agree to payroll reports filed with the IRS and the client’s state agencies.
Accounts Receivable Should Make Sense
If your business uses Accounts Receivable, the year-end balance should represent money customers owe you.
That means reviewing the Accounts Receivable Aging Report.
Are there invoices that were actually paid but still show as outstanding?
Are there duplicate invoices?
Are there old balances that are no longer collectible?
Were customer payments recorded but not properly applied to invoices? This usually means duplicated income that you will pay income tax on if it is not corrected!
Your tax professional may need to know about these balances, particularly depending on your method of accounting.
An Accounts Receivable report containing years of inaccurate balances is not only inaccurate, it is not useful.
Accounts Payable Should Make Sense
The same applies to Accounts Payable.
The year-end Accounts Payable balance should represent legitimate amounts the business owes vendors.
Old bills may need to be investigated.
Perhaps they were paid but the payment was recorded incorrectly.
Maybe a bill was entered twice.
Maybe vendor credit was never applied.
Or perhaps the business really does still owe the money.
The important thing is knowing which is true.
Undeposited Funds Should Be Reviewed
Undeposited Funds deserves special attention in QuickBooks.
This account is designed to temporarily hold customer payments until they are included in the deposit that reaches the bank. Think of this as the cash drawer in a business. Payments are held here as received during the day from your customers. When you make a bank deposit, you collect the checks and cash, fill out a deposit slip and transfer the funds from the drawer to the bank account.
Undeposited funds accounts is your cash drawer. You collect customer payments there and as you make bank deposits, you transfer the customer payments from undeposited funds to the bank account on the books.
When used incorrectly, it can accumulate old transactions and sometimes contribute to duplicate income.
A large or old balance in Undeposited Funds should be investigated before the books are considered tax-ready.
Loans Should Agree With Supporting Records
If the Balance Sheet says the business owes $72,000 on a loan, there should be support for that balance.
Loan payments frequently include both principal and interest.
The principal portion reduces the liability on the Balance Sheet.
The interest portion is generally recorded as an expense.
Recording the entire payment as an expense can understate the loan balance and overstate expenses.
Year-end loan statements or amortization information may be needed to verify balances and properly record activity.
Payroll Should Agree With Payroll Records
If you have employees, the payroll recorded in your accounting system should be consistent with your payroll records.
Your bookkeeper may need to compare QuickBooks with payroll reports and review accounts such as:
- Wages
- Employer payroll taxes
- Payroll liabilities
- Employee benefits
- Payroll clearing accounts
Differences should be investigated.
This becomes especially important at year-end when Forms W-2 and payroll tax returns are also reporting payroll information.
Your Tax Entity Type Should Be Reflected in the Books
Tax-ready books also require an understanding of how your business is taxed.
Simply knowing that a business is an LLC is not enough.
An LLC may be taxed as a:
- Sole proprietorship
- Partnership
- S corporation
- C corporation
The tax classification can affect how owner-related transactions should be recorded.
For example: an S corporation shareholder who performs services for the corporation needs to receive reasonable compensation through payroll.
A partner in a partnership, on the other hand, is not an employee of the partnership and should not receive a W-2 for services performed as a partner. Depending on the circumstances, payments for services may be treated as guaranteed payments.
There may also be special treatment for items such as health insurance and certain other benefits provided to a more-than-2% S corporation shareholder.
Other owner transactions may need to be distinguished between:
- Wages
- Draws
- Distributions
- Guaranteed payments
- Contributions
- Loans to or from the business
- Reimbursements
- Benefits
These distinctions can affect both the financial statements and the tax return.
Your bookkeeper should understand enough about your entity type to record routine transactions appropriately and recognize when something needs to be discussed with your tax professional.
Fixed Asset Purchases Should Be Identified
Did your business purchase a vehicle this year? A piece of equipment? Machinery? Furniture? Computers? A building?
Major purchases should be identified and recorded appropriately rather than automatically buried in an expense account.
Your tax professional can then determine the appropriate tax treatment, including whether an item should be depreciated or qualifies for a particular tax deduction.
Your bookkeeper does not necessarily make those tax decisions. But your tax preparer needs to be able to find the purchases. Your bookkeeper can inform your tax preparer throughout the year about changes to your fixed assets to help the tax preparer with tax planning as well.
Personal and Business Activity Should Be Properly Separated
Personal transactions sometimes make their way through business accounts.
That does not make them business expenses.
Before the books are considered tax-ready, personal expenditures paid by the business should be identified and recorded appropriately.
Likewise, if an owner personally paid a legitimate business expense, that transaction may need to be recorded in the business’s books.
The goal is to make sure the Profit and Loss Statement reflects the business’s income and expenses.
Uncategorized Transactions Should Be Resolved
Accounts such as:
- Uncategorized Income
- Uncategorized Expense
- Ask My Accountant
can be useful temporary holding places while questions are being resolved.
They should not become permanent storage.
Before sending your books to your tax professional, all transactions sitting in these accounts should be researched and properly classified.
If a question truly requires the tax professional’s input, your bookkeeper can contact them for guidance before sending the books to them. The tax preparer can either identify how to categorize it now or tell the bookkeeper to clearly mark the expense for them to review when they do the tax return.
That is much different from handing over hundreds of transactions that no one has reviewed.
The Profit and Loss Statement Should Be Reviewed for Reasonableness
Once the underlying accounts have been reconciled and reviewed, it is time to look at the Profit and Loss Statement.
Ask questions such as:
- Does revenue seem reasonable?
- Are there unusual income accounts?
- Are any expenses significantly higher or lower than expected?
- Are there negative expense balances that need explanation?
- Are personal expenses included?
- Are there large transactions that may actually be asset purchases?
- Are there duplicate accounts for the same type of expense?
- Does gross profit make sense compared with prior periods?
This is where bookkeeping becomes more than data entry.
Sometimes a number is technically recorded in QuickBooks but still does not make sense.
Someone needs to notice.
Supporting Documents Should Be Available
Tax-ready does not mean your tax preparer will never ask another question.
They probably will.
But supporting information should be reasonably organized and available.
Depending on your business, your bookkeeper should supply the following information to your tax professional:
- Year-end bank statements
- Loan statements
- Vehicle purchase information
- Equipment invoices
- Closing statements
- Payroll reports
- Forms 1099 (both received and sent out)
- Accounts Receivable and Accounts Payable reports
- Health insurance information
- Owner contribution or distribution information
- Prior-year information
- Other tax documents
Good bookkeeping makes these conversations much easier.
What Tax-Ready Does NOT Mean
Tax-ready books do not necessarily mean that every tax adjustment has already been recorded.
Your tax professional may still need to address items such as:
- Depreciation
- Amortization
- Tax-specific elections
- Meals limitations
- Nondeductible expenses (they should all be grouped together on the Profit and Loss report so the tax professional doesn’t have to adjust them on the books)
- Tax basis considerations
- Certain fringe benefits
- Year-end adjusting entries
- Other tax-specific issues
That is normal.
There is a difference between bookkeeping adjustments and tax adjustments.
The goal of tax-ready bookkeeping is to give your tax professional reliable accounting records so they can focus on preparing and advising on the tax return, not spend their time doing a year’s worth of bookkeeping first.
Why Do Tax-Ready Books Matter?
Tax-ready books can make tax season easier for everyone involved.
Your tax professional receives cleaner information. You spend less time answering questions about transactions from months ago. There is less scrambling to find missing information. Problems can be identified earlier. And perhaps most importantly, you have better financial information throughout the year.
Because tax-ready books are not just about taxes.
The same work that makes your books useful at tax time also makes them more useful for running your business and making better business decisions on a daily basis.
Reconciled bank accounts matter in July just as much as they matter in January.
Accurate Accounts Receivable matters when you are managing cash flow.
Correct loan balances matter when you are talking with a lender.
Reliable financial statements matter when you are deciding whether you can afford another employee, piece of equipment, or expansion.
You should not maintain good books simply because the IRS requires a tax return.
You should maintain good books because you own a business and need to make good business decisions.
A Simple Tax-Ready Books Checklist
Before your books go to your tax professional, you should ideally be able to say:
✓ All significant financial activity for the year has been recorded.
✓ Bank accounts are reconciled through year-end.
✓ Credit card accounts are reconciled through year-end.
✓ Accounts Receivable has been reviewed.
✓ Accounts Payable has been reviewed.
✓ Undeposited Funds has been reviewed.
✓ Loan balances have been reviewed against supporting records.
✓ Payroll accounts have been reviewed.
✓ Sales tax liabilities have been reviewed, when applicable.
✓ Uncategorized transactions have been resolved.
✓ Fixed asset purchases have been identified.
✓ Owner transactions have been recorded according to the business’s entity type.
✓ Balance Sheet accounts have been reviewed for unusual or unexplained balances.
✓ The Profit and Loss Statement has been reviewed for reasonableness.
✓ Supporting documents are organized and available.
✓ Questions requiring the tax professional’s input have been identified.
If you cannot check every box, don’t panic.
It simply gives you a place to start.
“My Tax Preparer Has Always Fixed My Books at Tax Time.”
This is something I hear from business owners fairly often.
You may send your QuickBooks reports to your tax preparer at the end of the year, answer some questions, and receive adjusting journal entries to enter into QuickBooks.
After those entries are made, the financial statements may agree with the numbers your tax preparer used to prepare the tax return.
But there is an important distinction: making year-end adjusting journal entries is not necessarily the same thing as fixing your bookkeeping.
A Journal Entry Can Correct a Balance Without Correcting the Transactions
Tax preparers commonly use journal entries to make year-end adjustments.
That is completely normal.
Journal entries may be appropriate for things such as:
- Depreciation
- Amortization
- Certain tax adjustments
- Reclassifications
- Accrued expenses
- Prepaid expenses
- Owner or shareholder accounts
- Loan balance adjustments
- Other year-end accounting and tax adjustments
But sometimes journal entries are also used to adjust account balances when the underlying bookkeeping has not been maintained correctly.
For example, suppose QuickBooks says a loan balance is $45,000 at year-end, but the lender’s statement says the actual principal balance is $38,000.
A year-end journal entry could adjust the loan account by $7,000.
The Balance Sheet may now show the correct $38,000 balance.
But that journal entry does not necessarily tell us why the account was wrong in the first place.
Were loan payments recorded entirely as expenses instead of being divided between principal and interest? Were payments duplicated? Were some payments missing? Was the original loan recorded incorrectly?
The journal entry fixes the ending balance.
It may not fix the transactions that created the incorrect balance.
The Same Problem Can Happen With Other Accounts
Imagine that Accounts Receivable contains old customer invoices that were actually paid two years ago.
A journal entry might be used to adjust the Accounts Receivable balance for tax purposes.
But the old invoices may still be sitting in the customer records.
Your Accounts Receivable Aging Report may still be wrong.
Or perhaps Undeposited Funds contains years of old customer payments.
A journal entry might adjust the general ledger balance, but it does not necessarily correct how those individual customer payments and deposits were recorded.
The same issue can occur with:
- Accounts Payable
- Credit cards
- Payroll liabilities
- Sales tax liabilities
- Loans
- Fixed assets
- Owner equity accounts
- Customer balances
- Vendor balances
- Undeposited Funds
Sometimes the appropriate solution is a journal entry.
More often than not, however, the better bookkeeping solution is to go back to the underlying transactions and determine what actually happened.
Why Does That Matter?
Because you use QuickBooks for more than preparing a tax return.
Suppose your tax preparer makes a journal entry that gets the total Accounts Receivable balance correct.
That’s helpful for the financial statements and tax return.
But if the individual customer transactions were never corrected, your Accounts Receivable Aging Report may still tell you that customers owe money they don’t actually owe.
That’s a problem if you use that report to manage collections.
The same is true with Accounts Payable.
A journal entry might correct the total liability on the Balance Sheet, but your vendor reports could still contain bills that were actually paid months ago.
A journal entry can make a financial statement balance correct without making all of the supporting detail correct.
And that supporting detail matters when you are actually using QuickBooks to run your business.
Tax Preparation and Bookkeeping Have Different Goals
Your tax preparer’s primary responsibility during tax season is to prepare an accurate tax return based on the information available.
They may not have been hired to go back through twelve months of individual QuickBooks transactions and determine exactly how every bookkeeping error occurred.
That could require reviewing:
- Bank statements
- Credit card statements
- Customer payments
- Deposits
- Vendor bills
- Loan statements
- Payroll reports
- Prior reconciliations
- Individual transactions
That is bookkeeping cleanup work.
Your tax preparer may identify that an account balance is wrong and make the adjustment necessary for tax reporting.
A bookkeeper doing cleanup work may instead ask: why is this account wrong, and what needs to be corrected in QuickBooks so it stays right going forward?
Those are related—but different—jobs.
Tax Adjustments Are Still an Important Part of the Process
None of this means your tax preparer should not make adjusting journal entries. They absolutely should when appropriate.
There are many year-end adjustments that belong in the accounting records and are most appropriately determined by your CPA or tax professional.
Your bookkeeper should record those adjustments when they are provided and make sure the books agree with the final tax information.
The distinction is simply this: a tax adjustment is not automatically a bookkeeping cleanup.
If your books contain problems at the transaction level, those problems may need to be corrected at the transaction level rather than covered up with a journal entry.
Why Tax-Ready Books Make a Difference
When your books are properly maintained throughout the year, your tax preparer can focus on the work you actually need them to do.
Instead of spending time trying to figure out: “Why is this account $17,000 off?” they can focus on questions such as:
“What is the appropriate tax treatment of this transaction?”
“What depreciation method should we use?”
“Are there tax elections we should consider?”
“Are there planning opportunities for this business owner?”
That is a much better use of your tax professional’s expertise.
Good bookkeeping gets the accounting records ready. Your tax professional takes it from there.
What If My Books Aren’t Tax-Ready?
Don’t be embarrassed. Maybe you are six months behind. Maybe nothing has been reconciled. Maybe you have been accepting everything QuickBooks suggests because you were not sure what else to do.
Maybe your previous bookkeeper left. Maybe your business grew and the bookkeeping became more complicated than you expected. Maybe you have no idea whether your books are right.
That’s okay.
You don’t need to know what’s wrong before asking for help.
And you certainly don’t need to clean everything up before calling a bookkeeper. That is what cleanup and catch-up bookkeeping is for.
The important thing is to start.
Bank statements can be gathered. Accounts can be reconciled. Balances can be investigated. Transactions can be corrected. Questions can be answered.
And your books can move from something you are worried about to something you can rely on.
Need Help Getting Your Books Tax-Ready?
At Melton Bookkeeping & Accounting Services, my goal is not simply to get transactions entered into QuickBooks.
I want the financial records to be accurate, organized, and tax-ready.
That means reconciling accounts, reviewing the Balance Sheet, investigating unusual balances, asking questions when something doesn’t make sense, and helping make sure your tax professional receives reliable financial information at year-end.
I am also happy to work directly with your CPA or tax preparer so that bookkeeping and tax preparation work together instead of operating as two separate processes. I have been a licensed CPA in the state of Missouri since 2003. I have been preparing business tax returns since 2001. I know what your CPA or tax preparer needs and I speak their language.
And if your books are already behind, don’t wait because you are embarrassed about their condition.
You don’t have to get your books ready before you call me. That’s where I come in.
If you are looking for help with ongoing bookkeeping, cleanup and catch-up work, or getting your QuickBooks records tax-ready, call Melton Bookkeeping & Accounting Services at 417-630-0057.
