You set up the account hierarchy for your business based on how you want to manage and control your business on a day-to-day basis. However, when it is the time to make tax payments, which is now every quarter, you need to regroup your accounts in the way IRS wants them reported. We are going to look at how to do that using the tax features of GnuCash.
- From the menu select Edit | Tax Report Options. The Income Tax Identity window will pop up. Enter the name of your business and in the Type field, select the business entity type with the matching US tax form that you file as shown in the following screenshot:
- Once you click Apply, you should be in the Income Tax Information window. In the Accounts pane, Expenses will be selected by default.
- Open the Expenses account tree to see the individual accounts. Select Professional Fees and then click on the Select Subaccounts button. All of its subaccounts will be selected. The Tax Related checkbox should be already checked by default. If not, check it.
- The TXF Categories list on the right will become enabled. Scroll down to see all the Income Tax return Form 1040 Schedule C (Profit or Loss From Business for a Sole Proprietorship) line items. Click on Sched C Legal and professional fees. In the gray box at the bottom you should see a brief description of this item as well as that this is currently line item 17 in the income tax form Schedule C as shown in the following screenshot:
Note
Many of the tax preparation software have support for a standard data format known as the Tax Exchange Format (TXF). These files have a file extension
.txf. As TXF is an accepted standard for saving tax data in financial software, most income tax preparation software will import TXF files.
- Click OK to complete the mapping of this account. Go ahead and map other accounts in the same way.
- Back in the GnuCash main window (also known as the Accounts Tree window) click on the down arrow on the column name line. Select Tax Info from the list. You should now see an additional column in the Account Tree showing the Schedule C mappings for each account as shown in the following screenshot:
How does a small business in the US calculate income tax? Someone who is totally unfamiliar with the US Internal Revenue Service (IRS) might say something like, "Well, run the Income Statement also known as the Profit & Loss (P&L) Statement, attach it to your tax return, and pay tax on whatever is the net income for the year." Someone like a Martian who just landed on earth. A Martian who is looking for trouble.
Note
We are not giving you tax advice. We are trying to get you up to speed with using GnuCash for your business accounting. The examples we provide are intended to be illustrative. Regarding what type of business entity is suitable for your business, which form and schedules to use for your tax returns, and what specific items will go into which line item in the schedule, you should seek the advice of an accountant or a tax consultant.
This brings us to a point where we cannot help but say something in defense of the IRS. Ok, give us a minute while we work up the nerve to say it to this group of small business owners. Most of you use part of your home for business purposes. Most of you use your personal cars and trucks for business purposes. Some of you may not even have a separate bank account or a separate credit card for your business. What is Travel and Entertainment expense for one may be Sales Promotion expense for another and Business Development expense for a third. So, how are the good people at the IRS supposed to figure out what is the true revenue, expenses, and taxable income of any small business?
The answer to that question is Schedule C. To avoid wading through all these different terms, and assessing taxes of all businesses in an equitable manner, IRS has standardized things. Every business is required to report their income, expenses, cost of goods sold, vehicle expenses, and other expenses in Schedule C of Form 1040. This is for sole owner businesses. Partnerships and Corporations are required to use other standard forms with their own schedules.
As a civic minded citizen, I know you are as anxious to pay your fair share of taxes as the next person. In turn, of course, you are equally demanding when it comes to the delivery of services from your government. On the other hand, you want to make sure that you are not overpaying taxes either.
Note
Don't leave out any income and expense accounts unmapped
It is in your best interest to make sure that none of the expense accounts are left unmapped to Schedule C, unless you have a specific reason for doing so, such as claiming a mileage rate instead of reporting car expenses. If you do, you will unnecessarily leave out on legitimate business expenses and over-report income and pay higher taxes on it. On the other hand, the IRS doesn't want you to leave out any income account either. So, make sure that you map all of your income and expense accounts to Schedule C.
Good bookkeeping and maintaining source documents such as receipts and vehicle logs will help you to account for business expenses and make sure that you are not overpaying taxes.
- Partnerships file income tax returns using which form to IRS?
a. 1065
b. 1120
c. 1120S
d. 1040
- What is the format of the file suitable for importing into tax preparation software?
a. TXT
b. TFX
c. TXF
d. TAX