Tax Planning/2012 Taxes - CPA did not communicate
I own a small business with my business partner, we are in the contracting business. 2012 was an extremely good year for us, and our company grew by 3 times gross revenue and profits. My issue is our CPA who handles all our bookkeeping and financial reports did not sit down with us and explain to us that if we didn't make some capital purchases we would be paying a lot of personal tax money, we own an LLC. He told us we had a good year and if we needed to buy a few things then we should do that. Historically both of us have paid on average $5k-$8k in taxes personally each year, so we were assuming we'd pay a little more than that this year. Well he just sent us our approximate owed to the IRS and it's $120,000 + $25,000 to the state. Is there something we can do to fix this? Do we have grounds to sue him for not providing us good tax information/knowledge?
I hope you are ready for some frank talk.
No, your CPA has no liability.
And a qualified No on can you fix this. (Discussed at the end)
No, your CPA has no liability. He did as the accounting industry expects. He applied the math to the numbers that you gave him. If you had known more (like you had a lot of personal deductions that you had applied to the first money you earned which reduced your taxes a lot, but you don’t get to apply them to new money, so, the new taxes are going to be a LOT higher; or doubling income doesn't just double the taxes); if you were prepared to manage your taxes, when he gave you a thumbs up on being more successful you might have realized how important that was and tried to direct the conversation to “so what does that mean Tax wise”? But don't expect your accountant, to recommend good business decisions for you. He’s barely in business himself and hasn't made such great decisions on his side. Decision making and remaining informed are the business owners responsibility, you have to manage it.
Here are the realities:
1. The Tax preparer is not in a position to help you reduce taxes.
As the tax preparer, they only get to do the math on the information that you give them. Look at your return, see where the preparer sign? Does it say that he is responsible? Now look where you sign. What does it say? “That you know it is true and correct and that you are responsible”. The accounting information is given to your tax preparer AFTER the year end. It is too late by the time the tax preparer gets the info. Even if they are your bookkeeper, and you would argue that they should have known this next one is the killer for any hope that your CPA can do you some good.
2. CPA's are legally barred from informing you of your tax liabilities prior to the end of the tax year. That is a criminal act. Things changed but most people aren't aware of the change. Up into the 1970's it was common practice for your CPA to create a "Preliminary Tax Return"; maybe in October or November before the year end. This would outline projected possible taxes and give the business owner an opportunity to "adjust". I believe it was in the late 70's that the IRS made it ILLEGAL for a Professional to help someone reduce their tax liability, specifically preparing a preliminary tax return. Now, just to be clear, it is NOT illegal for you to reduce your tax liability. It is illegal for the professional to do it. The penalty comes down on the tax professional.
So do you have a case against him? No. Even if you thought you did, he's the lowest paid of all the professions, what do you think the chances are that you could collect even if you could win? When did you think he actually had a vested interest in your business success? His interest is solely keeping you as a paying client while expending as little effort on your behalf as possible. I'm guessing he isn't keeping you as a client after this year, but at least he didn't spend hours, weeks or months, actually thinking about how to help you when you weren't paying him for it (in his mind).
Welcome to being a business owner. This is but one of the many responsibilities that are now on your shoulders. The sooner you realize that your role is no longer contractor, that your new role is now business owner, and as business owner you have ALL of the responsibilities of management.
Let me just quote from TheBusinessDesigners.com:
Everybody’s Core Business is wonderfully UNIQUE. But each has many things in common, that is the Business Behind the Business, these are the same for everybody and that is where the problems come. Your business behind the business includes:
Bookkeeping and Accounting Management
Cash Flow Management,
Customer Relationship Management
Human Resources Management
Product Development Management
Investment Management, Asset Management, Time Management, resource management, people management. . .
Note that each of these includes the word “Management”. It is the management that is the responsibility of the business owner and cannot be passed off. Without management each is simply a runaway operation. Bookkeeping and accounting is an operation, Cash flow is an operation, Litigation is an operation. . . Without management, any one of these operations can wipe your business out. We develop your management skills.
The diversity of management responsibility grows as your business grows every day.
In this instance it is the tax management that is your downfall. If you had been prepared to know:
How to find a good tax preparer;
and how to communicate with your tax preparer, and;
how taxes affect your business;
you would have more effectively used his expertise. But he was just an employee, it is your responsibility to tease that out of your employee. Welcome to business ownership.
As a contractor, if you hired someone to pound nails you could quickly determine if their ability was at a usable and acceptable level. Because YOU know pounding nails you judge and analyze their work. If you don't know accounting but you hire someone to do it. . . with no standards and no oversight. . . that accountant will fail to do a good job, everyone needs standards, oversight, and continuous review to make sure that they continue to perform.
From our experience the difference between a business that succeeds long term and those that crash and burn before or after they show profitability, is: whether they realize, accept and perform these roles, or they ignore or avoid them.
So if you were thinking your business was big enough to need another employee (any employee), then the first employee you should hire is someone to do the job you know how to do. So that you can learn more jobs. Once you know the next job, then you can hire someone to fill that, and the next, and the next. . .
That is the frank talk that business owners need to hear.
The numbers that you stated, are enough to crush most businesses. While they cash flowed better, they also invested more back into the business. Those "investments" (tools, trucks, buildings, etc.) are after tax investments. I can imagine that you may not have $150,000 sitting in a bank account ready and waiting to pay the taxes. Most business owners don't, they spent (the IRS considers it “Invested”) that money on things to keep the business going. And now, they realize that they couldn't afford quite so much. But the money is gone.
You are in a tough situation, so let me just explain a little more. If you don't have the money already, it will be very hard (read: functionally impossible) to pay off that old tax debt out of new business income. Let's say that for illustrative purposes you are in a 50% total tax bracket (social security 12.4%, medicare2.9%, and federal and state income taxes 28% and 6.7%). Then your net taxable revenues last year would have been $290,000. IF you earn another $290,000 next year, and pay the taxes, you will have just enough after the taxes are paid to pay last year’s taxes.
That means 100% of your income from 2013 will be used up paying 2012 taxes. No money to pay you, payments on the new truck, no money to pay for equipment, no money to pay for permitting or licensing, or any contingency problems. If taxes are only 40% then it will take 80% of next year’s money to pay last years taxes.
So far, I haven't said anything that will make you feel any better, in fact you may be swearing at me right now because these are not things you wanted to hear. Let me try to make amends. Now you have all the bad news.
I'm not sure what you are willing to do to overcome this. If you were hoping that it would be a change to a checkbox on the tax return, that is not going to happen. In October or November 2012 we could have had that discussion and you'd be in a totally different position. But it is not 2012 anymore, your opportunity to make adjustments to cash flow are gone for that tax year. Not knowing the details of your business I won't presuppose that I have a workable plan for you yet. If you are willing to do what it takes to be successful and overcome this set back then call me. But it could be, depending on your specifics, a very aggressive and uncomfortable treatment.
So far I have injected examples of what might be (tax rates, dollar amount, etc). Your business is unique and how you come out of it will be specific to your situation. Once we know more I can develop a specific process to get you from where you are, to being in control of a successful business.
the Business Designers