How to set up S Corp accounting

Accounting set up is important since this affects your efficiency, your tax planning and tax liability, and your overall efficiency. S Corps follow the same accounting principles as the rest of the business tax entities (well, there are some technicalities, but they are not relevant for the accounting set up). So we suggest that you start your research with the following concepts:

Cash Basis Accounting

Many small business owners prefer cash basis accounting due to its simplicity and cost-efficiency. With cash basis accounting, income and expenses are recorded when cash is actually received or paid, making bookkeeping straightforward. This method is particularly suitable for small, privately-owned businesses that don't have to adhere to Generally Accepted Accounting Principles (GAAP) or deal with external investors or regulatory bodies.

For many simple S corps, cash basis accounting offers a less complex approach to keeping track of finances.

Accrual Accounting

On the other hand, accrual accounting may be a better choice in certain scenarios, especially if your business is growing or you manage more complex financial transactions and inventory. Unlike cash basis accounting, accrual accounting recognizes income and expenses when they are earned or incurred, regardless of when the payment is made. This approach provides a clearer picture of your business’s financial health and also helps you to time your revenue.

Key advantages of accrual accounting include:

1. Control Over Income Recognition: Accrual accounting offers the flexibility to manage when income is recognized. This can be beneficial for tax planning, since it allows you to defer taxable income to the next year.

2. Handling Large Profits and Inventory: Businesses with higher profits or significant inventory needs may be required to use accrual accounting. It ensures that inventory is accurately accounted for and better reflects your business's overall profitability.

   
   

But for many small to mid-sized S Corps, cash basis accounting is just enough. No reason to over-complicate things, right? However, as your business grows or if you have specific financial reporting needs, transitioning to accrual accounting may offer more long-term benefits.

Accounting Software and Professional Support

The IRS requires S Corps with over $250K in gross revenue or assets to include a balance sheet on their tax returns, which requires a specific accounting setup. Simple Excel documents are no longer sufficient. Modern accounting software, like QuickBooks Online and Xero, are most popular accounting software as they allow automated bank statement reconciliation. This feature saves time and reduces errors. But professional oversight is still needed since someone needs to make adjustments for tax laws related to S Corps. In my experience, most business owners struggle with accurate bank reconciliations as this is obviously a boring, confusing and time consuming chore.

Tax Planning + Timely Accounting = Tax Savings

For S Corp owners, accurate and timely accounting is important for effective tax personal planning. Since these businesses pass net income to the individual level for taxation, having up-to-date financials is critical for determining timely tax strategies. Without proper accounting, personal tax planning becomes guesswork with surprise tax bills in the tax season.

Outsourcing Your S Corp Accounting

As I mentioned before, outsourcing accounting saves time and money. These days online accounting software allows to add accountants to clients books virtually by simply sending an email invitation. Accountants log in into the client's software account and perform bank reconciliations on the clients' behalf. Since CPAs also know tax, they can also prepare your books for the tax season as they do bookkeeping. For example, this is how our CPA firm handles S Corp accounting:

1. We properly categorize new purchases: We ask you questions about big item purchase so that we can figure out how to correctly categorize them on the 1120 S tax return. By properly categorizing the asset, we will be able to make a timely tax planning decision on whether we can ( and want ) expense it in the current tax year or it is better to stretch out depreciation expense over the next several years

2. We handle accountable plans reimbursements: We send timely reminders and process reimbursements, ensuring compliance with S Corporation tax rules. We also properly book these reimbursements in your books - something that an accounting software cannot do yet, since it requires manual decision

3. Record Keeping: We maintain detailed and accurate receipts of most of the transactions, which can come in handy in the case of an IRS audit.

   
   

Accounting Service Options

Not all small businesses want to pay for monthly accounting services. And we understand that. If business profits are small, accounting costs will eat up your profits. Here are two additional accounting options that you could consider. They are usually cheaper, since they require less of the bookkeeper's attention.

1. Quarterly Accounting: This is a more affordable option, since this service includes quarterly work, meaning that the accountant will jump on your books only once each quarter. This approach still works for tax planning since estimated tax payments are due each quarter and you have a lot of time to fix things

2. Yearly Write Up: This is a one time project when the accountant work on business financials only once a year and does all accounting at once. This is so called a "post fact accounting" and it works for some business owners. However, by the time the client gets around to the write up, many tax planning opportunities are missed. Yearly write up options work well for business owners with a predictable yearly income and little desire for tax planning.

   
   

   

   
   

Final Thoughts: When setting up accounting for your S Corp, it’s important to choose between cash or accrual accounting, get the right software, and think about outsourcing to save time. Our firm takes care of your accounting on time, giving you a clear view of your finances and helping you use all the tax-saving options available. You can learn more about our services here.