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 A deduction on the individual tax returns which is taken into account when calculating Adjusted Gross Income

 A plan that follows IRS regulations and is created to reimburse employees for business expenses which they paid personally. To qualify, the expense must have a business purpose and be paid in connection with the employee performing their duties for the business. Reimbursements under an Accountable Plan are not included in the employee’s wage income.

Adjusted Gross Income is the calculated income on an individual's tax return before taking into account Standard or Itemized Deductions (and Exemptions which are not applicable while the TCJA is in effect). This is frequently used for other government benefit calculations and bank loans.

The minimum interest rate on a loan required to make the loan an arm’s length transaction. This rate is updated monthly by the IRS. A link to the updates can be found in our Links page.

When you have income in different states, you are required to allocate a certain amount of income to each state based on apportionment factors. These vary by state. For individuals, this is mostly based on the actual income you received in the state. For businesses, states may use a single factor or up to three or four factors to determine the income to the state. Factors include Sales Revenue, Fixed Assets and Payroll. In most cases, due to the inconsistency of apportionment calculations, a business can be taxed on either more than 100% of their net income at the state level or less than 100% of their net income.

 A trade transaction where goods and/or services of value are exchanged with no cash involved. For example, a catering service provides catering for an advertising company in exchange for work the advertising company has done for them. These are often overlooked for recording in the accounting records, but they should be recorded at Fair Market Value. In this example, because the income and expense for the catering company are equal (sales income and advertising expense), the transaction has no net effect on their bottom line, but this could affect their apportionment if they do business in multiple states. For the advertising company, again there is no effect on their net income for their financial statements (sales income and meals expense), but this could affect their apportionment if they do business in multiple states, and if the meals expense is only qualified for a 50% deduction for their tax returns, they have understated their taxable income. If you have a barter transaction, please be sure to let your accountant know so they can record it appropriately!

Bonus and 179 depreciation are accelerated depreciation systems. Typically, when you purchase a large asset, you must capitalize it and take depreciation over a number of years specified by the Internal Revenue Code. From late 2017 to 2022, taxpayers could take 100% bonus depreciation on many of their large assets in the first year. In 2023, the phased out of bonus has begun, and bonus is reduced to 80%. By 2027, bonus depreciation will be 0%. Section 179 depreciation also allows you to expense many large assets in the first year with some additional restrictions such as not being able to make the taxable income go negative as can be done with bonus depreciation.

Gain on investments such as stocks or non-personal real estate. Long-term capital gain (gain on assets held for more than a year) are taxed at beneficial rates (lower than the regular income tax rates) under current tax law.

For large purchases of items which can be used multiple years (office furniture, kitchen equipment, machinery, buildings, etc), a taxpayer cannot usually take the full expense in the first year. The item must be capitalized – it must be recorded in the long-term assets portion of the balance sheet. The item can then be depreciated over a set number of years.

The tax code deals with constructive receipt for determining taxable income. For example, if you are a tax basis taxpayer and receive a check from a customer in the mail on December 31st, you have constructively received the income whether or not you have deposited it into your bank account, and it should be recorded in your income for the current tax year.

A credit is a dollar for dollar reduction of your tax liability. A deduction is a reduction of your taxable income (the income on which your tax liability is calculated).

 For large purchases which would otherwise be Capitalized and Depreciated, the IRS makes a special allowance for taxpayers to expense these items immediately if they are under $2,500 as long as the De Minimis Safe Harbor Election is included with the tax returns. Most tax return preparers routinely include this Election with all business tax returns prepared now.

Depreciation is the expense a business takes over a set number years for large, physical assets acquired. Amortization is similar, but it is for intangible assets such as Goodwill.

Generally refers to tax first paid by a C Corporation on its earnings, then tax paid by the shareholders when they received dividends from the C Corporation. Pass-through entities (S Corporations and Partnerships) avoid this issue.

The amount of cash or goods you contributed to a Partnership or S Corporation, plus income passed-through to you, minus losses passed-through to you, minus distributions of cash or goods from the business to you. Equity basis helps determine whether you can take business losses in the current year on your tax returns and is part of the gain or loss calculation when you sell the business.

Various tax credits and benefit qualifications are based on the number of employees a business has and is based on Full-Time Equivalents. It can vary by credit or company benefit, but a Full-Time Equivalent is generally 30 or 32 payroll hours.

The value of a business above its assets net of liabilities. The value is generated from being in business for a number of years and having an established customer base. Goodwill is generally only recorded as an asset on the balance sheet if it came from the purchase of an existing business.

This is a type of account you can have if you have a qualified High Deductible Health Plan. You can make pre-tax contributions to the HSA account up to an annual limit and then pay for qualified medical expenses from this account. It is a good way to take a tax deduction for medical expenses when your income is too high to take medical expense as an itemized deduction or if you take the standard deduction.

The IRS considers a hobby to be an activity the taxpayer doesn’t carry out to make a profit. Any income from the hobby must be reported as income on the tax return, but a loss from a hobby activity is not allowed. The taxpayer would report all the income and enough of the expenses to bring the net income down to, but not below, zero.

 Taxpayers can either take a standard deduction against their adjusted gross income, or, if itemized deductions are higher, they can itemize. Itemized deductions include medical expenses, state income taxes, real estate taxes, personal property taxes, mortgage interest, and charitable donations.

In order to prevent income shifting from parent to child to avoid taxes, the IRS implements a Kiddie Tax. If a child’s investment income (from a brokerage statement, for example) exceeds a certain threshold, the child’s income is taxed at the parents’ tax rate.

Under Section 1031, taxpayers are allowed to defer the recognition of gain from the sale of certain real estate if they use the funds to purchase other real estate within a set time frame. The real estate sold and purchased must both be business or investment property and a qualified 1031 intermediary must be used to qualify for the deferred gain.

Modified Accelerated Cost Recovery System is the depreciation system used under the tax code.

 The tax code provides a tiered tax rate system. Your marginal rate is the tax rate applied to the next dollar of taxable income you earn.

You participate regularly, continuously, and substantially in a business or other income generating activity. Material participation can help determine whether or not you can take a loss in the current year from an activity.

This refers to whether you have sufficient physical presence in a jurisdiction to cause a tax filing requirement. The sufficient physical presence definition varies from place to place and has become more confused in recent years with more online sales. Previously, if you have no contact with a state or city than shipping goods into the area using a third party delivery system (USPS, UPS, FedEx, etc), you probably did not have a filing requirement. Now, a certain sales threshold could trigger either income tax or sales tax requirements.

 Net Investment Income Tax was created to help pay for Obama care. This is a 3.8% tax applied to certain investment income for individuals, estates, and trusts with taxable income above certain thresholds.

Net Operating Losses occur when expenses exceed income. These are typically carried forward into the next tax year to offset future income.

If you owe the IRS a lot in back-taxes and cannot pay, they may accept a proposal to pay back a lower amount. The taxpayer provides details of their assets, liabilities and income for the IRS to determine whether they will accept a lower amount than the total owed.

Investment income where the taxpayer does not materially participate. Passive activity losses are generally limited and carry forward to offset future passive income.

Partnerships and S Corporations generally do not pay tax. Instead, the income is calculated at the business level and then allocated to the owners on a Form K-1. This is then reported on the individual’s personal income tax returns, tax is calculated at their individual rates and is paid personally.

Many states now allow pass-through entities to elect to pay state taxes. This is to go around the $10,000 limit imposed on tax expense allowed on individual itemized deductions by taking the state tax expense at the business level. The individual tax payer receives a credit on the state tax returns based on what the company has paid in state taxes.

Qualified Business Income Deduction was created with the TCJA and is set to expire after the 2025 tax year. It allows up to a 20% deduction of Qualified Business Income if all requirements are met.

If your only income is from wages, you generally do not need to worry about making quarterly estimated tax payments. For business owners and investors, the IRS requires tax payments four times a year to cover your tax liability caused by your activities. If at least 90% of the tax owed for the year is not paid during the year, estimated tax penalties are assessed. Because this can be difficult to predict, the IRS (and most states) offer a safe harbor. When the safe harbor is met, no estimated tax penalties will be assessed, even if you have paid less than 90% of the tax liability. The safe harbor is 100% of the prior year taxes for taxpayers with prior year AGI less than $150,000 and 110% of the prior year taxes if AGI is greater than $150,000. 

Tax Cuts and Jobs Act was enacted in 2017. This created, among other things, the Qualified Business Income Deduction, lower tax rates, and 100% bonus depreciation. It also raised the standard deduction and removed the exemptions taken on individual tax returns. Many tax changes are set to expire at the end of 2025.

The original cost of an asset minus any depreciation expense taken. The tax basis is subtracted from the sales price to determine taxable gain or loss on the asset.

When you have not paid sales tax on an item (which is often collected by the retailer on behalf of a jurisdiction in which they have nexus) and you are the end user, you must pay use tax on the item for the jurisdiction in which you are using the item. This is more strongly enforced for businesses than individuals.

Wages are subject to Social Security and Medicare taxes and are reported on your W-2. Partners in a partnership do not receive wages. Instead they receive Guaranteed Payments which are subject to self-employment taxes on their personal tax returns. Guaranteed Payments show on the K-1 created with the partnership tax returns. Distributions are cash the owner takes from the S Corporation or Partnership which are not subject taxes (unless distributions are in excess of basis). Distributions are taking out cash on which taxes have already been paid.

When buying and selling stocks, if you sell a stock at a loss and purchase substantially the same stock within 30 days before or after this, it is a wash sale loss. The loss is disallowed until you ultimately dispose of the stock.

An employer-sponsored retirement savings program which allows you to contribute a portion of your current wages into a retirement account. The employer frequently pays a percentage of matching contributions and some plans include a profit-sharing option to employers to contribute additional in years with good company profits.

These are created by actuaries based on a number of statistics to estimate remaining life expectancy. Required minimum distributions from retirement accounts are calculated from these tables.

If you have a number of independently operated companies with substantially identical ownership or have related businesses that work together to provide goods or services, they must be aggregated for benefit purposes. If you are the 100% owner of a restaurant and a retail store, for example, the you cannot offer benefits to the retail workers and not offer the same benefits to the restaurant workers.

Contract with an insurance company to pay you a set amount periodically over a set period of time.

An employer plan where the pay out in retirement is a guaranteed amount.  These are rare now but were used frequently decades ago with automotive manufacturers.

An employer plan where the employer contributes a set amount to the employee’s retirement account during employment.  This is the most common type of retirement plan now.

The age at which you can apply for 100% Social Security Benefits. If you were born between 1943 and 1954, your Full Retirement Age was 66. If you were born in 1960 or later, your Full Retirement Age is 67. Between 1954 and 1960, add 2 months to 66 for each year above 1954.

An Individual Retirement Account is a personally held retirement account. The contribution limits are much lower than an employer sponsored plan.

An employer-funded retirement plan for self-employed individuals. The contribution limits are significantly higher than an IRA.

Several plan types, including 401(k), may have a Profit-Share Plan added in. This allows the employer to elect to contribute up an amount equal to up to 25% of a company’s payroll to the employee retirement plans.

Minimum distributions from a retirement plan which must be taken after reaching age 72 or 73.

A traditional retirement plan is funded with pre-tax dollars, giving you a tax deduction now, and the distributions during retirement, which includes the earnings on the account, are fully taxable at that time. A Roth retirement plan is funded with post-tax dollars, which means you do not get a tax deduction now, but the distributions, including the earnings on the account, are tax free when taken. Roths are generally most beneficial for those who start contributing to their retirement plans when they are younger but could benefit anyone depending on their circumstances.

When there are highly compensated employees and business owners, the company must go through nondiscrimination testing to ensure the retirement plan does not overly favor these individuals over the other employees. To avoid this annual testing, a company can instead elect to make safe harbor contributions to all employee retirement accounts which are then by definition nondiscriminatory.

Simplified Employee Pension Plan allows employer contributions to traditional IRAs set up for each employee. The employer can choose how much in retirement contributions to make each year so long as the contributions are allocated uniformly among the employee accounts. These have lower administrative costs than 401(k) plans, but no employee deferrals are allowed.

Savings Incentive Match Plan for Employees is available for employers with less than 100 employees. Employers can choose to contribute 2% for all employees whether or not they participate or a 3% match for the employees who contribute to their retirement accounts. These accounts have lower administrative costs than 401(k) plans, but the employee deferral amounts are a little lower.

Some retirement plans allow for a vesting period. An employee’s wage deferrals always belong to the employee, but the employer contributions may take time for full vesting. This means the employer makes contributions to a retirement plan on behalf of the employee, but the employee may not have full ownership of them until they have worked for the employer for several years. This is a common strategy to assist with employee retention. Should the employee separate from service before vesting is complete, only a portion of the employer contributions will belong to the employee with the remainder surrendered back to the employer.

American Institute of Certified Public Accountants

Cash, inventory, accounts receivable, fixed assets, notes receivable, etc.

A statement as of a single point in time showing the assets, liabilities, and equity of a company. Assets equal liabilities plus equity.

A calculation of value is a condensed version of a business valuation. A value of the business is calculated but fewer factors are considered than in a full business valuation, and so the value of the business could be substantially different than one which is determined during a business valuation.  For this reason, most business valuation accountants will not offer litigation support when only a Calculation of Value has been prepared.

A determination of the value of the business taking into consideration multiple factors including the history of the business, the business industry, the current economic conditions, and projections for the future of the business. The business valuation offers an opinion of value which most business valuation accountants are willing to defend in litigation support services.

An agreement between partners in which they agree to a method for one buying out the other and under what circumstances this would be done. The agreement also generally includes how to calculate the value of the business in order to avoid the need for the preparation of a Business Valuation which is costly.

The cash basis of accounting recognizes expenses when paid and income when received. The accrual basis recognizes expenses when incurred and income when earned. The tax basis of accounting is a hybrid of these two.

In simple language, debit means left and credit means right. The left and right refer to which column a transaction is recorded to under each account. To determine the account balance, the left and right are netted together, and the larger column carries the net balance. For asset and expense accounts, the net balance is in the debit column. For liabilities, equity, and revenue, the net balance is in the credit column. When looking at financial statements, if the balance is a negative, it means the net balance for the account is in the opposite column of its normal column. For every debit entered in one account, a credit is entered in another account. This is the basis of double-entry bookkeeping first documented by Luca Pacioli in 1494.

An owner of a company removing cash or goods directly from the company as a return of owner equity.

Assets minus liabilities or the value of the owner’s interest in the company. This is the amount of cash the owner would receive if the business was to liquidate and shut down as of that date.

 Generally Accepted Accounting Principles are issued by the Financial Accounting Standards Board (FASB) in the United States. This is the framework for accrual basis accounting and is used by all publicly traded companies. A private company generally does not need to keep their financials on a GAAP basis unless they are a government contractor, or it is required by a bank or for insurance bonding. We generally recommend small businesses keep their financials on a tax basis of accounting, so they can better understand the tax implications of their financial situation. 

This shows the business revenue and expenses over a period of time, generally the calendar year, quarter, or month.

Accounts payable, credit card payable, sales tax payable, wages payable, lines of credit, deferred revenue, long-term loans, etc. Anything where you owe someone money or a service.

The owners’ funding of the business, plus any revenue or minus any losses, minus owner distributions.

Short-term is generally anything receivable or payable within a year (cash, inventory, credit card debt). Long-term is generally anything held more than one year (fixed assets, buildings, auto loans, business loans).

Similar to the income statement, but removing non-cash transactions such as depreciation and amortization and adding in cash outflows that are not expensed such as debt pay-down or purchases of equipment. Shows the cash flow of the business rather than the income.

The value of money over time deteriorates due to inflation. A dollar is worth more today than a dollar tomorrow.

A report showing the balance of all balance sheet, income and expense accounts at a point in time, usually showing a column for debits and one for credits. The debits and credits in a trial balance are equal to each other.

These are a measurement of how your business is doing financially. Because these are frequently ratios and percentages, they can easily be compared to your peer group to see where you are doing well and where you may want to try to improve.

Time period in days times your average Accounts Payable divided by your purchases. A low number of days indicates you are doing well keeping up with your bills, but you are losing out on the benefit of holding on to your cash to earn a little more interest in your bank account by paying the bill on time instead of early. A high number of days may indicate you are having cash flow issues and trouble meeting your debt obligations.

Time period in days times average Accounts Receivable divided by your Revenue. A low number of days means you are doing well with collecting revenue from your customers quickly after sending them the bill. A high number of days indicates you are having trouble with collections and may result in cash flow issues for your business.

Current assets over current liabilities. This shows your ability to cover your short-term liabilities if you needed to use your current assets to cover the debt immediately. Ideally, this ratio should be at least 1 and preferably higher. A ratio less than 1 means you cannot cover your current debts.

Total debt over total equity. This shows how much of the company’s operations are financed by debt compared to capital invested into the business over time. The lower the ratio is here, the more solvent the business is.

Earnings Before Interest, Taxes, Depreciation, and Amortization. This is used frequently during business sales and for loan applications. Removing the depreciation and amortization helps show a more realistic cash flow.

Company cash over monthly operating expenses. How much cash does the company have in the bank to cover its operating expenses if it was generating absolutely no revenue and no new outside invested funds? For a start-up company, this generally needs to be a much higher amount as they typically generate losses before gaining traction. For an existing company, the business may want to have anywhere from 3 to 6 months or more of operating expenses covered by the current cash in the bank account.

Revenue over your average fixed asset balance. This ratio is most relevant for companies that need to invest a lot of money in equipment to generate sales. A higher ratio indicates the business is using its assets effectively to generate revenue.

Revenue after subtracting Cost of Sales. The ideal margin for this will vary depending on your industry.

EBIT (Earnings Before Interest and Taxes) over interest expense. This looks at a company’s ability to meet its required interest payments on loans and other debt. A higher ratio indicates a better capability of meeting those obligations.

Cost of sales over your average inventory balance. This is an indicator of whether the company has too much or too little inventory. A higher ratio may indicate you want to have more inventory on hand or may simply mean you are very efficient in purchasing just enough inventory to meet demand as it occurs. A lower ratio may mean you have too much inventory on hand, depending on your industry.

Your bottom line after taking into account all other income and expenses of the business.

Cash, cash-equivalents, and short-term receivables over current liabilities. This shows your ability to cover your short-term debt immediately with easily available cash. Ideally, this ratio should be at least 1 and preferably higher. A ratio less than 1 means you cannot cover your current debts.

Net profit over the company’s average asset balance. This indicates how well the company is using its resources to generate profits. A higher ratio indicates higher efficiency in this area.

Net profit over your average equity balance. This indicates how well the business uses owner investment to generate profits. A higher ratio indicates higher efficiency in this area.

The profit earned on an investment over the cost of the investment. A historic average for return on investment from the general stock market, for example, is about 7%. Lower risk investments will have lower return on investment while higher risk investments should have a higher return on investment. This is the reason people with great credit scores are usually able to obtain loans at better interest rates than people with poor credit scores.