Accounting method for software business
I'm nearly complete and preparing to launch my business. However, I've noticed that taxes aren't as simple as everyone makes them out to be. I'm mostly confused about cash vs accrual accounting for my situation.
I'm planning on calling the IRS tomorrow for more clarification, but I'd like some opinions from other people. Anyway, to my question -
I'm going to make my business a sole proprietorship. My business sells a single piece of software available only via download. The IRS however says that most businesses that sell things have an inventory. I don't understand how this would apply to me. I do not stock anything, the downloads are available free and the user is simply purchasing a license key from me. There's no stock of these either - they're generated on demand. Do you guys thing that I would be okay with cash based accounting?
Tax USA IRS Sole Proprietorship
2 Answers
IRS do not provide tax advice. You should call a tax adviser (EA or CPA) who can help you.
Taxes are significantly more complicated than TurboTax commercials make them appear. If you're starting a business you must have a reputable and professional tax adviser who will walk you through all the issues, educate you on how to manage your books, and will prepare and set up all the needed accounts and tables for you (capital and expense accounts, depreciation tables - these are needed for (almost) all businesses. Some businesses will require more, especially in a Corp or LLC (Partnership) settings).
One of the things you'll get educated about is the accounting methods. What is cash, what is accrual, when this one is better, and when that one is better. Maybe you don't have a choice? Maybe you can use hybrid methods? Talk to a pro.
Inventory may not apply to you, but capitalization of your development expenses certainly does. How do you do that? Talk to a pro.
IRS won't help you - they're not allowed anyway, and whatever they tell you will be the most conservative interpretation of the law. You don't have to follow what they tell you, different interpretations are available. At times, IRS interpretation contradicts settled law (existing Tax Court and Supreme Court precedents). Your tax adviser will guide you through the best interpretations, and best options available to you.
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That's sobering advice. I was hoping to launch this week, but if I absolutely must consult a CPA I'll have to save money. I bootstrapped this project hoping it wasn't going to be this complicated. Unfortunately, ignorance isn't a valid defense. Thanks. – Asdaf3wq 12 years ago
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My Dad was a CPA. Don't become another beer and barbeque anonymous example of how not to do it. Get a professional and quick. Otherwise, you'll be getting someone to both set you up sanely _and_ bail you out of your mistakes. Remember, it's not what you know that will hurt you the most, it's what you don't know. – Edwin Buck 12 years ago
It doesn't have to be as bleak as the other answer suggests. I've run several businesses over decades and the one time I hired a specialist accountant it went badly wrong. They kept making basic errors and even got their clients involved in a tax scam, which they said was perfectly legal and within the rules. When the tax authorities took them to court, they said their "advice" should have been checked by their clients, so the fines and penalties weren't their responsibility. Thousands of clients were each thousands of dollars out of pocket (big scandal). Not sure who they thought we should "check their advice" with though, as we'd hired them to be our accountants and handle our taxes.
Anyway, after that I realised I couldn't trust anyone with this stuff any more, so I learned to do all my business and personal taxes, financial statements, etc myself. Now I have a couple of spreadsheets and it is trivial.
Of course, I don't mean to imply that all accountants are incompetent, but you do have to be careful who you put your trust in. As always, IMHO, YMMV, etc.
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Well, if the only person you've ever dealt with was a crook, no wonder you trust nobody. Of course one can learn everything, after all - most CPA's and EA's do, no-one is born with the knowledge. The question is whether one *should*. The way the OP asked the question shows that he hasn't got a clue. That's not a bad thing, most people don't. The question is what you do with it. – Littleadv 12 years ago
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@littleadv The firm I mentioned was an international firm of accountants, well known in the field, not some small time crook, as you suggest. – Steve Jones 12 years ago
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@SteveJones Sorry to hear about your experience; however, in life and business there is no guarantee of success. I'd wager that those who seek professional tax advice generally obtain far better advice than they can generate working it out on their own. Of course, there are exceptions to every rule, but by the time you can provide tax advice that is on par with a professional, you have invested enough time in the effort to be a professional (or, you're just kidding yourself). – Edwin Buck 12 years ago
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@Steve If the firm was well-known, I'm sure you can provide a link to the story, which there are plenty of. I'm not saying there are no crooks. I'm saying that those who don't live and breath the tax law won't know many of the things. Even those who do - specialize in some areas and don't go into others. So you may have learned the minimum required to do your own business, but you can't learn it all. 99% of non-accountants don't, and I'll tell you more: some of the CPA's don't either. Not all the CPA's are in tax area, many aren't at all. – Littleadv 12 years ago
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@littleadv Please keep our rules on civility in mind. It's perfectly fine to disagree with someone and explain why you disagree with what was said, but personally attacking someone is never acceptable. I've edited the offensive portions out of the previous comments. – Zuly Gonzalez 12 years ago
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@zuly, it was not my intention to offend. I'm sorry that suggesting to Steve that he might not be perfect seems offensive. I stand by my words, if Steve ever lets me audit his accounting - I **will** find mistakes. Some may in fact be very beneficial for him to have fixed, he just doesn't know that. If the notion of a layman most likely not being as good as a pro seems offensive - then I'm sorry, but there's nothing much I can do about that. – Littleadv 12 years ago
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And by the way, may I also point out that the mere proposition that he makes in his answer that pros are crooks and should never be trusted is not only offensive, but is ridiculous and contradicting any common sense in business. – Littleadv 12 years ago
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@littleadv It's just best not to make things personal, especially since written communication can be misinterpreted. It's fine to state that most layman aren't as good as trained professionals, but when you specifically target an individual as being "clueless" it puts that person on the defensive. I believe that it wasn't your intention to offend, but it was taken that way. I'm not taking sides. I'm just acting on a flag. – Zuly Gonzalez 12 years ago
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@littleadv at no time did I suggest that all pros are crooks and shouldn't be trusted, I simply recounted my own experience with one firm. My point, which seems lost in this self-indulgent mess, was that for simple cases, which many businesses are, you sometimes don't need an accountant. Also, for you to suggest that you "will find mistakes" in my accounting is the kind of patronising comment I was referring to earlier, before it was removed (quite rightly, no doubt). – Steve Jones 12 years ago
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@Steve, the person asks a question which clearly shows he doesn't know even the basic accounting terms. On what are you basing your suggestion to ignore professional advice? Just because you cannot identify crooks when you see them, it doesn't mean that everyone else has to ignore anyone who has credentials. I'm sorry if I sounded patronizing, but your self-confidence is based on nothing. I've seen, met and worked with people like you. You can't imagine what are the things you don't even know exist. – Littleadv 12 years ago
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@littleadv No, my self-confidence is based upon actual real world experience. Nobody can know everything about a subject, even a professional, but my argument is that some people can know enough for day to day activities. If I was handing a merger or acquisition, then I would seek professional advice, but just book-keeping and preparing financial statements is so trivial that I use spreadsheets. Not everyone will agree, but for me it makes perfect sense. I never suggested "ignore professional advice", I said "IMHO, YMMV". By the way, how do you "identify crooks when you see them"? – Steve Jones 12 years ago
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@Steve - 2 things. I didn't suggest the OP to have an accountant handle his bookkeeping. Bookkeeping is not at all relevant to the question asked. Why are you bringing this topic in? He asked a question about accounting methods, and said he's going to call the IRS to ask about it. Now he is right to identify that he has a lack of knowledge and need to ask someone, he's just wrong about whom to ask. That was what I explained to him. If you think that when you don't know something you shouldn't ask someone who definitely does - you have a problem. – Littleadv 12 years ago
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Second thing: its not what you do know. Its what you don't. And you don't know what it is that you don't know. So for you the minimum you know makes perfect sense, but it doesn't mean that you know everything you **need**, or that what you know is in fact correct. Tax law frequently doesn't make sense. Some things change very often. Some deductions you could take last year, you can't take this. Some deductions were invented anew. Some expenses can be deducted in full, others have to be capitalized, and for some you have choice. – Littleadv 12 years ago
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My point is that without knowing you and without even seeing your accounting I'm 100% positive you have mistakes. **100%** positive. You know why? Because **everyone** makes mistakes. Including professionals, they don't have to be crooks for that. But the severity of the mistake and the liability for the results is on you, and not on your pro adviser's insurance carrier. And that is a major difference, that you don't take into account. – Littleadv 12 years ago
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As to crooks: if it sounds too good to be true - it **is** too good to be true. If someone offers you tax benefits and refunds that "no-one else can get you" - run away. You didn't post a link to your particular story, but there are plenty of those. Almost all of them have one thing in common: the crooks promise something that only they can deliver. And that is a clear sign of fraud. Also, once in several years have another, unrelated professional to audit your permanent pro's work. Public companies **must** do it, you can volunteer. – Littleadv 12 years ago
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@littleadv I think you got the wrong impression about the accountant issue I mentioned earlier. It wasn't a "too good to be true" thing at all. Anyway, you are partially correct when you agree with me that nobody knows everything about a topic, even professionals. I find it ludicrous that you continually make the point that you would find mistakes in my accounting, as you have no idea about my businesses or my capabilities. You seem to be blinded by your professional pride and incapable of accepting my point of view, so I suggest we leave this pointless, self-indulgent discussion now. – Steve Jones 12 years ago
