Common mix-ups with tax-compliant categories – Heard

We recognize that practice owners and bookkeepers may sometimes see things differently when categorizing transactions. We want to clarify our bookkeepers' choices, especially for tax compliance.

The business-related expenses must be considered necessary and ordinary to the business, according to the IRS. Your bookkeeping team will carefully categorize transactions in order to:

Ensure that the owner's distributions are accurately stated, preventing the practice owner from overpaying or underpaying their overall tax obligations.
Maintain accuracy in the practice owner's financial records, reducing the risk of being subjected to a tax audit.
Exclude certain transactions from the practice owner's profit and loss statement, which could lead to inaccurate quarterly tax estimates and misleading financial reports.

Here are a few examples of tax-compliant categories and common mix-ups. These descriptions capture the basics of the categorization, but they may not apply to every situation in a therapist's books.

Health, Dental, and Vision Insurance Transactions (Sole Proprietors): Health Insurance is a personal expense. However, you will be able to claim the self-employed health insurance deduction on your tax return filing instead of your practice’s Profit and Loss statements.

Auto-Related Expenses: If you use your personal vehicle for business, you can claim some expenses related to the use and maintenance of your vehicle on your tax return. The IRS only allows you to claim a percentage of eligible expenses; therefore, we collect information about the use of your vehicle during annual tax filing. We’ve put together a comprehensive article here: What Therapists Need to Know About Deducting Business Mileage. If a business vehicle was purchased under the business name, you can upload your registration documents to Heard.

Payment of Federal and State Taxes: Federal and state tax payments are not considered business expenses. This is because the individual taxpayer makes the tax payments, not the business. Therefore, these payments should not be included in a practice owner's books or their Profit & Loss statement. This is why bookkeepers categorize tax payments as Owner's Distribution. If you pay a franchise or business tax to your city or state, this will be categorized as City Taxes or Franchise Taxes.

Money Transfer vs. Owner’s Distribution vs Owner’s Investments

Money Transfer: money transferred from one business bank account to another business bank account.
Owner’s Distribution: money transferred from a business bank account to a personal bank account for personal use.
- - To ensure compliance for S Corporations, it’s important to avoid mixing personal transactions in business accounts. Mistakenly taking personal expenses as small business tax deductions also opens you to risk during an audit. The IRS, state authority, and creditors can hold the owners personally liable for piercing the corporate veil, a special instance where the court holds the shareholder personally liable for the corporation's debts, if there is a significant amount of personal transactions or assets mixed with business transactions.
Owner’s Investment: money transferred from a personal bank account to a business bank account for the purpose of keeping the practice up and running.

Credit Card Payments vs. Owner’s Distribution vs Owner’s Investment

Credit Card Payment: payment from a business bank account on a business credit card.
Owner’s Investment: payment for a business credit card that’s made from a personal checking/savings account.
Owner Distribution: personal credit card payment made from a business checking/savings account, because it’s intended for personal purposes.
- For example, a payment for a bank account that’s not connected to Heard, is categorized as a personal transaction.

Retirement Contribution vs. Owner’s Distribution

For S corporations, Payroll: Employee Benefits are used to categorize an S Corporation owner’s retirement contributions since S corporations have retirement plans through payroll that can be deducted.
For sole proprietors, retirement contributions are considered personal transactions or Owner's Distributions for money transferred to a retirement account or withdrawn for the purpose of contributing to a retirement account.

Travel expenses, Meals, and Entertainment vs. Owner’s Distribution

The expenses that can be considered related to the business because they are being spent in a business setting don’t always apply to S corps. For example, if a Sole prop practice owner travels to a conference for their practice, they can write off some of those travel expenses. An S Corp practice would claim a reimbursement under an Accountable Plan.
Business meal expenses (including travel meals) are food and beverage purchases that are directly related to conducting business. These can include meals with clients, colleagues, or professional contacts where business discussions occur. This means a coffee purchase during one's lunch break isn't a business expense. It's a personal expense and categorized as an Owner's Distribution. Client entertainment expenses are purchases for entertainment activities aimed at developing business relationships.

Charitable Donations: Any donation made on behalf of the business to a registered charity. Only donations to 510c3 organizations are tax deductible. However, they are not deductible when calculating net profit for tax; they are deductible elsewhere on return. For that reason, these transactions should be excluded from your Profit & Loss statement.

Uniforms & Laundry: This category is reserved for uniforms or safety equipment bought for yourself as a business owner or for your employees. This is not a common one. This DOES NOT include clothing that can be worn outside of work hours (suits, business shoes, etc). These types of purchases are treated as personal. Clothing that is considered a tax-deductible business uniform would be clothing with a business logo on it.

Other Expenses vs. Owner’s Distribution

Other Expenses are for business expenses that don't fit into specific categories. Use this category sparingly, as it's closely reviewed during tax audits. Try to use other available categories for most transactions. If an expense truly doesn't fit elsewhere, it may be placed here, but only at your request, with a note explaining the expense.
If the expense was non-business related, then it’s an Owner’s Distribution. There may be a situation where the bookkeeper can’t determine how the expense is business-related, which is why they may put the expense as an Owner’s Distribution.
If the practice owner is an S corp, then any personal expenses will automatically fall into the Owner’s Distribution category.

Therapy Income vs. Owner’s Investments

Income earned from providing therapy services that is deposited into a business bank account is considered Therapy Income. However, it's important to note that W-2 income earned outside of the practice should not be included in Heard's bookkeeping or the Profit and Loss statement. Only the 1099 income generated by the business through services should be recorded.
If money intended to keep the practice up and running goes into a business bank account (i.e., to pay for operating expenses), it's Owner’s Investments.
Sometimes, earned income is deposited into the practice owner's personal account and then transferred to the business account. This might be misclassified as an Owner’s Investment by the bookkeeper. It's important to leave a note clarifying that it's actually income to avoid understating total earnings.