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The CARES Act included provisions for several financial relief programs to support businesses during the COVID-19 pandemic. One of them, the Employee Retention Credit (ERC), rewards those that continued paying wages despite experiencing decreased revenues or operational shutdowns.

Initially, many taxpayers eligible for the ERC were uncertain whether wages paid to owners employed by their businesses qualified for the payroll tax credit. The Internal Revenue Service (IRS) issued a notice that answers the question definitively, but it can be challenging to decipher.

Here’s a more readily digestible explanation of the guidance to help you understand whether your owner wages qualify for the ERC.

Do Owner Wages Qualify For the ERC?

You probably won’t be able to include owner wages in your calculations when claiming the ERC. The IRS doesn’t expressly forbid it, but its interpretation of familial attribution and constructive ownership rules render most majority owners ineligible. The reasoning behind its position is circuitous, but doesn’t leave room for interpretation.

Previously, the IRS confirmed in its ERC FAQs that wages paid to employees related to their employers aren’t eligible for the ERC. For the purposes of the credit, relatives are defined as the following:

• A child or a descendant of a child
• A brother, sister, stepbrother, or stepsister
• The father or mother, or an ancestor of either
• A stepfather or stepmother
• A niece or nephew
• An aunt or uncle
• A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law

When the employer is a corporation, a related individual includes any person who has one of the relationships above with a majority owner. A majority owner is an individual who directly or indirectly owns at least 50% of the corporation’s stock.

However, the FAQs make no reference to wages paid to owners or their spouses, which led to the previously referenced confusion among taxpayers. To clarify its stance, the IRS issued Notice 2021-49.

Notice 2021-49 asserts that the constructive ownership rules for determining who is considered a majority owner of a corporation apply to the ERC. These rules state that an individual is considered to own, by extension, all stock their family members own. Family members include ancestors, siblings (whole or half), and lineal descendants.

Here’s where things get a little confusing. The notice then alleges that applying these rules to the ERC means that wages paid to majority owners with living siblings, ancestors, or lineal descendants don’t qualify for the tax credit.

Here’s the logic: If you’re a majority owner, your siblings, ancestors, and lineal descendants are also considered majority owners. Because they’re considered a majority owner, you’re related to a majority owner. As an employee related to a majority owner, your wages aren’t eligible for the ERC, per the original exclusion in the FAQs.

Ultimately, you must have no living ancestors, siblings, or lineal descendants to claim the ERC for your wages as a majority owner. Alternatively, you can be a minority owner with less than 50% ownership in your corporation after taking the family attribution and constructive ownership rules into account.

Note: Since only corporations can pay wages to their owners, they’re the only employers relevant to this discussion. If your business operates under any other legal entity structure, then owner compensation is automatically disqualified from the ERC.

Examples of Owner Wages and the ERC

The rules regarding owner wages and their eligibility for the ERC can be frustratingly abstract. Let’s discuss some examples to help you understand whether you can claim the ERC for your owner wages.

Owner Wages Ineligible

Corporation A is an employer that can claim the ERC for qualified wages paid in 2020. During that period, it paid wages to John, who owns 60% of Corporation A’s stock. John has a wife named Susan and a daughter named Mary, both of whom also work for the company.

Because Mary is related to John, a majority owner, her wages don’t qualify for the ERC. In addition, as his family member, she’s also considered a majority owner. Because John is related to Mary, a majority owner, neither his nor his wife’s wages qualify for the ERC.

Owner Wages Eligible

Corporation B is an employer that can claim the ERC for qualified wages paid in 2021. During that period, it paid wages to Lisa, who owns 100% of Corporation B’s stock. Lisa has no living ancestors, siblings, or lineal descendants. Her husband, Chris, also works for Corporation B.

Lisa is a majority owner, but she has no relatives who meet the requirements to share her status by extension. As a result, qualified wages paid to her and her husband are eligible for the ERC if the amounts satisfy the other requirements to be treated as qualified wages..

Apply For the ERC

The ERC can be incredibly lucrative, with the potential to reduce your payroll tax liability by $26,000 for each employee retained through 2020 and 2021. The window to earn the credit is closed, but eligible businesses can still claim the credit retroactively. Even if your wages don’t qualify due to the owner exclusion, you may still be eligible for a credit if you had employees on the payroll during the pandemic.

The CARES Act established several financial relief programs to help businesses manage the economic fallout from COVID-19. Among them was the Employee Retention Credit (ERC), which rewards organizations for keeping employees on the payroll during the pandemic.

Unfortunately, accounting for the Employee Retention Credit can be challenging. Many companies will encounter timing issues, and there’s a lack of relevant guidance in the Generally Accepted Accounting Principles (GAAP).

Here’s what you need to know to record the ERC in your financial statements correctly, including how the credit works, how to claim it retroactively, and which accounting models may apply.

How Does The Employee Retention Credit Work?

The Employee Retention Credit is a refundable payroll tax credit. It reduces your business’ payroll tax expense directly, dollar-for-dollar. If the credit exceeds your liability, you get a refund. That makes it significantly more lucrative than a tax deduction, which only reduces your taxable income.

However, businesses must meet strict requirements to be eligible for the ERC. Generally, these include having a limited number of employees on the payroll and suffering a significant decline in revenue or a suspension of operations during the pandemic.

Established organizations that meet these requirements can receive up to $26,000 in payroll tax credits per employee retained through 2020 and the first three quarters of 2021, depending on the amount and timing of the qualified wages paid.

Companies that opened after February 15, 2020, may also claim the ERC via the provision for “recovery startup businesses” if they have annual gross receipts under $1 million and one or more W-2 employees, though the credit limits are different.

If you didn’t claim the ERC because you thought receiving a Paycheck Protection Program (PPP) loan disqualified you, note that the Consolidated Appropriations Act expanded ERC access to allow recipients of PPP loans that meet certain conditions.

Fortunately, though the window for earning the ERC is now closed, eligible businesses can still claim it by filing an adjusted payroll tax return, Form 941-X, for each qualifying quarter.

Generally, you must do so within three years of filing the original Form 941. However, Forms 941 for a calendar year are considered to be filed on April 15th of the following year if filed before that date.

It’s also highly recommended that you consult a tax professional to help you navigate the process, maximize your benefits, and organize your documentation in case of a future audit.

How To Record The Employee Retention Credit In Your Financial Statements

When you claim the ERC, you must update your financial statements to reflect the credit. Depending on your circumstances, there are three standards you can implement to follow GAAP accounting for the Employee Retention Credit. They include:

• International Accounting Standards (IAS) 20, Accounting for Government Grants
• Accounting Standard Codification (ASC) 958-605, Not-for-Profit Entities – Revenue Recognition
• ASC 450, Contingencies

All not-for-profit organizations must follow ASC 958, but businesses can generally choose from any of the three options. However, if you accounted for your PPP loans using IAS 20 or ASC 958, you should do the same for the payroll tax credit.

Now, let’s explore how each ERC accounting method works.

ERC Accounting Under IAS 20

When following IAS 20, you should recognize the ERC over the periods in which you recognize the expenses it's meant to offset. To do so, you must have “reasonable assurance” that you’ll receive the credit.

Having reasonable assurance of an event means its occurrence is probable. In the case of receiving the ERC, you generally cross that threshold when your business meets the credit’s eligibility requirements and pays the necessary payroll costs.

IAS 20 lets you record the ERC on the income statement in two ways. You can show it as a separate credit, such as other income, or by netting it against the related payroll costs. In the latter case, you should include a disclosure explaining the presentation.

The other side of your journal entry to record the ERC would be a debit to reduce your payroll tax liability. If that reduces what you owe below zero, the excess amount shows on your balance sheet as a receivable.

ERC Accounting Under ASC 958

Under ASC 958, you must treat your ERC credit as a conditional contribution. That means you can recognize it on the income statement only once you’ve “substantially met” the conditions to earn it.

That’s a more difficult threshold to cross than IAS 20’s requirement of reasonable assurance, and some judgment is required to determine when you've reached it.

At the very least, you must meet the decline in revenue or suspension of service requirements and pay the eligible payroll costs. Preparing and filing the IRS forms to receive the credit may also be required, depending on whether you consider that to be “more than an administrative task.”

Not-for-profit organizations must record the ERC as revenue, while business entities can show it as either grant revenue or other income. However, neither entity type can net the credit against their qualifying costs.

Once again, the other side of the journal entry to record your ERC should be a payroll tax receivable or a debit to reduce your tax liability. Conversely, if you received an ERC advance before substantially meeting the conditions to earn it, you’d show a liability for any unearned portion until you clear the requirements.

ERC Accounting Under ASC 450

If your business accounts for the ERC using ASC 450, you’d treat the credit as a gain contingency. That involves recognizing it on the income statement only once you’ve resolved all uncertainties regarding receipt of the credit and the income becomes “realizable.”

That’s the most restrictive of the three ERC accounting approaches and generally requires deferring recognition of the credit until you’ve received your funds from the IRS or at least a formal letter approving your claim.

Either way, you should then record the credit as a separate account on your income statement like you would under ASC 958 rather than netting it with the related payroll expenses.

Apply For The ERC

The ERC can significantly reduce your payroll tax liability, with up to $26,000 in credits available per employee retained through 2020 and 2021. Even though the window for the ERC is closed, qualifying businesses can still claim the credit retroactively.

Because of the complexity of the ERC accounting rules, the repeated program revisions, and the timing complications, it’s essential that you consult a tax professional for assistance with claiming the credit.

In the meantime, apply for the ERC using our guided online application tool to determine whether you qualify.

After the start of the Covid-19 pandemic in March 2020, Congress passed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which provided numerous aid packages for both individuals and businesses. Part of the legislation was the Employee Retention Credit, which was designed to provide impacted businesses with a tax credit to help fund employee wages. Subsequent legislation extended this credit to 2021 as well.

In order to maximize your credit for both 2020 and 2021, it's important to fully understand (and document) your company's eligibility based on the ERC shutdown test. Here's everything you need to know in order to qualify.

Employee Retention Credit Eligibility Requirements

As a credit, the ERC directly reduces your business's tax obligation. You may be eligible for the credit due to either a full or partial suspension of your operations. Even essential businesses with impacted revenue may be eligible.

In order to increase your chances of getting approved based on basic IRS guidance, it's important to be as detailed as possible in your application. Learn the eligibility requirements, plus our best tips for submitting your application for the ERC.

General ERC Eligibility Requirements

The eligibility requirements for the ERCwere updated in 2021. 

2020 qualifications:

• Qualifying wages of up to 100 full-time employees
• A decrease in gross revenue of at least 50% compared to the corresponding quarter in 2019
• Or either a full or partial suspension of business operations created by a government mandate 

2021 qualifications:

• Qualifying wages of up to 500 full-time employees
• A decrease in gross revenue of at least 20% compared to the corresponding quarter in 2019
• Or either a full or partial suspension of business operations created by a government mandate

ERC Government Shutdown Tests

So, how do you determine if your business experienced a full or partial suspension due to a government order? In general terms, a suspension constitutes a government order having an impact on operations in either hours or service capacity. If a business faced a direct order to fully suspend their business, then they qualify under the ERC. If a business or portion of a business was deemed essential but were limited in hours and service capacity, they may still qualify as a partial suspension. This ERC shutdown test may seem straightforward at first, but there are a lot of murky areas that have been addressed by the IRS. 

Your business was essential but supplier shutdowns impacted operations. Even if your business was considered essential throughout the pandemic and wasn't subject to shutdown orders, you may still have experienced a shutdown if your suppliers were unable to make deliveries of critical goods or materials due to a governmental order that caused the supplier to suspend its operations. Documenting these negative setbacks that hurt your revenue could help qualify as a partial suspension.

Your business was required to reduce operating hours due to a governmental order.  The ERC partial suspension test acknowledges that some businesses may have scaled back on hours or the scale of operations in part rather than in full due to a governmental order. An example would be a business where part of the staff was able to work remotely, but other operations required in-person work and was shut down. 

Alternatively, a dine-in restaurant that switched to carry out and delivery during the pandemic would  be considered a partial shutdown since their operations were reduced but not completely stopped. 

Your business operated in multiple jurisdictions with varying degrees of shutdowns based on location. According to the IRS, this would still be considered a partial shutdown. It's important to note all states and locales in which you operated, since some may have had stricter shutdown rules than others.

Shutdown Impact

Once you’ve determined if you experienced a full or partial shutdown, the IRS wants you to prove you were affected greater than 10%. Here’s how that works. 

The Size Test

The size test for ERC qualification means that more than a nominal portion of your operations were suspended because of the government order, you can qualify for the tax credit. This is measured by either a reduction greater 10% of the total gross receipts or a greater than 10% reduction in the total employee service hours for the specific quarter measured year over year. 

The Effect Test

Another way you can qualify after a partial or full shutdown is the effect test. To meet the effect test, the IRS has said that you either have to demonstrate that the suspended portion of your business made up a greater than 10% portion of total operations, or that modifications made to the business due to governmental orders resulted in a greater than 10% impact to your ability to provide goods or services to your customers. For example, a restaurant had to limit occupancy to 50% due to a governmental order and could only seat guests in every other booth. Or, a dance studio had to cut group lessons and only offer one-on-one classes due to a governmental order. In each of these scenarios, the business would pass the effect test.

Best Practices to Demonstrate ERC Shutdown Eligibility

It's not too late for eligible businesses to apply for the Employee Retention Credit. To claim the 2020 credit, the application must be submitted by April 15, 2024. The deadline for the 2021 credit is April 15, 2025. IRS form 941-X is required to claim eligible employee wages.

However, the IRS has left quite a lot of gray area in terms of guidelines for the ERC shutdown test and has also noted that it doesn't plan to issue any further guidance. So it's important to be as thorough as possible when applying for the credit in order to maximize your tax savings. 

Lendio can help you apply for this tax credit. Here are some of the things to include in your application. 

• Revenue activities: Explain your business operations and how you typically bring in revenue. 
• Changes in income-producing strategies: Include details on how you adjusted your operations throughout the pandemic in order to continue bringing in cash flow.
• Total revenue: Analyze exactly how much your revenue fell between 2019 and 2020 on a quarterly basis. 
• Operating locations: Be specific with all the different states and jurisdictions in which you operated.
• Employee working hours: Talk about any changes in employee scheduling and number of hours of work that had to be adjusted in order to comply with social distancing best practices.
• Sales metrics: Give color to exactly how your business sales were impacted. Perhaps your foot traffic significantly dropped or you had difficulty closing sales over video or phone compared to in-person meetings. 
• Vendor disruptions: Even essential businesses experienced disruptions, particularly from other vendors who may not have continued smooth operations. List out vendor names, dates, and specific challenges and setbacks your business experiences because of third parties.

While the government passed multiple COVID relief packages for small businesses, including the CARES Act, the quick action often left questions about eligibility requirements. For restaurant owners, many wondered whether tips are included in the Employee Retention Credit. To address this valid concern, the IRS released guidance on when tips are considered qualified wages for the ERC, which also applies to businesses that have already filed for the ERC. 

Here's everything you need to know about counting tips as qualified wages for this important tax credit.

What Businesses Qualify For the Employee Retention Credit?

Before jumping into whether tips count as wages, make sure your business is eligible for the Employee Retention Credit. The food and hospitality industries were among the most impacted by the pandemic. Many restaurants and other related small businesses that survived and have employees who receive tips as income are likely eligible to meet these requirements.

2020 qualifications:

• Qualifying wages of up to 100 full-time employees
• A decrease in gross revenue of at least 50% compared to the corresponding quarter in 2019
• Or either a full or partial suspension of business operations created by a government mandate 

2021 qualifications:

• Qualifying wages of up to 500 full-time employees
• A decrease in gross revenue of at least 20% compared to the corresponding quarter in 2019
• Or either a full or partial suspension of business operations created by a government mandate

Businesses impacted by the pandemic may qualify under either full or partial suspension of operations. For instance, restaurants that switched from sit-down service to curbside pickup would qualify under a partial suspension. And if your business had locations in multiple jurisdictions, you could still apply based on the government restrictions experienced in some states, even if other states in which you operated were more relaxed.

Are tips qualified wages for the employee retention credit?

In most cases, tips do count as qualified wages, with just a minor exception. Notice 2021-49 from the IRS clarified that tips are included as qualified wages eligible for the employee retention credit as long as they exceed $20 in one calendar month. Under the IRS definition, tips can include cash or any other form of payment. So for each month an employee earned $20 or more in tips, that money can be included in their qualified wages to help qualify for an additional amount from the Employee Retention Credit.

What about the FICA tip credit?

Another clarification from the IRS confirmed that small businesses claiming tips as qualified wages are also eligible to claim the same wages for the FICA tip credit. This credit is available via IRS Form 8846. It allows food industry businesses to receive a tax credit on the social security and Medicare taxes paid on any tip income that's over the federal minimum wage. Your business can still claim the Employee Retention Credit while simultaneously claiming the FICA tip credit as well.

What if your restaurant already applied for ERC?

Even if your small business already applied for the Employee Retention Credit without including eligible tip wages, it's not too late to take advantage of this update. You can resubmit Form 941-X as an amendment to your previous tax filing for eligible years.

Note that the application deadlines for the ERC are April 15, 2024 for the 2020 tax year and April 15, 2025 for the 2021 tax year.

Lendio's tax partners have the necessary expertise to make sure you maximize this tax credit opportunity. Our platform integrates with your HR and payroll systems so you can avoid manually gathering and entering relevant documentation.

The COVID-19 pandemic created a variety of challenges for small businesses. Despite this, however, countless startups have successfully made their debut across the country during this time. If you launched a venture after February 15, 2020, you might qualify as a recovery startup business and be eligible for the Employee Retention Credit (ERC). Let’s take a closer look at what the ERC is and how you may benefit from it.

What Is the Employee Retention Credit?

The ERC is a refundable tax credit claimed on quarterly payroll tax filings. It was originally part of the CARES Act of 2020 and designed to help business owners who have struggled financially as a result of the pandemic. 

The American Rescue Plan of 2021 made changes to the ERC by extending it to “recovery startup businesses”. Depending on your situation, you may be able to claim the credit retroactively for both 2020 and 2021.

What Is A Recovery Startup Business?

Per the American Rescue Plan Act, a business that opened its doors during the pandemic can receive the credit. Your startup may be eligible if you meet the following criteria. 

• You started your business on or after February 15, 2020.
• Your average annual gross receipts don't exceed $1 Million for 2018, 2019 & 2020.
• You have one or more W2 employees, not including owner-operators or family members.

For example, if you launched a food delivery business on April 1, 2020 with three employees and earned $500,000 for the 2020 and 2021 tax years, then you’re considered a recovery startup business and a perfect candidate for the ERC. 

Unfortunately, if you started your venture in the second quarter of 2021, you won’t be able to claim any credit for 2020 or for the first two quarters of 2021. But, if you meet certain revenue reduction or government restriction criteria, you might be able to claim the credit for earlier quarters.

In addition, if you purchased an existing business that was in operation on or before February 15, 2020, you may or may not be considered a recovery startup business. It all depends on your unique circumstances. Since the rules around this particular eligibility requirement are complex, working with ERC tax experts can help you determine if you qualify.

What Can My Business Claim?

If you’re considered a recovery startup business, you can receive a credit in the amount of $7,000 per worker, per quarter. The max is $50,000 for the final two quarters of the year. To maximize your credit, pay close attention to your gross receipts and make sure you didn’t go over the $1 million annual revenue run rate limit for the 2020 and 2021 tax years. 

Let’s say you have four employees. If you multiply four employees by $7,000 per employee in quarter 3, you get $28,000. When you perform the same calculation for quarter 4, you also come to $28,000. As a startup with four employees, you’d receive a $56,000 check from the IRS. That’s a significant amount of money! 

You can put these funds toward inventory, equipment, a new office space, marketing, or any other expenses that can help grow your business. Another option is to simply distribute the cash to the owners. There is a lot of flexibility with how you may use the ERC.

What Are Qualified Wages?

Under the CARES Act, the definition of qualified wages depends on the size of your business. 

If you’re a smaller venture with an average of 100 or fewer full-time or full-time equivalent employees in 2020 or fewer than 500 full-time employees in 2021, qualified wages include all wages you paid to your employees, whether they were working or not. This includes qualified health plan expenses during an eligible quarter. A full time employee (FTE) is defined as anyone that worked more than 30 hours on average per week.

In the event you had more than the 100 (FTE’s)  in 2020 or 500 (FTE’s) across all affiliated businesses in 2021, qualifying wages have a slightly different meaning. These are wages that were paid to an employee for time that they weren’t working due to either suspended operations or a substantial decline in gross receipts.

How To Claim The ERC

While you’ve likely already filed your taxes for 2020 and 2021, you can still claim the credit retroactively. To do so, fill out Form 941-X. Be prepared to calculate your total qualified wages and health insurance costs for each quarter. You’ll subtract that amount from your deposit on Form 941. ERC Calculations and rules can be complex so often it makes sense to consult ERC tax experts for help.

If you meet the criteria for a recovery startup business, you owe it to yourself to take advantage of the ERC. While it’s widely available to many startups who launched during the pandemic, it’s often untapped. The ERC can give you the extra cash you need to meet a variety of business goals.

A hard inquiry takes place when you apply for financing—like a loan or a credit card—and a lender reviews your credit report during the application process. Hard inquiries have the potential to damage your credit score. But that doesn’t mean you have to worry about a credit score drop every time you seek new credit. And you shouldn’t be afraid to apply for financing when you want or need it either.

The subject of credit inquiries—especially hard credit inquiries—causes many misunderstandings. Here’s what you need to know about how hard inquiries really work and how to protect your credit score from damage.

What are inquiries on your credit report?

Consumer credit reporting agencies like Equifax, TransUnion, and Experian can only share your credit file details with those who have a permissible purpose to view that information. The Fair Credit Reporting Act (FCRA) outlines who is allowed to access your credit information and when. The same federal law also requires a credit reporting agency to let you know anytime it grants anyone else access to your sensitive personal credit information. 

A credit bureau informs you that someone has reviewed your credit information by placing a record of the access on your credit report. That record is called a credit inquiry.

What is a hard credit pull?

A hard credit inquiry—also known as a hard credit pull—is a type of credit inquiry that has the potential to impact your credit score in a negative way. However, if a hard inquiry does affect your credit score, any damage is typically minimal. 

Below are some common examples of hard credit inquiries. 

• Loan applications 
• Credit card applications 
• Applications for lines of credit
• Applications for credit limit increases

“When you apply for a credit card or any other type of loan (a mortgage, auto loan), you give the issuer or lender permission to check your credit report to assess your ‘creditworthiness’,” says CNBC contributor Elizabeth Gravier. “In essence, your potential lender is looking to see how likely you are to pay back the money you borrowed. The healthier credit history you have, the less risk you demonstrate, and the greater the likelihood you’ll qualify for that new credit card or loan.”

While you don’t need to totally avoid hard inquiries, you should be aware that they appear in your credit history.

How do hard inquiries affect your credit score?

Hard credit inquiries can often impact your credit score in a negative way. When they do, however, the impact is typically slight. 

Consider FICO® scores as an example. The “new credit” category of your credit report is worth 10% of your FICO score. And the number of hard inquiries that have appeared on your credit report in the last 12 months is one of the factors that influences this credit score category.

It’s also important to note that inquiries only factor into your FICO score for 12 months. FICO also ignores all inquiries that took place in the last 30 days when calculating your score. 

Consumer credit scoring models like FICO and VantageScore also don’t penalize consumers for rate shopping for certain types of loans. With FICO scores, you can apply for multiple mortgage, auto, or student loans within a 45-day period and the scoring models will treat applications for the same type of loan as a single inquiry. (Note: Some older FICO scores only allow for a 14-day rate-shopping period.)

How many points will a hard inquiry lower your credit score?

A new hard inquiry on your credit report won't cause you to lose a specific number of points from your credit score. And some hard inquiries might not result in a credit score point loss at all. According to FICO, one additional hard credit inquiry takes away less than five points from most people's FICO score. Of course, a large number of hard credit inquiries in a short period of time could lead to potential credit problems. Excessive applications for new accounts is considered to be risky behavior by credit scoring models. And too many hard credit inquiries could signal to potential lenders that you might be in financial trouble. 

Therefore, it’s wise to limit your credit applications. You should aim to apply for loans and credit cards for which you’re likely to qualify. It’s also smart to avoid seeking too much new credit at once.

How long do hard inquiries last on credit reports?

As mentioned, the Fair Credit Reporting Act (FCRA) requires consumer credit reporting agencies to disclose when they allow others to access your credit information. Depending on the type of credit inquiry, the FCRA may require it to remain on your credit report for anywhere from 12 to 24 months. As a matter of policy, some credit bureaus opt to leave all hard inquiries on consumer credit reports for up to two years.

What is a soft inquiry?

It’s important not to confuse hard inquiries with soft inquiries. A soft credit inquiry can also appear on your credit report as a record that someone has accessed your credit. Yet the key difference that sets the two types of inquiries apart from one another is the fact that soft inquiries will never damage your credit score. 

Below are some common examples of soft credit inquiries.  

• Checking your own credit report
• Employment-related credit checks
• Account maintenance credit checks (from current creditors)

Additionally, only you can see the soft inquiries that appear in your credit file. If a lender pulls a copy of your credit report, it will see only hard inquiries. Soft inquiries are not visible to potential lenders.

The bottom line.

As a small business owner, having good personal credit can be an asset when you apply for business financing. So, it’s wise to pay attention to the factors that influence your personal credit scores, including hard credit inquiries. 

You shouldn’t be afraid to apply for new credit when you want to borrow money for yourself or your business. Yet it does make sense to be strategic. Before you seek new credit, take the time to research financing options to discover the best solutions for your situation. 

You may also want to review your credit to learn where you stand prior to applying for new credit. It’s also helpful to discover which lenders have qualification criteria you are likely to satisfy. (For example, if a lender requires excellent personal credit and your personal credit score is fair, the loan probably isn’t a good fit.) 

Putting in extra effort to review your credit and research financing options up front might help you avoid additional (and unnecessary) hard credit inquiries. And you might also discover some great financing solutions for yourself or your small business at the same time.

When you're a small business owner, keeping your finances organized is crucial to your success—and it all starts with a good system for tracking your business expenses. Expense tracking is the gateway to cutting costs, improving cash flow, and optimizing your deductions during tax time.

Long gone are the days of balancing a checkbook and keeping an Excel spreadsheet. Now, there are dozens of tools out there that help business owners automate expense tracking and harness financial data that can level up your business. Here are some of the best tips and tools for tracking your small business expenses.

How to Track Business Expenses

1. Open a Business Bank Account
2. Get a Business Credit Card
3. Get an Accounting App
4. Evolve Your Tracking Methods
5. Keep Your Business Receipts
6. Record and Categorize All of Your Expenses
7. Consider Consulting an Accountant for Tax Planning

1. Open a Business Bank Account

Many businesses start as solo operations, and owners in these situations often focus on gaining traction and ignore everything else. It’s easy to create an accounting nightmare for yourself when that causes you to neglect the accounting function early on.

Business owners often run into this problem after a year or so of operations when they have to file their taxes for the first time.

For example, they might look back at the year and find they have no idea how large a tax deduction they can take for their travel expenses because each trip included some unknown amount of personal expense transactions. Come tax season, you won't have to dig through your statements and transactions to determine which expense was for your groceries and which was for your new office desk.

To avoid that issue, open a business bank account before you do anything else. Split your business and personal expenses as soon as possible by opening up separate accounts for your company. That usually includes a checking account and a credit card.

That said, they don’t have to be official business accounts, which may have different requirements or costs than personal ones. You can still use a card in your name as a sole proprietor. Just keep your funds separate to create a distinct paper trail.

You'll also get perks like checks with your business name on them, which makes your transactions appear more professional. Opening a business account and keeping it in good standing will help you build a business banking relationship as well, which may help you out when it comes to apply for a business loan.

2. Get a Business Credit Card

Contrary to popular belief, it’s not usually necessary to keep the receipts for all your business expenses. Feel free to ditch that messy shoebox crammed full of paper copies.

While business owners used to need those receipts for tax expense reporting purposes, they’re not as beneficial anymore. You generally only need to have documentation that proves the following:

• What you purchased
• When you purchased it
• How much it cost you

Fortunately, as long as you make your business purchases with dedicated business accounts, you’ll usually find all of that information in your bank statements and credit card bills.

Nowadays, you’d likely only need to keep an expense receipt if you want more insight into a transaction than a line item on a statement could give you.

For example, if you paid $1,500 to Amazon you might not be able to tell what it was for from your business credit card bill. You may need a receipt to document that $1,000 was for your new computer while $500 was for supplies.

However, you still don’t need to keep any receipts in paper form. It makes them far too easy to lose or damage beyond legibility. Take pictures of them instead and save the images in a folder for your records or auto-upload it to your bookkeeping software.

3. Categorize Your Expenses

Whether you complete your business purchases with a credit card, debit card, or cash, you need to have a system for categorizing them. It’s not enough to know that your business spent $500 last week. You need to keep track of which deduction to take.

In general, there are three ways to do this. The old-fashioned way is to keep a document or spreadsheet and manually log every transaction there. If your business pays for things in cash, you'll have to use that method.

However, there’s little reason to pay for anything in cash anymore. If you want to make tracking business expenses easy, always use a credit or debit card and create an electronic record for your transactions.

That opens up two other options for categorizing business expenses, both of which are superior to tracking things by hand. Namely, you can let either your bank or accounting software assign each expense category, manually updating them only when necessary.

Which option makes more sense for you depends on your needs. If you have a relatively low volume of expenses and little complexity, you can probably use your bank account or credit card statements to stay organized.

However, the more sophisticated your business transactions become, the more likely you’ll need bookkeeping software to stay organized. This makes it much easier to adjust your digital records directly.

4. Schedule Regular Check-Ins

Many business owners are uninterested in managing the financial side of things. They start their companies because of ambition or passion, and bookkeeping is significantly less exciting. As a result, it’s easy to procrastinate on the issue.

Unfortunately, tracking business expenses isn’t something you can neglect for long. Do you remember your days back in school when you received year-long projects? If you started at the last minute, you’d never be able to catch up in time.

Business expense management is a lot like that. You have the whole year to get your financial records in order, and you can’t afford not to use that time. Procrastination causes all sorts of problems, such as:

• Forgetting the purpose or details of expenses
• Compounding any early accounting mistakes
• Creating a massive headache for yourself during tax season

Conversely, if you stay on top of your bookkeeping from day one, everything goes much smoother. Expenses are fresh in your mind when you categorize them, fixing mistakes earlier prevents you from making them again, and you don’t need to rush at tax time.

Ideally, you should check in with your business expenses every month. If you don’t have enough activity to make it worthwhile, you can use a quarterly schedule instead.

You should generally check your expenses at least quarterly because that’s how often you need to make estimated tax payments. If you don’t know how much taxable income you had in the last quarter, you might not know how much you need to pay.

5. Finalize Your Financial Statements

Ultimately, business owners track their transactions to translate them into a balance sheet and income statement. These documents detail your business finances, including assets, liabilities, revenues, and expenses.

At the end of every year, you’ll need to update your financial statement to reflect the activity from the previous twelve months. Readers can use them to determine how much you earned or lost and your subsequent financial position.

Your financial statements essentially define your business, and you’ll need them to inform many different processes, including: 

• Calculating your annual tax liability
• Assessing the success or failure of your operation
• Determining whether you qualify for a business loan

Bookkeeping software is especially helpful at this stage. Creating your balance sheet or income statement in a spreadsheet is laborious and makes you susceptible to human error. You have to build the formulas yourself, and one mistake can throw everything off.

Meanwhile, bookkeeping software like Lendio's software can automatically categorize your transactions, generate your financial statements, and then update them in real-time in connection with invoicing software. Give it a try today!

6. Analyze Your Business Expenses

Once you have an accurate idea of your business’s spending trends, you have everything you need to pinpoint potential problems. More specifically, you can look for areas where you’re spending more than you’d like and make adjustments as needed.

Overspending doesn’t necessarily mean you were irresponsible with your budget like it would in your personal life. It could also mean you ran into surprise operating expenses or that costs ended up being higher than you expected.

As a result, tracking expenses can help you develop more accurate expectations, learn lessons from variances, and find areas where you can save money. For example, you could plan future estimated tax payments using your current revenues and expenses.

Bookkeeping software is also great for this kind of analysis. You can use it to facilitate many beneficial activities, like generating an expense report, comparing multiple data ranges, or drilling down into a financial statement.

7. Consider Consulting an Accountant for Tax Planning

With accurate financial records in hand, you can start to refine your tax strategy. If your business is sufficiently sophisticated, with reasonably high revenues and expenses, it’s often worth visiting an accountant for advice.

That doesn’t mean you have to hire one as an employee. Many small businesses don’t have the cash flow or the need to do that. Just reach out to a Certified Public Accountant (CPA) office and contract them out to help you with your tax strategy.

With an organized business expense tracking system and clean financial statements, any CPA would be happy to work with you. It makes their job much smoother, saving them time and you, money.

They can help you lower your tax liability each year by reorganizing your business’s legal structure, finding all potentially deductible expenses, and leveraging contributions to tax-advantaged accounts.

Reap the Rewards of Meticulous Tracking

Tracking all your business expenses is a lot of hard work—but it’s well worth the cost. With accurate expense data, you’ll be able to create dependable budgets, cash flow forecasts, and financial reports. You’ll know where you’re overspending and what expenses you need to cut or adjust to turn a profit.

With historical data to look at, you’ll know when the seasonal sales are coming and when the expenses tend to accumulate. Knowing this, you can prepare your business with a cash cushion or with the right small business loan.

Come tax season, you’ll be relaxed (or more relaxed) knowing the hard work is already behind you. If you choose to hire an accountant to handle your taxes, you’ll pay a smaller bill since they’ll have far less to do. Plus, you’ll take advantage of more tax deductions and credits, lowering your tax burden and saving your business extra cash.

Often, becoming a profitable business doesn’t require you to double your sales—it requires you to cut your costs. With expense-tracking data to guide your decisions, you’ll be able to confidently remove unnecessary expenses and prioritize the costs that move the needle. No, expense tracking isn’t always the flashiest administrative task, but it’s a necessary one.

The word depreciation strikes fear into the hearts of many. If you’ve taken an intro to accounting class, then a cold sweat may trickle down your spine as you recall calculating dreadfully confusing amortization schedules.

For small business owners, however, depreciation (done right) is a powerful tool not to be feared. Depreciation gives investors and lenders a more accurate look at your company’s financials, and it’s also a way to score sweet tax savings, too.

Take a hot shower, shake off the cold sweats, and get ready for a straight-line walk down depreciation lane. First, let’s start with the basics: what exactly is depreciation?

What Is Depreciation?

Depreciation is a way to allocate the cost of an asset over its useful life. Basically, when you buy something, it loses value over time due to use, wear and tear, and simply because it becomes outdated. While there might be nothing wrong with your iPhone 11, depreciation is the reason you can barely get $100 for it even though you bought it for $700 a few years ago.

Buildings, equipment, and computers aren’t the only things that depreciate. Your intangible assets like patents, copyrights, and software can all depreciate, too.

Depreciation can save your net income when it comes to the assets your business needs. For example, if you’re in the trucking business and need a big ol’ $150,000 truck to operate, you know you’re not going to recoup that cost for years to come—and depreciation understands that, too. 

That’s why depreciation empowers you to expense the value of your asset over the life of its usefulness. Thanks to this method, you’re not going to suffer an annual loss every time you make a major investment in your business—which is a huge perk when you’re trying to get a bank or alternative lender to loan you some cash.

What Assets Depreciate?

According to the IRS’s Publication 946, vehicles, machinery, heavy equipment, computers and office equipment, and real estate (excluding land) are all depreciable assets. In addition, assets must meet the following requirements:

1. You must own the asset.
2. You must use the asset for business- or income-producing activities. 
3. Your asset must have a determinable useful life.
4. Your asset must be expected to last at least 1 year.

In certain scenarios, even intangible assets like patents, copyrights, and software can be listed as depreciable.

How Depreciation Can Help Your Business

As a business owner, you’ll inevitably take out a loan or front the costs to acquire specific items for your business. Whether that’s a fleet vehicle, a new piece of specialized equipment, or some other asset doesn’t matter. Whatever you purchase will likely lose its value over time. Instead of deducting the total amount of the purchase up front as an expense, depreciation allows you to recover the cost of the property over the course of its life. That means you can make some of the money you spent on it back each time you file your taxes—or at least reduce the amount of your taxable income, which boosts your tax savings.

Here are a few fantastic advantages that will make depreciation your business’s best friend:

Tax Savings

Several business expenses are tax-deductible, and depreciation is no exception. By claiming depreciation expenses on your assets, you lower your taxable income, increasing your tax savings. When business is slow and the revenue is trickling, some small business owners decide to depreciate using the accelerated method: this method allows you to claim larger deductions early on, helping to offset the price of the asset (more on this later).

Expense Reporting

Depreciation expensing paints a clear picture of how you’re using your capital. When you estimate the cost of an asset’s use over a period of time, you’re then able to compare how much revenue it generated (over that same period of time). When you can compare the expense and the resulting income side-by-side, you’ll have a good idea of your efficiencies or inefficiencies and be able to adjust accordingly.

Accurate Asset Valuations

It’d be misleading to you (and potential investors and lenders) if you only recorded the initial value of every asset you purchased. Because the truth is, that van you bought for the company a few years ago may be worth less than half its purchase value now. By depreciating your assets, you’ll know at any given time how much potential liquidated capital you actually have.   

Cost Recovery

If you bought a $5,000 freezer and it depreciates over the 5 years of its useful life, then each year you’d depreciate the asset by $1,000. You’d also know that you should save $1,000 each year so that in 5 years, you’ll have enough money to replace the freezer. Without the depreciation expense, you may not have saved enough money by the time the asset needed replacing, or you could have saved too much—needlessly tying up a portion of your capital.

Types of Depreciation

There are 4 standard depreciation methods businesses use. One isn’t better than the other, per se—you’ll just need to run the numbers for each scenario and see which is most appropriate for your operations. While the straight-line method is the most common, take your time before you choose. The hassle of calculating a more complicated method may be worth the immediate thousands in tax savings.

1. Straight-Line Depreciation Method

The straight-line depreciation method expenses an asset at an equal amount each year over its useful life. Most small business owners love this method because the formula is so downright simple: you just subtract the asset’s salvage value from its initial cost, and you divide that number by its useful life. Voilà—that’s the amount you depreciate each year. Here’s the equation:

(Asset Cost – Salvage Value) / Years of Useful Life

Let’s look at a practical example. Let’s say you want to depreciate a copy machine for your business. You’d open the IRS’s Publication 946 and find that a copy machine is classified as a 5-year asset. You bought the copy machine for $2,000, and you estimate you’ll be able to salvage the copy machine for $200:

($2,000 – $200) / 5 = $360

There you have it—each year, you’d depreciate the copy machine by $360.

2. Units of Production Depreciation Method

The units of production depreciation method is more appropriately applied to assets used to produce goods or services. If the age of an asset matters less than how much it can produce before it dies, then consider using this method. For example, you might want to use units of product depreciation on a mold used in your assembly line or on a piece of equipment used to make a t-shirt.

Units of production depreciation makes sense to use when the use of your asset fluctuates. If your use is consistent, then it’s more simple to use the straight-line method. However, if varying seasonal demand puts an inconsistent strain on your asset, units of production depreciation might give more accurate insights about the life of your equipment.

Here’s the equation you’d use to calculate units of production depreciation:

(Asset Cost – Salvage Value) / Estimated Total Units of Production

Let’s look at an example. Let’s say you bought a stone oven that you estimated could produce 10,000 pizzas before you needed to replace it. The oven cost $10,000, and you believe it’ll salvage for about $1,000:

($10,000 – $1,000) / 10,000 = $0.9

So each pizza you produce would incur a $0.9 depreciation expense for your oven. If you cooked up 1,500 pizzas over a year, your oven would have depreciated $1,350.

Since you’re likely not counting how many pizzas come out of your oven, units of production depreciation may not be the best method for every business. Manufacturers will benefit the most from this depreciation schedule since they keep a closer eye on the inputs and outputs of all their operations.

3. Double-Declining Balance Depreciation Method

The double-declining balance method may sound like a hip new dance the youngsters are doing, but it’s much cooler than that. With this method, you depreciate more of an asset’s value upfront and less and less over time. It’s similar to how you might approach your dinner plate when you’re dangerously hungry—you attack and eat your first helping lightning quick, and then you peter off and eat at a more mellow pace for the rest of the meal.

This depreciation method leads to bigger tax write-offs in the years right after you’ve purchased your asset and smaller write-offs towards the end of its useful life. Here is the formula for calculating double-declining balance depreciation:

2 x Basic Depreciation Rate x Book Value

Let’s break the formula down. First, let’s find the basic yearly write-off. The basic yearly write-off is the cost of your asset divided by its years of useful life:

Basic Yearly Write-Off = Cost of Asset / Years of Useful Life

To find the basic depreciation rate, divide your basic yearly write-off by the cost of the asset:

Basic Depreciation Rate = Basic Yearly Write-Off / Cost of Asset

Confused yet? Don’t worry. Let’s look at a practical example, and then you’ll have a good understanding.

Let’s say you bought a taxi for $10,000. According to the IRS, a taxi would depreciate on a 5-year schedule. So the taxi’s basic yearly write-off would be $10,000 divided by 5:

Taxi Basic Yearly Write-Off: $10,000 / 5 = $2,000

Now, let’s find the taxi’s basic depreciation rate. You’d divide the basic yearly write-off ($2,000) by the cost of the taxi ($10,000):

Taxi Basic Depreciation Rate: $2,000 / $10,000 = 0.2%

Now, plug that number into our double-declining balance depreciation formula:

Taxi Double-Declining Balance Depreciation: 2 x 0.2% x $10,000 = $4,000

So, after the first year, you’d have a $4,000 depreciation expense for the taxi. But next year, when you calculate the depreciation, the taxi’s book value will only be $6,000 ($10,000 – $4,000). At that rate, the second year’s depreciation expense will be $2,400. Then, the third year’s depreciation expense would be $1,440.

Hopefully, with this example, you can see how the asset starts at a super high depreciation expense, and that number starts to dwindle over time. So, why would anyone want to use the double-declining balance depreciation method when the straight-line method is obviously more straightforward?

4. Sum-of-the-Years-Digits Depreciation Method

The sum-of-the-years-digits depreciation method (SYD method), like the double-declining balance method, is another form of accelerated depreciation. It’s not quite as fast as double-declinching, but it’s still quicker than straight-line depreciation.

To calculate depreciation using the SYD method, assume you bought a pickup truck for $30,000 with a salvage price of $10,000 after 5 years. Here’s the formula you’d follow:

(Remaining life / Sum of the Years Digits) x (Cost of Asset – Salvage value)

Remaining life would be how many more years of useful life the asset has left. So, the first year you depreciate, it’d have 5 years of useful life. The second year you depreciate, it’d have 4 years of useful life remaining.

Find the sum of years digits by adding how many remaining years of usefulness are left after each year. So, for a 5-year asset, the sum of years digits would be 5 + 4+ 3 + 2 + 1 = 15.

Plug those numbers into the equation for the first year, and you’d get…

SYD Depreciation Expense Year 1: (5 / 15) x ($30,000 – $10,000) = $6,666

Do it again for the second year, and you’d get…

SYD Depreciation Expense Year 2: (4 / 15) x ($30,000 – $10,000) = $5,333

Choosing the Right Depreciation Method

There’s no one right way to depreciate your assets. Your business is free to adopt whichever method is most appropriate (and beneficial) to your operations. Depending on your current financial situation or even your predicted tax bracket in the coming years, you may opt for one method over another.

The straight-line method is the most commonly used because it’s easy to calculate, causes fewer reporting errors, and is simple to report on tax returns. However, you may use an asset heavily at the beginning of its useful life and less as times goes on (maybe because you expect to buy more of that asset as you expand). If that’s the case, the double-declining depreciation method may more accurately describe the asset’s expense.

“The “best method” is the one appropriate for your business and situation, says Morris Armstrong, an agent at Armstrong Financial Strategies. “Sometimes, people want to write something off as quickly as possible, even if they do not have the annual income to warrant it. So they accelerate the deduction schedule, only to realize later on that they would have been better off taking the depreciation at a slower, more consistent pace. You should run the various depreciation-calculation scenarios through the tax program with an eye not only on the current return but on returns down the road and the condition of your company in future years as well.”

In the end, it’s up to you to decide how you’re going to depreciate an asset. You don’t have to depreciate all your assets the same way, but you need to make sure you’re consistent with each asset.

The Bottom Line

For those of us non-accountants out there, we don’t have to pretend that depreciation is fun. Because it’s not. But, hopefully, you can now see how incredibly useful it can be for your small business. Get your depreciation strategy right, and you could save a boatload of cash when you need it. Get it wrong, and you could find yourself in an unnecessary tax crunch at an inopportune time.

While you may have an accountant or defer all your tax obligations to one, it’s still good to understand the fundamentals so you can help make important business decisions. With this basic understanding, you now have the knowledge you need to leverage depreciation to its maximum potential. Congratulations, entrepreneur!

While it’s easy to dislike depreciation (what’s to like about a whole bunch of math?), keep in mind all the good it can do for you and your business. Remember: don’t hate, depreciate.