By Karen Wiseman, EA
The bulk of small businesses in the country today have less than 3 employees. Many of today’s entrepreneurs started their business to make a living and survive. If you can start a business, feed your family, pay your mortgage and create some value, I would consider you a success. My goal with this article is to pass along some knowledge and tools to help you.
When you start a business, you wear all the hats… janitor, IT professional, office manager, and bookkeeper. If you are like many small business owners, bookkeeping is probably not your top priority. In fact, I’m willing to bet that you don’t like the task of bookkeeping at all. Our tax system is a self-assessed tax system. You determine what your tax obligation is based on your profitability and then pay the corresponding tax. If you can’t calculate your profitability numbers accurately then how can you remit the correct tax?
No matter what type of business you have, every dollar you spend to run it is generally deductible. However, you must keep all your receipts to ensure that you can back up any expenses. What about cash payments? In that situation your receipt becomes your only documentation. If you lose that then you have no deduction. Do you need to keep a receipt if you have a credit card statement listing the charges? You need to keep both the receipt and the statement. The receipt tells a story… a restaurant receipt tells how many people were in attendance the date, time, etc. Get in the habit of jotting down on the back of the receipt the people that were with you and a few words to help you recall what business you discussed. This ensures that if the return is pulled for audit two 2 years later you will be able to remember those details.
Just because less than 1% of all returns are audited, it doesn’t mean you will continue to get a pass for all the years you expensed your personal auto at 100% or paid personal expenses through your business. It just means your return hasn’t risen to that 1% number…yet.
THOU SHALT NOT CO-MINGLE FUNDS!! – If you are self-employed technically you don’t need a separate bank account however I strongly encourage you to set one up. Co-mingling your business funds with your personal opens the door to the IRS’s ability to review both. Personal expenses could be considered compensation to the business owner and could make them subject to payroll taxes. It also creates a bookkeeping nightmare of what is or isn’t a business expense.
Vehicle expenses are another area where business owners can get into trouble. Let’s take for example, a taxpayer filing his own return that took 100% of his auto expense. When the return was pulled for audit, he was asked if he went to the grocery store, out to eat or to the bank during the year and if so did he go on foot! Obviously, that was more than likely false. You need to be able to provide accurate facts and circumstances to support your deductions and they need to be reasonable. There are many “apps” on the market that can help you document your mileage and provide you with an annual report.
How long should you keep records for? For as long as their content is material to your return. According to the IRS, all documents that support an item of income, deduction, or credit shown on your tax return should be kept for a minimum of 3 years and some indefinitely depending on the activity they support. Returns can be audited up to three years after the tax return is due or filed. That means if you filed an extension which extends the filing of your return to October 15 then for the 2015 TY you need to keep that return until October 15, 2018. Tax returns where you omitted more than 25% of your income or that contain fraudulent deductions have no statute of limitations.
Which records do you keep forever? If you have a change in your accounting method – where you go from cash basis reporting to accrual you need to keep the relating documentation. All purchases of tangible or real property should be kept in a permanent file.
Let’s use your personal residence as an example. There is nothing to report when you purchase your house but when you sell it you need to report the sale on your return. This doesn’t necessarily mean it is taxable. To calculate whether it is taxable or not we take the purchase amount and add any capital improvements you made to the home (new windows, tile floors, remodeled kitchen) less the selling price and the net of that is what goes on your return. (subject to any exemptions) It is the same principle with business property. You bought a new desk for the business. You need to keep the receipt and that is your basis in the property. If you dispose of it or sell it you will have a gain or loss.
QuickBooks, Spreadsheets, or columnar paper – it doesn’t matter what you do your bookkeeping on. Whatever works for you as long as the records reflect everything that went on in the business. The most important thing is that you understand your reporting obligations and you keep the financial records in order!
Wiseman Tax & Bookkeeping
This material has been prepared for informational purposes only and it is not intended to provide, and should not be relied on for tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.