Updated December 8, 2020
The IRS is becoming increasingly vigilant about closing the Tax Gap; that is, the difference between what is owed and what is paid. The Service is checking small businesses to make sure that all income is reported and that deductions are legitimate. Now might be a good time to review, refine and/or implement an extremely important practice that will minimize your chances of getting audited by the IRS, or, if you are audited, of surviving an audit with a smile. While not much can be done about last year, you can certainly make yourself less audit-prone this year.
You must make sure that you capture and keep all business records to support your business’s deductions. Keeping good business records can help you find what you need with minimal hassle, but more importantly, those records will be needed to support your tax deductions and avoid problems with the IRS. Work on this principle: “You can’t deduct it if you can’t find the record.” So, the first, and probably the most important, task you have in business record keeping is keeping track of your records. That is, you must gather up the records, store them in some semblance of order and organize and record them for reporting on the appropriate tax return. If you don’t keep the records, you won’t have anything to substantiate to the IRS, and you won’t be allowed to take those deductions and credits.
Here is a quick list of categories of records to capture:
- Income/Receipts. Keep all deposit slips, and be sure to note the source of and reason for each payment. This is especially important if you own multiple entities and one is making a payment to another. Make sure each payment received is matched to an invoice, sales slip or closing statement. If you make a loan to your business you must make sure it is supported by a promissory note.
- Purchases and Recurring Expenses. Keep all bank and credit card statements, canceled checks (using duplicate checks is a good idea), and credit card slips or receipts from in-person expenditures. Keep all invoices and other receipts. And don’t forget to use petty cash slips so you can capture all those small cash expenditures. When you seek reimbursement from your business for expenses you incurred on its behalf, make sure you note the date, amount and reason for each every dollar you spend.
- Travel Expenses. Keep a log of all travel by car; log every trip – when and where you went, who and what did you see, and why. Keep your receipts for all expenditures for air travel, lodging, and meals.
- Assets. Record all information about the purchase of business assets starting with the purchase price and including setup, delivery, and training. Keep track of maintenance and other expenses for use of the asset, and don’t forget to record accumulated depreciation.
- Employment Taxes. Keep all employment tax records for at least four years.
Keep things organized; that is, keep it simple and safe. No matter how small or large your business, you need to keep your records in a usable, organized fashion. Here are some tips:
- Get a file cabinet (a box will do, or one of those plastic file folder holders from the office supply store) and a bunch of cheap file folders.
- Create as few categories as possible. Use the five categories above, for example. Don’t worry about getting things into a specific detailed category. All you really care about is maintaining the record at this point; it really doesn’t matter how many or how few folders you have. It may be as simple as one folder for income, one for expenses, one for bank statements and credit card receipts, one for travel, one for asset purchases, and one for outside services (independent contractors). You may not have petty cash or employment taxes.
- Keep the file folder system next to the place where you sort your business mail, so all you have to do is take it out of the envelope, note what it is about, and deposit it in the correct folder. All in one smooth motion. No wasted effort.
- Make notes on statements, particularly bank account statements and the credit card receipts. If there is no detail available on deposits or receipts, make a note of who the income came from and who the check was written to.
- Capture asset paperwork. If you buy an asset during the year, capture the paperwork in the “asset” file.
- Capture travel paperwork after every trip or every month. For travel, make a separate file and dump all receipts (don’t forget tolls) and mileage logs into a file folder.
Implementing a system that will capture the business records you will need later if essential. It’s up to you to keep the records; they are your principal weapons to fight an audit.
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