How do I organize my business records?
This is one of the most common questions I receive. There is no single answer but the simplest response is it depends on you and your business. First and foremost, while you are likely good at your business, the bookkeeping portion can be a real headache. It doesn’t have to be. Let’s look at several factors affecting the way you need to keep your records.
SIZE OF BUSINESS
This is a big factor. Obviously a large corporation is going to have different record keeping methods than a mom and pop operation. Quickbooks is a good place to start and will help you keep your business books separate from your personal income and expenditures. I can help you at any level, from basic set up of your Quickbooks to complete ongoing bookkeeping throughout the year. The primary thing to remember is to use a method that you will keep up with. Trying to compile a year’s worth of activity can be tedious if you don’t have some sort of plan.
TYPE OF BUSINESS
There are two primary types of business: Service based and Merchandise based. In a service based business, your primary product is a service that you or your employees provide, such as lawn care, welding, delivery, consulting, or repair. You bill based on your time and work, rather than primarily selling a product.
A merchandise based business means you primarily sell a product, such as cosmetics, vitamins, and shoes, whatever. This is a bit more complicated when it comes to keeping records. Used to be you had to take an annual inventory of goods on hand to sell and report everything on an accrual basis. However, the IRS now allows small businesses to maintain cash books, i.e. reporting all transactions based upon when the cash changes hands. Call me and we can decide which works best for you.
A third type of business would be a combination of both. If you are a repair person, for instance, you might charge for the cost of your time to make the repair plus the cost of the parts needed to make the repair.
Finally, you might sell a product but not maintain an inventory of merchandise. Usually you sell an item based on product samples that you have purchased but merchandise is ordered only on the basis of what is sold (like Tupperware). In this case you need not take an inventory count because what you keep on hand is primarily product samples and not merchandise you keep to sell directly.
There are many ways to keep your records; you should choose what best suits your time and bookkeeping inclinations.
Assuming your business is a sole proprietorship, you are not required to have a separate bank account. However, for ease in recordkeeping I highly recommend you keep your business money and your personal money separate. If you use a credit card for business purchases I recommend the same thing: have one credit card dedicated to business use only. Also, try to pay via credit card, debit card, or check, rather than cash. Oftentimes cash transactions get lost in the shuffle costing you needless tax dollars.
I recommend you use Quickbooks to maintain your records. Other methods are certainly acceptable but Quickbooks is uniquely designed to help you organize your books and records and grows in function as your business grows in size.
WHAT INFORMATION DO I NEED TO COMPILE?
First would be your income. This is what you take in for what you sell, whether it is your service, merchandise, or a combination of both. This is probably the easiest part. You may also have received one or more forms 1099 for services you rendered. Be sure to include those with your tax information.
The more difficult part is your expenses. The obvious ones are items that are directly related to your business, including the cost of the merchandise you sell, office or shop rent, postage and shipping costs, salaries paid to employees.
Less obvious are overhead expenses. These include office supplies, business insurance, business travel, advertising, etc.; any expense that you would not otherwise incur except for your business.
Two other major items are car expenses and expenses for maintaining an office in your home.
CAR AND TRUCK EXPENSES
These days most business owners use a car or truck in their business, whether it is to haul lawn care equipment to a job site or deliver merchandise to a customer. Other business uses of your automobile include driving to the post office to mail invoices, the bank to deposit income, the office supply store to pick up pens and paper, attending business related seminars or conferences, and calling on a potential customer to give an estimate or deliver a catalog. Even if no business actually culminates from the drive, as long as the primary purpose is to conduct business, it is business mileage, and should be tracked.
You can use a couple of different ways to track your mileage. Ultimately, a vehicle mileage log should be kept, recording odometer readings, dates, and purpose of the trip. That can be a pretty tall order but will pass an audit easily.
There are apps available to help you as well, utilizing either your odometer or GPS to track your trips daily. For a small fee they will also produce reports for year end reporting.
You can also keep a diary of trips and number of miles driven, along with the purpose of the trip and the customer name. A pocket calendar, blackberry or other date record is acceptable.
Keep one thing in mind: If you believe you can go back and fill out a calendar or datebook with that information, years after the fact, the IRS is on to that. If they determine that is what you did, rather than keeping contemporaneous records, you could be charged with fraud. So just make up your mind that the deduction is worth the effort and do the work.
The least favorable method, although acceptable, would be to count up the number of trips made to business related destinations along with known round trip mileage to each destination. This can be accomplished by reviewing your check register or receipts, determining the number of trips during the year to the locations depicted and multiplying by the round trip mileage to those destinations. This method is least favorable because first, you are likely to overlook some deductible mileage. Money does not always change hands on a customer visit so you might not remember that extra trip to see that customer. You won’t always know the round trip mileage and spend a lot of time searching an online direction service to determine that.
Bottom line, use SOME sort of way to track your mileage. You are allowed 57.5 cents per mile for business mileage. While you may think, well, I don’t really drive all that much. But here’s an example of even a small amount of business mileage and what it can save you in taxes:
You only drive an average of 20 miles per week for business, or 1000 miles a year (assuming a two week vacation). At the current mileage rate that is a deduction of $575. The lowest income tax rate currently available is 10%; the self employment tax rate is 15.3%. That means you will pay at least 25.3% of your bottom line profit to the IRS. That minimal mileage deduction is worth $145 in your pocket if your business is showing a profit!
If you commonly use more than five vehicles in your business or prefer to use the actual cost method, you will STILL NEED TO TRACK YOUR MILEAGE. The IRS allows you to take the business portion of actual expenses but that business portion is determined by comparing business miles driven to total miles driven.
The types of actual out of pocket expenses you need to compile include fuel, maintenance (oil changes, car washes, etc.), repairs, insurance, tags, and interest on your car loan; basically any costs related to the upkeep of your automobile.
Some actual expenses are deductible using either method, so if you use the mileage rate option, you will still need to keep up with:
- Interest paid on your car loan
OFFICE IN HOME
This is a scary topic for some taxpayers. Don’t let it be. It is a legitimate expense and, if taken correctly, will NOT be a “red flag”.
An office in home is a space you use exclusively for your business. It can include an actual office, storage space for merchandise, a room you use exclusively to meet with customers, etc. It can even include a corner of your bedroom or family room where your desk is located and where you take care of invoicing, customer calls, and other business exclusively. Notice the repeated use of exclusive. This is an IRS requirement. You cannot take the deduction if you simply use your dining room table to compile your paperwork. You cannot take your garage used to store your car that you occasionally use for business. You cannot take the space of a bathroom if your customers occasionally use the facilities. It is a place set aside for business use only, or a separate structure utilized for business use only.
For this deduction, you need to determine the size of the business space and the size of your home. For example, you have a 1500 square foot home and use a 10 x 15 room for your business. I need those numbers to report on your return but you will basically be getting 10% of all monies spent to maintain your home. Those expenses include, but are not limited to: rent, mortgage interest, mortgage insurance, real estate taxes, hazard insurance, utilities, maid service, pest control, carpet cleaning, painting, etc.
Keep in mind the business space must benefit from the expense. In other words, the cost of painting your living room would not count. The cost of spraying the entire house for bugs would count. If the expense is strictly for the business space, you need to list that separately as you are allowed to take that entire cost. Examples of that would be painting the room or buying drapes for the business space.
If your business suffers a loss (as opposed to a profit), you will only be allowed to deduct the business use portion of your real estate taxes and mortgage interest. However, the other expenses, while not deductible that year, are available to be carried forward to the next year, which might be more profitable. So track the expenses, even if you expect to lose money this year.
The IRS just announced that for tax years beginning in 2013 (tax season 2014), you may choose to deduct $5 per square foot of office space, up to a maximum of $1,500, for office in home expense in lieu of tracking all the actual expenses. All other limits and exclusive-use rules still apply.
Another important aspect of taking the Office in Home deduction is how it affects your business mileage. If you do operate your business out of your home and you do NOT take an office in home deduction, then the first trip out of your driveway every single day is not deductible, regardless of the purpose of the trip. The IRS reasons that, if you're not taking the office in home deduction then the first trip of the day is considered commuting and is NOT deductible.
CANCELED CHECKS VS. RECEIPTS
Which should you keep? Well, these days, few banks actually return canceled checks. If you’re lucky, your bank might provide copies in your monthly statements. They are often available online. Receipts are the preferred method of proving an expense. Canceled checks can be used, but are a higher risk for disallowance of the deduction.
Neither is necessary for me to prepare your return. However, in the unlikely event of an IRS Tax Return Examination, they are essential. Basically, what you cannot prove with either a receipt or canceled check will likely be disallowed, thereby resulting in your owing the IRS more money. So keep that in mind as you’re thinking of tossing those receipts.
I also have available a business organizer to help you compile your income and expenses. It is a generic form intended to be a “tickler” to help you remember what income and expenses are deductible. However, if there is ever a doubt, include the item in question. Better to include something that is not deductible than to leave off a potential deduction.
Bottom line, unless you want to pay me an hourly rate to organize and total your records, I do not need to see your canceled checks or receipts. A listing of what you made and what you spent is all I need. Just remember, in the event of an IRS audit, YOU are responsible for providing the IRS with proof that the expenses exist via receipts, cancelled checks, and diary records.
Please contact me if you have any questions about your business recordkeeping.