As your business ramps up, employing a foolproof system for tracking expenses and revenues will keep you from getting in over your head or inadvertently overpaying Uncle Sam.
To claim business expenses, like office supplies or meal expenditures, the Internal Revenue Service now expects you to keep not just receipts but detailed records describing the date, location and reason for making an expenditure.
Here are some proven ways to do that:
Keep detailed accounts
One of the first things that you want to do is track your expenses day by day. You can do this with the aid of a good old-fashioned FiloFax, where you can cram the receipts in their respective monthly slot. Another option is to go digital with a service such as shoeboxed, which can create an online archive of your receipts.
In particular, here are specific types of receipts that should be on your radar:
– Office-related expenses. This includes things like paper and ink for your printer, pens, files, and paperclips – the stuff that keeps your office running smoothly. You can also keep track of things like phone and internet expenses, which are important to keep any office humming.
– Dining-related receipts. Remember that those times when you’re discussing a deal over dinner qualify as a write-off.
– Car-related expenses. This includes gasoline for those trips to pick up supplies and to meet clients. If you do take any business-related trips, of course, save any expense receipts from your time on the road.
You also need to have a solid day-to-day bookkeeping plan in place in which you can systematically keep track of your business financial transactions. Using accounting software such as QuickBooks can make tracking of expenses easier. If you do have an accountant, it can be helpful if you use the same software, because it will make importing information a breeze at tax time. Another option is to track this information in a basic Excel spreadsheet.
One important thing you shouldn’t overlook here is the accounting method that you select for keeping the company’s financial books. There are two key choices – cash-basis accounting and accrual accounting. Which one you choose can actually impact your tax bill.
With cash-basis accounting, you record any money earned on the day the money is paid. So, if you are, say, a carpenter who builds bookshelves and you bill a client for a $2,000 for some custom shelves on December 28, 2015, but the client doesn’t pay you until mid-January, the tax bill for this would fall into your 2016 income.
However, with accrual accounting the revenue is recorded when the transaction takes place. So, as soon as the contract for the bookshelves is completed, it would be recorded as income. You could, of course, in both cases note the expenses for the bookcases, such as the lumber, nails and any paint needed that you supplied for the job. Such expenses are recorded when they are incurred, even if these haven’t been paid for yet.
What that means for the bookshelf billed on December 28, 2015, is that if accrual accounting is used, the tax bill will be higher since you have to include the income from the shelves in addition to subtracting the expense of building them. Meanwhile, with cash-accounting, you’d be able to deduct the expense of shelves in 2015 and not worry about the income made from these until 2016.
Some businesses may not have a choice here; it is generally accepted that all incorporated companies must use accrual accounting methods, so always check with your accountant to make sure the method you choose is right for you.
Whatever the method you use, as long as you diligently stick to your tracking plan, consistently writing down what comes in and what goes out, you won’t find yourself answering embarrassing questions from Uncle Sam this year or any other.