End of Year Catch-Up: Part 1

Fall is here.  The leaves are turning, school is back in session, and you, like many owners, may be in the early stages of panic about your business finances for the year.  Happily, now is the best time, for the rest of the year, to get caught up on your records, filings, and tax payments for 2017.  Whether you are starting from absolute zero, or you have incomplete records, read on to discover the best tasks to undertake to make your tax preparer love you, come January.

Need to Track Down Income and Expenses for the Year?

Tracking and recording your business activity throughout the year is one of the most important steps to being self-employed.  If you aren’t tracking activity, how do you know if you’re doing well? How do you measure yourself?  The first step is to identify business income and expenses, and there are several methods to identifying and categorizing this activity, depending on your banking set-up. 

If you have maintained a separate bank account for your business, it should be very easy to allocate business expenses into appropriate categories.  Simply download an Excel or CSV report of all your YTD transactions, and add in notes for what each expense was, and its category.

If your business activity is, instead, tied up within personal bank accounts and credit cards, this process will be more extensive.  You will have to review all transactions, for all accounts, for the whole year to identify all the business-related activity, and then categorize transactions appropriately.

Often, the more transactions you can deduct as business expenses, the better, however it is important to be aware of common expense deduction categories– A lot of activity can be business related, but not everything.

What is the Best Way to Record Activity?

Depending on the size of your business, some record keeping options may be better than others.  For the particularly well organized, a detailed spreadsheet may be sufficient, with monthly totals for income and expense categories, and separate pages showing the transaction details.

For others, using Quickbooks, or a similar bookkeeping software may make the most sense.  For many owners with a Schedule C return, Quickbooks Simple Start or Self Employed is sufficient.  As the company grows, it is easy to upgrade into more robust software.  Keep in mind that the initial set up can take time and effort, but once it is up and running, maintaining a QBO file is simple.

What Other Records Should I Track Down?

If you can produce a detailed, and complete activity record, receipts for that activity should be your second step.  As discussed in previous posts, receipts are audit insurance for your business.  It is more difficult for an auditor to disallow a questionable transaction if a receipt is provided to back it up.  Receipts for supplies, advertising costs, travel, meals, subscriptions, etc can be annoying to track down, but are usually well worth the effort in case of an audit.

Lastly, Assets

As business owners, our operations require computers, equipment, desks, vehicles, and other large purchases, however it can be difficult sometimes to determine whether the asset should be recorded on the business’s books or not.  In the end, it comes down to the question: Who receives the benefit and utility of the item?  Purchased a laptop for email and client work, yet you use it every evening to watch Netflix?  Maybe you purchased a car to go and visit clients and job sites, but you also ferry your kids around to school, practice, or other events.  In both instances, the separation between the business and personal uses is blurry and unclear, and your tax preparer will have a more difficult time making a case for the expense.  You are better off purchasing another laptop for personal use or a separate vehicle for your family’s needs.

If you purchased a business asset, be doubly sure to keep those receipts handy – Your tax preparer will want to know the details of the transaction to record it appropriately.

 

Next in this series: How to Catch Up on Missed Tax Payments.

Receipts - To Keep or Not to Keep?

Receipt collection inspires the same adage and advice, again and again.  “Make sure you keep your receipts!” is nearly always the first thing to come out of people’s mouths when discussing self-employment.  However, anyone who has ever made consistent receipt collection their New Tax Year’s resolution after a particularly frustrating tax season will have hit all the same road-blocks since tracking and collecting receipts is frustrating

Why Is Saving Receipts Important?

The easiest way to justify tracking and managing receipts is to compare this process to transaction insurance in case of an audit.  Receipts prove that your transactions are business related, and are therefore legitimate business expenses.  Additionally, if retail items are purchased, receipts record whether sales tax was paid upon purchase, preventing additional tax and penalties on the goods.

In case of a normal IRS audit, a transaction that is ambiguous in whether it should be a business or personal expense, may be dis-allowed, causing Net Income to increase, thereby increasing Self-employment and Federal taxes due.  If this dis-allowed expense was from a previous year, late penalties may also be assessed

When considering whether the process of saving receipts is worth it to you, keep in mind the potential risks of that transaction in an audit situation.

Which Receipts Need Extra Attention?

There are some receipts that owners should think critically about.

  • Meals & Entertainment Receipts:  Because of the rules and regulations surrounding Meals & Entertainment (M&E), be sure to manage them properly.  When a viable M&E expense occurs, write who the meeting was with, and what was discussed on the receipt.
  • Asset Purchases:  When purchasing equipment, software, furniture, vehicles, or other assets, keep the receipts with your records.  Your tax preparer will thank you.
  • Cash Transactions: Any purchases in cash (From Craigslist, Offer-Up, or similar) should have some record made by the owner.  That way cash withdrawals can be proven as expenses, instead of an owner’s distribution.  Templates for this type of receipt can be found easily online.
  • Business Travel:  Because travel, like meals, can easily be either a business or personal expense, be sure to write the purpose of the travel on the receipts.
  • Ambiguous Transactions:  For transactions and vendors that could be for both business or personal use, be sure to add any notes or details to help prove that they are viable business expenses.  I.E. if a Real Estate Agent purchases a house warming gift for a client from a boutique store that sells clothing, home goods, and jewelry, they should write “Smith Housewarming Gift” on the receipt.

Collection Strategies

As accounting technologies and document storage move to the cloud, there is no longer a need to keep original paper receipts.  If paper receipts and their organization speaks to you, then collect paper receipts; however, try and avoid the annual shoe box method.  Even separating receipts out by monthly envelopes will save time and frustration for you, a tax preparer, an accountant, or an auditor.

Alternatively, look to using digital or cloud solutions for receipt management; either a digital folder on your desktop, a GoogleDocs or DropBox account, or a paid solution like HubDoc or ReceiptBank.

At BalanceMonkey, we set up all our clients with a HubDoc account for their document management needs.  HubDoc has an app that can be used to snap photos of receipts, and automatically uploads them to your account.  Once a legible photo is snapped of the receipt, feel free to toss that slip of paper in the recycling.

Do I Need a Business Bank Account?

Just as every self-employed owner should be an LLC, every self-employed owner should open a separate business bank account to capture business activity in.  There is a myriad of benefits that should be taken into consideration.

Legitimacy/Professionalism

Every owner wants to be seen as professional and legitimate, and so opening a separate business bank account under the business’ name can increase that impression.  Additionally, having clients write check to a business name instead of the owner’s name improves their image of the legitimacy of a business as well.  A business bank account also opens the door to having a merchant processing account, and therefore being able to accept credit cards for payments, adding flexibility for clients.

Taxation and Separating Activity

As a business owner, it is imperative to separate business and personal activities.  Co-mingling transactions and activity can leave an owner open to scrutiny by the IRS in an audit.  While the occasional use of the incorrect card can slip by, the cleaner and more separated the books are, the less the IRS will find issue with.  Additionally, if it is clear that all transactions being counted as business expenses, and therefore tax deductions, are truly related to the business, the IRS is less likely to disallow deductions.

Using an EIN instead of a SSN

One of the main benefits of using a business bank account is that the account, and any business credit card, can be opened using the business’ Employer Identification Number (EIN) instead of the owner’s Social Security Number (SSN).  This element really helps to cement the separation between personal and business activities.  Additionally, this EIN set up gives a bit more liability protection to the owner’s assets and other accounts.  If the business checking and CC are personal accounts being treated as business accounts, the owner has left a wide-open path for an auditor to go into the rest of their personal activities.

Banks as Your Ally

The banking relationship between a chosen bank and a business owner can be a powerful avenue.  Not only will the banker be able to help with in-house banking needs, but they can also have contacts in other spheres to add to your pool of resources. 

Is My Dry-Cleaning Tax Deductible?

One of the most frequent questions we get asked is whether this or that can be recorded as a business expenses – Dry cleaning, business suits, car washes, gym memberships, etc.  The simple answer is: No.

These costs are not considered business transactions, but are instead classified as personal care expenses.  Unfortunately, even if it is a pseudo-requirement of your position or business to present a specific image, the IRS does not allow you to deduct personal expenses as business transactions, including personal care costs. 

For example, a business laptop is a viable expense because the utility of the unit is primarily for business purposes.  A gym membership’s utility is not for business purposes, and cannot be justified as such.  The same with a business suit – Because the suit can also be worn to non-work functions, the line that separates a business owner’s business and personal activities is not clear.

Making sure to only use business funds for business transactions helps to lower your audit risk – The more questionable transactions appear on the books, the more opportunity there is for questions from the tax preparer or auditor.