Every American fears the words tax audit.
A letter from the I.R.S., especially one ordering a tax audit, will unnerve even the calmest person. But, for a small business owner who does all of their own recordkeeping it’s not just scary, it could spell disaster.
If you receive an I.R.S. audit letter, call your tax accountant and set an immediate appointment; representing clients at tax audits is part of a tax professional’s job. It will be your job to locate and furnish all of the documents needed to win that audit. If you have kept audit-proof records, that will be easy.
Because most small business owners have no bookkeeping training, few realize how easy it is to keep audit-proof records. Some end up turning recordkeeping into a complicated computer-driven chore, and many simply ignore everything until tax time.
Business recordkeeping doesn’t have to be complicated or time consuming. There are only two things you need to do to make beating a tax audit easy. The first is to adopt a recordkeeping system that is super simple; the second is to learn exactly what the I.R.S. expects from the small business owner at tax time.
Recordkeeping for a one or two-person business is done primarily to satisfy the I.R.S., so why not keep audit-winning records. Follow these ten simple rules during the tax year, and you’ll not only be ready for a tax audit, but you’ll simplify your recordkeeping duties as well.
Rule # 1 – Document Income. Absolutely all business income, including all cash & tips, must be deposited into a separate checking account used only for business funds. Do this and all you’ll need at tax time are 12 bank statements to total your income.
Rule #2 – Keep a Paper Trail. Every penny spent or charged for your business needs a paper trail. If a receipt is not provided you can make your own; be sure to include all of the necessary details. Working from expense receipts simplifies the recordkeeping process for a small business owner.
Rule #3 – Record Barter Exchanges. Every business barter exchange requires a paper trail assigning value to your time, or the product that you traded. The value of a barter exchange is the same amount you would charge if it had been a cash sale.
Rule #4 – Track Every Expense. Sorting expense receipts is easy, when you use the business expense alphabet. From advertising to Ziploc bags, if you use it in your business there’s a place on your tax return to deduct that expense.
Rule #5 – Depreciate Equipment. Any equipment purchased that has an expected life of 2+ years must be depreciated or expensed at tax time. It is important to keep a list of all business equipment purchased, the date you bought it and the price paid, with your tax records.
Rule #6 – Log Your Miles. Unless your car is used only for business, keep a small notebook in your car for tracking business miles. If you don’t keep a mileage log, and are asked to furnish one for a tax audit, you will fail the audit.
Rule #7 – Track Inventory. The I.R.S. considers all items that you make or buy for resale to be inventory; inventory costs cannot be deducted until that inventory is sold. Inventory expensing is easy once you learn how to calculate the cost per item value.
Rule #8 – Get Educated. No matter how good your tax professional is, if you don’t provide all of the necessary information and figures your tax return will be wrong.
Rule #9 – Plan Ahead. Tax laws change every year. During your annual tax visit ask if there are any new changes that affect you, what tax laws are in the works, how those will affect your business, and what you can do now to lower future taxes.
Rule #10 – Keep Everything. Without receipts you will fail a tax audit. Box or bag all of your tax receipts each year, and keep them for a minimum of six years. If you get an audit letter from the I.R.S., simply take the box or bag containing receipts for the year being audited with you when you meet with your tax professional.
I can’t tell you not to worry about a tax audit, we all do. But, if you’ve followed these ten rules, the receipts and the audit should be in the bag!