It was a rough morning, and I was on the verge of a mental breakdown. I was sitting at the HR Block`s office, holding a massive pile of paperwork on my lap. My brain was as mushy as a warm banana I held in my hands. It was my first small business tax return, I was scared to death. I had no idea what to do or what to expect.
Are you a newbie small business owner setting up your accounting records and getting ready to file taxes? Great!
The post will share four small business accounting lessons I learned by doing things wrong. The information will help you to set your accounting records correctly, reduce time and stress during your tax season, and even help to save money!
Lesson #1: Separate Business and Personal banking
By law, you are required to keep your banking for business and personal completely separate. If you are driving to Walmart and you made a purchase of the office supplies and your kid’s school supplies on the same receipt with the same debit card, you just crossed the line.
Business and person must remain separate. Why does it matter?
Legal Asset Protection
By the way in the unlikely event of litigation (read: you are being sued), LLC legal asset protection only applies if your business and personal expenses are separate. LLC creates a legal asset shield and a separate legal entity that can shelter your assets from your business-related lawsuit. That said, the protection is declared VOID the moment you MIX your personal and business banking. Keep that in mind. Do not mix business and personal expenses/income.
- Drive to your bank.
- Open a separate checking, savings and credit card accounts just for business-related transactions (expenses and income).
- Charge all business expenses and deposit all business revenue to your business account.
- Do not use your banking accounts for business. Trust me, I did it many years ago, and it was a real mess at the tax time.
Lesson #2: Save your business receipts
IRS Supporting Business Documents Requirements states that you need to maintain records that “clearly shows your income and expenses” and proof of the transactions that were charged to your business account. Your files also must include a summary of all your business transactions (accounting journal or ledgers). The books should reflect gross income, deductions, and credits.
IRS recordkeeping requirements
- IRS requires you to keep business paper records for a minimum of three years and up to seven years, depending on the type of documentation.
- IRS also reserves the right to audit your tax return up to three years back, starting from the day you filed the return (Credit: gov)
- Every year create a physical paper folder to save all the receipts, from all the transactions charged to your “business only” account.
- Note expense category or purchase purpose at the top of the paper receipt
- Start a separate email inbox folder, to save all electronic receipts and purchase confirmations. I use it for my Dropbox, Google Drive storage, MS Office subscription receipts, etc. Remember to drag and drop your receipts to your inbox folder.
- Keep a record of your invoices issued to clients and payments received. This will help you to create a year-end summary that you will need to provide to your tax preparer during tax time.
Lesson #3: Deduct only “ordinary and necessary” expenses
According to IRS, you only can deduct business expenses that are necessary and ordinary for your line of business. What does it mean?
It means that If you were running a landscaping company, it is expected you will get some mileage on your business car and deduct some lawn maintenance supplies. It is not likely that you will deduct your family trip to Costa Rica on your tax return, however. Keep it real, seriously. You know what I am talking about.
When in doubt, check IRS rules for the type of expenses you can deduct.
Lesson # 4: Avoid “Shoebox” charges by your accountant – create a summary!
Create a monthly expense/income summary using your paper folders and bank account statements
For me, the epiphany moment happened when my tax accountant shared about his “side business” of making an extra $400-600 by scanning, entering and categorizing hundreds of business receipts for business owners. I was outraged by the story and made a mental note that I need to prepare and provide my business statement summaries only.
- Use MS Excel, Google Sheets, or Quickbooks to keep track of your transactions
- Add a “Monthly RECEIPT Summary” appointment to your calendar and every month set aside an hour or two to create a quick Excel summary sheet including date, amount, account # charged to, purpose and expense category.
- If your expenses do get little more complicated and you have a more extensive operation, consider getting QuickBooks or another accounting software to help you to simplify your recordkeeping and accounting tasks.
Avoid tax time nightmare! Keep things organized. As a result, you will save time, reduce stress and save money by not paying “ receipt shoebox charges.” Awesome, right? Everyone wins.
I founded and operated four successful business ventures before I relocated to America in 2003. I was not new to business ownership.
When time was right, in America, I started my consulting business. I did not think twice about how to keep records, create summaries, separate personal from business, or keep receipts. I had so much on my mind; I did not want to worry about accounting! I tried to grow my business and get new clients.
I must admit; I paid for that oversight at the end of the year! My tax return was a nightmare. I was missing receipts, could not locate statements, could not remember the purpose of the purchases and created a complete cluster boo for myself. I was stressed, confused and scatterbrained. I lost sleep.
My HR tax prepared trained me about many things, including keeping personal and business banking separate. I recall, one day in his office, I confessed that for the first few months our personal and business expenses were charged to the same account. He yelled at me and told me a scary story about “piercing LLC protection” and how I put my home and my personal assets at risk. I got the message.
My spouse recalls that day when he had to listen for an hour-long lecture about “how we are doing it all wrong” and “we have to fix it today.” I was on fire.
Next morning, I drove to the bank, asked to open a set of new checking, credit and savings accounts for my business. I got my brand new shiny debit, credit cards and got my temporary checks. I started my paper folders and diligently saved all receipts. By no means, I am perfect today, but I`ve learned and grown a lot since that day.
Our HR Block guy saved my business and my reputation; he trained me about the what, the how and the why of proper recordkeeping and I am forever grateful for the lessons I learned from him.
Do take advantage of my mistakes, learn from them, and avoid them!
Disclaimer: Logio Solutions LLC and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
Copyright @ Logio Solutions LLC 2019. All rights reserved.