What we see in the tax business are small businesses that are running a profitable business but their bookkeeping processes don’t hold up under an IRS audit. When you have difficulties proving your income and expenses to the IRS you then have to in essence recreate the business’ books properly. This is expensive for the owner(s) as this type of bookkeeping comes at a premium cost. Audits are normally done years after the tax return is filed and it is difficult to remember all the details of your business transactions, which could result in unallowed deductions or additions to business income.
Here are a couple of common stumbling areas for small business bookkeeping that we see over and over:
- Combining personal and business accounts. There is nothing illegal about doing this, but it greatly complicates an audit and brings your personal accounts into the audit process. If you sell a personal car on Craigslist and that income goes into your personal account which is included in the audit, then you have to prove that the sale of your personal car was not business income. In an audit the IRS will go through every single deposit and you have to show that it was not business income. Personal expenses paid out of your business account can be identified as an owner’s draw, however an excessive amount of personal expenses will cause the auditor to question if some of the business expenses are in fact personal in nature and not deductible. For LLCs and Corporations this starts to breakdown the legal distinction between the person and the company.
- Not keeping invoices or receipts. Several businesses use their credit card statements that show where the purchase was made as their method of proof of a business expense. This is not a fool proof plan. In a Washington State audit if you have made a purchase over the internet the credit card statement will not show if you paid sales tax. In an audit if you can’t prove via an invoice that you paid the sales tax, then you will be required to pay use tax (the same rate as sales tax). Since I run a tax business a purchase from Staples would logically be a business expense and accepted in an audit, however a purchase from Lowes would be questioned and I’d likely need to show an receipt proving that what I purchased was needed for the business. The best plan it to scan in all your receipts and write any notes about the purchase on the receipt or invoice.
- Not using a professional bookkeeper. Bookkeeping seems pretty easy to do, until it isn’t. A professional bookkeeper is a cost effective method of keeping your business records straight. At the very least have a professional set up your books and show you how to make the entries correctly. Going back to fix the books is incredibly frustrating and time consuming for a business owner. I know since I’ve had to do it myself. A professional will also bring other accounting/tax knowledge to your team besides just the books themselves.
We don’t do bookkeeping as part of our tax services but we can refer you to reputable companies that do bookkeeping. Good luck with your business!