April 15th will be here in a few short months and to prepare for the tax season rush, I am offering a process to help track expenses and ease the burden of tax time. If you are audited by the IRS, State, or Local Government, it will be necessary to prove that the information reported on your return did in fact occur. It is extremely important to keep track of all supporting documentation used in your tax return. The documentation proves the transaction happened and warrants the reduction on your return. In the event of an audit, the burden of proof is on you to prove your tax return is legitimate. A paper trail is your best defense on an audit. Supporting documentation for revenues and expenses includes billing, cash receipts, deposit slips, invoices, and proof of bill payment including canceled checks and credit card statements. It’s a pain, but you have to do it to protect yourself.
Follow this seven-step process to organize and track expenses:
1. Use an accounting software package to track revenues and expenses. There are good ones out there which are accurate and easy to follow. Choose one!
2. Arrange clients and vendors in the appropriate accounting area. This will allow you to view how much you billed a client over time and to see vendor spend reports with historical activity. This is important information which can help your business in addition to preparing your taxes.
3. Set up general ledger accounts which cater to your industry. Keep it simple so you can more easily follow your own paper trail.
4. Don’t procrastinate. Record revenue and expense activity on the day it occurs so you won’t forget it. You wouldn’t want to lose a deduction by not recording.
5. Have someone review all data entry to verify its accuracy. It is easy to make a data entry mistake or add an extra zero onto a number and you don’t want a misstatement of revenues or expenses. Nor do you want expenses showing up in the revenue section and revenue showing up in the expense section. Properly stated financials is the goal.
6. Proper record keeping is imperative. Invest in a filing cabinet, file folders and a label maker. Establish and maintain a good filing system so if you ever need to research a record, you can do it quickly and easily. File and sort cash register tapes, billing reports, canceled checks, bank account statements, credit card statements, payroll reports, and expense receipts. Keep records according to IRS guidelines. To learn how, visit www.irs.gov.
7. Prepare monthly account reconciliations on all balance sheet accounts. After all, this financial statement shows the value of your business. Properly maintaining these accounts from the start spares you from unraveling years of data. You should be able to explain exactly what makes up the balance in each balance sheet account.
If you establish and maintain a consistent system, you will be able to track expenses more accurately and file your tax returns more easily.
I have been involved in numerous audits including everything from Internal Revenue Service, Securities Exchange Commission, State Sales Tax, and Internal Audits of large corporations. The first items always requested by any organization are your tax returns and financial statements backing up the information on your return. Once the auditors start looking at the numbers on the financials, they will request backup for the items showing proof the transaction occurred. Without the backup, you may be unable to properly verify your tax return. This can expose you to additional taxes, penalties and possibly jail time. Keep it clean, report the correct information on your tax return and have proper backup documentation. If you do, you’ll avoid the nightmare of the tax audit. Make it your e-commerce New Year’s resolution toâ€â€do your homework!
