For tax purposes, it is very important to make sure you maintain the proper documentation, in case the taxing authorities audit you. Business expenses, whether they be related to self-employment income, W-2 income, or rental income, are the most frequently audited items on a tax return. If you do not keep good records, or take a deduction for which you are not entitled to or cannot prove, you will likely be assessed additional tax, interest, and penalties and even criminal penalties in severe cases.
Proper documentation generally includes the receipt that you received from the store or vendor where purchased. If you purchase a business item online, be sure to print a receipt or email confirmation. For items such as phone bills, car payments, office rent, etc where there is usually no receipt, you should keep the statement or some other recap of the expense. You should have some sort of bookkeeping system to keep track of all the receipts, whether you do it yourself or have a bookkeeper do it for you.
In addition to the receipt, you should keep copies of your bank and credit card statements showing how the purchase was made. Paying cash for a business expense is not a good idea, since you will not be able to prove the purchase. For any expense deducted, you will also have to prove that the purchase made was for a legitimate business expense, so keep good notes, especially for larger purchases. An expense must be "ordinary, necessary and reasonable" for your particular line of business to qualify.
A common business deduction for both the self-employed and employees are cell phone purchases and monthly charges. You can only claim the business use of the phone, which is often difficult to determine. If you get an itemized phone bill, you can measure your business versus personal use based on the phone calls made. Alternatively, you could get a second phone number and use it exclusively for business.
With a computer that is used partially for business, you will need to keep some sort of record of how many hours it is used for business and how many hours you or your family use it for personal purposes so that we can determine the correct deduction.
One of the most frequently audited items is the business use of an automobile. You should keep good records of the mileage driven (business, personal and commute), and the receipts for gas, repairs, tolls, insurance, etc on the vehicle. IRS regulations require that you must keep a contemporaneous mileage log, so keep a notebook in your car and keep track of the business miles. To figure the personal and/or commute miles, note the mileage at the beginning of each tax year, and document it with a repair order or other proof prepared on or near January 1.
Entertainment expenses are another area where documentation is very important. You should not only keep the receipt, but also a record proving how the entertainment was "directly related and associated". To be directly related, the entertainment must take place in a clear business setting, or that the main purpose was the active conduct of business and that you did engage in business with the person and that you had more than a general expectation of getting income or some other business benefit. To meet the associated test, the entertainment must be associated with your business, and directly precede or follow a substantial business discussion.
To qualify for a home office deduction, there are several tests that must be met (and you must be willing to allow an IRS auditor to enter your home to verify that you qualify):
· You must use a specific area of your home only for that business. The area used can be a room or other separately identifiable space. In other words, if you use the
area for both business and personal, you will not qualify.
· You must use the area for your business on a consistent and regular basis. Incidental or occasional use does not qualify.
· The office must qualify as your principal place of business. You will meet this requirement if you use it exclusively and regularly for administrative or management
activities and you have no other fixed location where you conduct your administrative or management activities.
· If you are an employee, the space must also be used for the convenience of your employer, not your own convenience (i.e. you voluntarily choose to work at home or
you tele-commute a couple days a week).
If you pay someone else to help you in your business, you should give them a W-2 or 1099. If they are an employee of yours, you must give them a W-2 and file quarterly payroll reports. If they are a self-employed sub-contractor, you should give them a 1099-misc if you paid them over $600 for the year. The difference between the two is sometimes difficult to determine and should be considered carefully in order to avoid significant tax penalties.
Another frequently audited item for a small business is the gross income claimed on the return. You should keep good records on all the business income you receive, whether reported on a 1099 or not. Gross income should include all the money you receive, as evidenced by your bank statements, Paypal accounts, etc. If you receive cash, it is a good idea to deposit it in your bank account so that you have a record of receipt. Separately keep track of cash received that is not deposited. If you do receive a 1099, compare it to your own records to make sure it is correct.
The IRS says you should keep your records "as long as they may be needed for the administration of any provision of the Code". Generally, this means you must keep records that support items shown on your tax return until the period of limitations for that return runs out. For most people that is three years from when the return is filed. You should keep records related to acquisition of a business asset for three years after you dispose of that asset. If you understate your income by more than 25%, then the period of limitations increases to six years. There is no period of limitations on fraudulently filed returns, or for returns not filed.
Please let me know if you have any questions or concerns. This is only a general overview of the basic rules and may not apply to your specific situation.
Tom Horner
The Tax Advantage
(925) 754-9299
Proper documentation generally includes the receipt that you received from the store or vendor where purchased. If you purchase a business item online, be sure to print a receipt or email confirmation. For items such as phone bills, car payments, office rent, etc where there is usually no receipt, you should keep the statement or some other recap of the expense. You should have some sort of bookkeeping system to keep track of all the receipts, whether you do it yourself or have a bookkeeper do it for you.
In addition to the receipt, you should keep copies of your bank and credit card statements showing how the purchase was made. Paying cash for a business expense is not a good idea, since you will not be able to prove the purchase. For any expense deducted, you will also have to prove that the purchase made was for a legitimate business expense, so keep good notes, especially for larger purchases. An expense must be "ordinary, necessary and reasonable" for your particular line of business to qualify.
A common business deduction for both the self-employed and employees are cell phone purchases and monthly charges. You can only claim the business use of the phone, which is often difficult to determine. If you get an itemized phone bill, you can measure your business versus personal use based on the phone calls made. Alternatively, you could get a second phone number and use it exclusively for business.
With a computer that is used partially for business, you will need to keep some sort of record of how many hours it is used for business and how many hours you or your family use it for personal purposes so that we can determine the correct deduction.
One of the most frequently audited items is the business use of an automobile. You should keep good records of the mileage driven (business, personal and commute), and the receipts for gas, repairs, tolls, insurance, etc on the vehicle. IRS regulations require that you must keep a contemporaneous mileage log, so keep a notebook in your car and keep track of the business miles. To figure the personal and/or commute miles, note the mileage at the beginning of each tax year, and document it with a repair order or other proof prepared on or near January 1.
Entertainment expenses are another area where documentation is very important. You should not only keep the receipt, but also a record proving how the entertainment was "directly related and associated". To be directly related, the entertainment must take place in a clear business setting, or that the main purpose was the active conduct of business and that you did engage in business with the person and that you had more than a general expectation of getting income or some other business benefit. To meet the associated test, the entertainment must be associated with your business, and directly precede or follow a substantial business discussion.
To qualify for a home office deduction, there are several tests that must be met (and you must be willing to allow an IRS auditor to enter your home to verify that you qualify):
· You must use a specific area of your home only for that business. The area used can be a room or other separately identifiable space. In other words, if you use the
area for both business and personal, you will not qualify.
· You must use the area for your business on a consistent and regular basis. Incidental or occasional use does not qualify.
· The office must qualify as your principal place of business. You will meet this requirement if you use it exclusively and regularly for administrative or management
activities and you have no other fixed location where you conduct your administrative or management activities.
· If you are an employee, the space must also be used for the convenience of your employer, not your own convenience (i.e. you voluntarily choose to work at home or
you tele-commute a couple days a week).
If you pay someone else to help you in your business, you should give them a W-2 or 1099. If they are an employee of yours, you must give them a W-2 and file quarterly payroll reports. If they are a self-employed sub-contractor, you should give them a 1099-misc if you paid them over $600 for the year. The difference between the two is sometimes difficult to determine and should be considered carefully in order to avoid significant tax penalties.
Another frequently audited item for a small business is the gross income claimed on the return. You should keep good records on all the business income you receive, whether reported on a 1099 or not. Gross income should include all the money you receive, as evidenced by your bank statements, Paypal accounts, etc. If you receive cash, it is a good idea to deposit it in your bank account so that you have a record of receipt. Separately keep track of cash received that is not deposited. If you do receive a 1099, compare it to your own records to make sure it is correct.
The IRS says you should keep your records "as long as they may be needed for the administration of any provision of the Code". Generally, this means you must keep records that support items shown on your tax return until the period of limitations for that return runs out. For most people that is three years from when the return is filed. You should keep records related to acquisition of a business asset for three years after you dispose of that asset. If you understate your income by more than 25%, then the period of limitations increases to six years. There is no period of limitations on fraudulently filed returns, or for returns not filed.
Please let me know if you have any questions or concerns. This is only a general overview of the basic rules and may not apply to your specific situation.
Tom Horner
The Tax Advantage
(925) 754-9299
Proudly powered by Weebly