As a business owner, you must deposit all business receipts in a separate bank account. If possible, you should also make every single one of disbursements by check. In regard to all business entities, with the exception of corporations, a disbursement from the business account is not compulsory to qualify the expenditure as a business expense. A check written on a personal account for business purposes will be eligible if that expense is otherwise permissible. It is important to document both business income and business expenses.
Write checks payable to yourself only when making withdrawals of income from your business for your own use. Keep away from writing business checks payable to cash as it is important to identify which disbursements are business and which are personal. In the event of an IRS audit, this is an area that will get close scrutiny. The IRS auditor will not only look at each check to see to whom it was paid, but will also look at the reverse of the check to see by whom and how the check was endorsed. If you must write a check for cash to pay a business expense, include the receipt for the cash payment in your records. If you cannot get a receipt or a cash payment, put a statement in your records at the time of the transaction to explain the payment.
Get receipts for all business expenditures. For all business trips, make sure at all times to get receipts from hotels and motels. Toll receipts can also help to substantiate travel expenses. Take receipts from the post office when you purchase stamps and mail larger envelopes and packages. You should establish a petty cash fund for small expenses. All business expenses paid by cash should be clearly substantiated by documents showing their business purpose.
Maintain your entries with sales slips, invoices, canceled checks, paid bills, duplicate deposit slips, and any other documents that explain and support entries made in your books. File these materials in a safe place. Memorandums or sketchy records that approximate income, deductions, or other items affecting your tax liability will not be considered adequate by the IRS. Keep in mind, where the IRS is concerned, the burden of proof is on the taxpayer. You will not be given the benefit of the doubt.
Classify your accounts by separating them into five groups:
1. Income
2. Expenses
3. Assets
4. Liabilities
5. Equity (net worth).
For your assets, record the date of acquisition, cost or other basis, depreciation, depletion, and anything else affecting their basis. Basis is the amount of your investment in a property for tax purposes.
Keeping Records: You must keep the books and records of your business available at all times for inspection by the IRS. Records must be kept as long as they may be needed in the administration of any Internal Revenue law. Keep records supporting items reported on a tax return until the period of limitations for that tax year has expired. Usually, this is the later of:
1. Three years after the date your return is due or filed; or
2. Two years after the date the tax was paid.
However, you should keep some records indefinitely. For example, if you adopt the last-in first-out (LIFO) method of valuing your inventory or change your accounting method, records supporting these decisions and approvals from the IRS may be needed for an indefinite time.
You should also keep records that support your basis in property for as long as they are needed to figure the correct basis of your original or replacement property (including capital improvements). Keep copies of your tax returns. They will help you in preparing future tax returns and in making computations if you later file an amended return or a claim for a refund.