Whenever the discussion of tax savings comes up, one of the first things that comes to mind is “IRS Audit”. Business owners are so afraid of an IRS audit that they let it impact many areas of their life and ultimately usually end up paying more in taxes than necessary.
Essentially the IRS says that the “burden of proof” is on the taxpayer. This means that you as the taxpayer are responsible for being able to prove (substantiate) expenses in order to deduct them. This could include things like receipts, logs, documents, etc.
In this Blog we are going to be discussing how you can:
- Protect Yourself
- Feel Confident in Your Decisions
- Reduce Stress
- Avoid or Win an IRS Audit
What Are Best Practices For Bulletproofing Myself from an IRS Audit?
- No Commingling
- No personal expenses on the business bank or credit card account. In the rare occasion that you accidentally put a personal expense on the business account, record it as an owners draw or reimburse the business for it
- Separate Bank Account and Credit Card (If Necessary)
- Have a separate bank account (and credit card, if applicable) specifically for your business. This is important even for you sole proprietors. Regardless of your business setup, this is vital. If you are unable to get a credit card under your business name, make sure you dedicate one personal card strictly for business use only and use the payments to it as a reimbursement.
- Ditch the Cash
- Cash is hard to track and prove. In the rare event cash is your only payment option, be sure to get a receipt so you can properly document the business expense.
- Take Bookkeeping Seriously
- Proper bookkeeping is vital for you to succeed, ensure accurate tax filings, and remove stress often associated with this side of your small business. Make sure you are doing bookkeeping right from the start and try to update it monthly at a minimum.
What Documentation Do I Need for Expenses?
In order to prove an expense you will need:
- Receipt or Invoice
- Proof of Payment (Bank or CC Statement)
Lets go through those two:
- Receipt or Invoice
- A receipt or an invoice will outline exactly what it was that you purchased. It is always recommended to get an itemized receipt that breaks everything down in as much detail as possible. You will also need documentation that proves the business purpose of that expense.
- Write directly on the receipt:
- Who: List out who was all involved in the expense.
- What: List out what was all purchased.
- Where: List out where the purchase occurred.
- When: List out the date, time, and duration of the purchase.
- Why: Brief outline of the business purpose.
- You go to lunch at Moe’s Steakhouse with a potential client, Bob. The receipt you get from the restaurant will be itemized (what was ordered). It will have the restaurant name on it (where). It will likely have a time stamp on it (when). Then you will then write directly on the receipt: Met with Bob (who) to discuss bringing his business over to us (why).
- Proof of Payment
- The proof of payment simply provides proof that you actual paid for the item. This is usually pretty easy because it comes right out of your business bank account or on your credit card statement. Essentially this just stops someone from grabbing a bunch of receipts laying on the ground and claiming them as deductions even though they were never actually paid by that individual.
We recommend keeping all of this documentation in a digital file. You can sort it by year and month or by year and vendor name. Whatever is easiest for you, just ensure you are keeping them on file in an easy to find solution. As soon as you make the purchase, write on the receipt, snap a picture, and upload it. It is that easy for you!
What Documentation Do I Need for Automobile Expenses?
First things first, a mileage log is REQUIRED, even if it is a 100% business vehicle. There are a few options for a mileage log:
- Mileage Log For Every Day of the Year
- Here you would simply record every single mile you take. You would have a list of which of those miles are business related and which are personal related. At the end of the year you can have a total business vs personal mileage.
- Three Month Sample
- If your business activity is relatively consistent throughout the year you can do a three month sample where you basically do a full mileage log for 3 months (90 days) and apply that mileage and percentage to the entire year. This is our recommendation option!
- One Week a Month Sample
- Same as the three month sample idea instead you are doing it one week every month instead.
Of course, simply having a mileage log is the first step and then you need documentation to support the actual business purpose of the business miles as well. An easy way to do this is to have mileage right next to your appointment book as your meetings will help support the mileage you had.
Example: Lets say you have a client meeting at Starbucks. You’ll have a mileage log to track record from the office to Starbucks but you’ll also have a receipt from Starbucks (with documentation on it) to back up the business purpose.
What Other Documentation Should I File to Bulletproof Myself from an IRS Audit?
- Employees – If you are hiring someone in your business (example: child, spouse, etc) you need to have proof that it is a viable business expense.
- Time Sheet (Date / Description / Hours)
- Employee Agreement / Job Description
- Reasonable Wage Support
- Proof of Payment
- Tax Payments
- Form Filings
- Travel – Whenever you are traveling for business you should have a day-to-day log that tracks the business purpose and activity for the entire trip to prove the deductibility of it. If you have personal days in there was well, ensure that this is tracked properly.
- Where are you traveling to and why?
- Who are you meeting with and where are you meeting them?
- How much time did you spend on business for each day?
- Learn more about travel in our Blog and Podcast, How Can I Maximize Meals and Travel Deductions?
- Asset Purchases – Anytime your purchase an asset or something that you will be depreciating, ensure you are grabbing as much documentation as possible including:
- Bill of Sale
- Loan Agreement (If Applicable)
- Picture of the Asset
- Receipt / Invoice / Proof of Payment
- Agreements – Any agreements related to your business, keep on file while they are active because they often times can be helpful in defending an expense and serve as part of your proof. Examples include:
- Rental Agreement
- Lease Agreement
- Consulting Agreement
- Contractor Agreement
- Joint Venture Agreement
We strongly encourage business owners to fully take advantage of what is available to them, this is what we preach every week on the Podcast.
I want to be very clear, the purpose of this blog is not to scare you but rather encourage you to collect and record the proper documentation. This will help you sleep easy at night knowing that if the IRS ever did come knocking, you have nothing to worry about because you have all the documentation to back it up.
Be aggressive but also do not get greedy. Always do the sniff test, is this ordinary and necessary for my business? If I was sitting in front on an IRS agent would I be able to explain that to them and do I have the documentation available to back it up? If so, deduct away and take advantage of the laws the are advantageous to small business owners!
- The Time Is NOW To Start Paying Less In Taxes. Join Our Tax Minimization Program (w/ Stress Free Bookkeeping Training)!
What you’ll get:
- Library of Tax Strategies, Implementation Guides, Videos, Downloads, etc.
- Stress Free Bookkeeping Training Program
- Ask A Pro – Unlimited email access to our team, it is like having an accountant in your back pocket!
- Monthly Group Trainings
- Private Facebook Group
- Partner Directory