With the ever-increasing complexity of our tax system, it is commonplace for many small businesses to make mistakes with bookkeeping and filing. One way to avoid making errors is to be aware of the most commonly encountered pitfalls. Here are some tips to help keep the proper records.
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- Receipts – Even though the IRS does not require receipts for business meal expenses of less than $75, it is nevertheless wise to hang onto them. There is no better documentation than a credit card receipt since it has all the expense information required. All you need to do is write on the slip the purpose of the event, the individual(s) you were with, and your business relationship with that person or people.
- Auto Deductions – Generally, small businesses use either the actual expense method or the optional mileage method of deducting the business use of a vehicle, and both must account for any personal use of the vehicle, including commuting. When using the actual expenses method, the deducible business portion of the expenses is determined by multiplying the total expenses by the percentage of business use, which is found by dividing the business miles driven by the total miles driven. When using the optional mileage method, the business miles are multiplied by the IRS published standard mileage rate, which is 56 cents per mile for 2021 (down from 57.5 cents per mile for 2020). So, regardless of the method used, make sure you keep track of the total and business use miles for the year since it is required for either option.
- Gifts – Do not overspend on gifts to clients and business associates. The IRS will allow a deduction of only up to $25 worth of gifts to any individual per year. Being too generous will cost you. With only that first $25 per recipient considered a deductible business expense, the rest will be nondeductible. For deductible gifts, be sure to keep a copy of the purchase receipt and note on it the business purpose for making the gift or the benefit you expect to receive, as well as the name of the person to whom you gave the gift, his/her occupation or title, or some other designation that will establish your business relationship to the individual.
Individuals should hold on to their income tax records for at least 3 years after the due date of the return to which those records apply. However, if the original return was filed later than the due date, including if the taxpayer received an extension, the actual filing date is substituted for the due date. A few other circumstances can require taxpayers to keep these records for longer than 3 years.
- Business Equipment – Since equipment is considered a capital expenditure, it has to be depreciated. That is why lumping equipment together with supplies is not a good idea. This is true even when you elect to expense equipment purchases under Sec. 179 or claim bonus depreciation. If the purchases are not reported properly, the IRS could rule that the expense was improperly characterized. If that is the case, you would not be entitled to the deduction claimed on your return. There could be other repercussions, leaving you with no current deduction at all.
- Ordinary and Necessary – To be deductible, an expense must be ordinary and necessary. An expense is “ordinary” if it is customary and conventional for the taxpayer’s line of business. A “necessary” expense is helpful in the taxpayer’s business; but it need not be indispensable.
- Meals and Lodging – When traveling for business, lodging is 100% deductible but the away-from-home meals deduction is limited to 50% of the cost.* So, if the meals are charged to a hotel room, they must be accounted for separately, and keeping a copy of the statement from the hotel that shows the charges, as well as a credit card receipt or other payment receipt, is advisable.
- Entertainment at Sports Events and Theaters – Entertaining customers at sporting events and theaters is commonplace but as a result of the Tax Cuts & Jobs Act, which became effective in 2018, a tax deduction is no longer allowed for entertainment expenses. However, the Act did retain a deduction for business meals that are directly related to or associated with the active conduct of your business. The term “directly related” means that actual business discussions were conducted during the meal and you anticipated a specific business benefit from the meal. The term “associated with” is more liberal and includes meals either preceding or following a bona fide business discussion. In either case, the business deduction continues to be 50%* of the actual expense. Also remember that business meals must be documented, including the amount, business purpose, date, time, place and names of the guests as well as their business relationship with you. * However, for 2021 and 2022, the cost of food and beverages provided by a restaurant as a business meal is fully deductible.
See this related post from Dennis Harabin: Record Expenses in QuickBooks Online and On Your Phone
The money you spend to run your business must be recorded conscientiously for your taxes and reports. Here’s how to do it. You undoubtedly keep a very close watch on the money coming into your business. You record payments as soon as they come in and deposit them in your company’s bank account. But are you as careful about your purchases?
- Home Office Deductions – There are two methods for deducting the business use of a home. One is the conventional method of prorating the expenses (with some limitations) of the home by multiplying the allowable expenses times the business use square footage divided by the total square footage of the home. The other method, referred to as the simplified method, allows a $5 per square foot deduction (maximum 300 square feet) without having to keep records of expenses. Both methods have the same eligibility requirements.
Every business is unique, so if you need assistance in setting up your recordkeeping system or need further clarification on any of the topics discussed, please call this office at 551-249-1040.
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