Best Recordkeeping Practices For The Cash Intensive Business Owners
Recordkeeping sounds simple, but it must be sufficient to support your expenses if you’re audited. For your protection, any deducted item on a tax return should have proof of the deduction. If you get into good habits, it is easy to gather the proof. If not, you will spend hours digging through tons of paper, something none of us want to do.
In a recent audit for a client, the auditor referred to “economic reality” as a reason for the audit. She wasn’t the auditor from you know where, but she was abrasive and very unwilling to take our word on anything without proof to back it up. During the audit process, the business’s heavy involvement in cash became an issue. The number of cash expense receipts and the recordkeeping was questioned very thoroughly. Leading to the “cash intensive business” issue; which she pressed very hard.
The auditor was looking for “substantiation”, proof of the deduction in some capacity. The burden of proof always lies on the TAXPAYER, not the IRS. Although, the auditor’s discretion helps determine to what degree they are willing to accept your word as fact. It started with the largest deductions on the return and went to some of the smaller deductions on the return. We successfully defended the return with a small tax liability change in the end.
Why Was Being A “Cash Intensive Business” A Big Deal?
Being a cash intensive business, there are some methods to the madness of recordkeeping. My client learned this the hard way, so I want to help everyone else get ahead of the game. A payment on debit or credit card is not sufficient proof; unless it is clearly a business related item the receipt is still needed. Here are some methods that can be used if you don’t use traditional accounting or point of sales software.
How To Put A Recordkeeping System In Place
If you systematize your recordkeeping, you can be successful. If not, I wish you the best of luck reproducing receipts from at least 1 year ago if you ever get audited. Here are some pointers from my experience, that worked for my client’s audit:
- Create a system for where records are kept, how often they’re kept, and get a good filing system.
- Have tight systems and follow them, so you have complete records when needed.
- You’ll also look at your business and bookkeeping more frequently – helping you manage it, not just operate it.
- This makes routine habits and good habits last longer.
Create A System You Can Stick To
So how do you systematize your record keeping? Try the following.
- Cash Income
- Use sales reports, ledgers, anything available to track the payment type received (cash, check or Credit card), along with the customer. This not only proves your income and payment methods you accept but also your actual cash you received.
- Record the income as received. You won’t be able to remember what was reported or not reported later. Trust me, not doing this could cost you later.
- Cash Receipts
- Scan them if you can, the receipt tapes will fade over time.
- Save them by week, or month on your computer, or in a file cabinet. Receipts not kept, are lost expenses. Anticipate a 30% tax hit on the expense you forget to keep the receipt for – that should give you some motivation to keep them.
- Sort them chronologically to find them easier.
- Scan them using date first, vendor second, or vice versa to a folder for expenses. Example: ‘01-01-2015 Amazon’ or ‘Amazon 01-01-2015’.
- Do this routinely, a smaller pile is easier to get done than a much larger one!
Set Up A Filing System That Will Be Effortless
File in appropriate folder electronically if you want to go for electronic record keeping. After his audit, my client is going completely electronic per my recommendation, and his accounting and recordkeeping will be very detailed.
He will be using more apps through QuickBooks online, but they essentially accomplish the same result as above. Except that these apps typically require subscriptions and fees to do so. Since he will be doing all of his record keeping electronically, he has his data (Income and Expense receipts) scanned and filed in PDF format. Then he can shred all the originals that he doesn’t need a hard copy of. Now his record keeping will be in folders in a file, not 15 boxes he’d have to sort through.
However, this is not the only option. Although I recommend everyone use electronic record keeping, you can have adequate recordkeeping without being in electronic form. If you can follow the above steps, it will save you hours and you will be able to perform tasks more frequently (weekly or monthly). If you’re ever audited, you can reproduce the receipts efficiently in minutes – just find the right file cabinet or folder on your computer.
Remember, the burden of proof lies on you, and your auditor will not know which supplies were business related unless you show receipts. Need help setting up these systems, or want to learn about other options? Reach out and I’ll help steer you in the right direction.