How to organize your home business tax paperwork

Small business owners are more likely to be audited than big companies. It’s vital to keep your receipts handy and organized, so any audit you experience can be as painless as possible.

At the beginning of last year, I had an annoying scanner that was difficult to use. I had to feed in one sheet at a time, and most of the times I tried to use it, the software driver didn’t work and I had to tinker with 50 billion settings to figure out what was wrong. I also had an annoying printer with similar issues, probably because it was the same brand. These technological challeneges frustrated me, so instead of finding another way to organize my paperwork, I just kind of let things go. I’m really feeling it now that I want to do my taxes for 2008. So I did something smart and bought myself a really nice Epson all-in-one scanner/printer/copier/fax. That solved my technical issues, but what about the actual filing?

Whether you’re all paper, all digital, or both, an organized filing system is essential. A disorganized filing system – one that doesn’t accommodate everything you need to file – can be almost as bad as piling everything in the corner. This is how I created an organized system.

If you keep both electronic and hard copies, make mirror systems

I take some tax deductions each year. Most of my receipts are in the forms of emails, because they’re for online services and purchases. But others are store receipts. I’ve found that when I’m actually doing my taxes (yes, I do them myself), printed copies make the job much easier (I use the “draft” setting and print on both sides of the page – I even bought a duplexer for my printer that does this automatically – to reduce the environmental impact). But longterm, I just want to keep electronic copies of everything for audit purposes. There is debate on whether or not it’s safe to destroy original paper receipts yet – the IRS is apparently way behind the times – but someday it will be acceptable to keep only scans, and when that day comes I want to be able to shred everything without checking to make sure I scanned it first.

Once I decided on what files I needed to categorize the various types of receipts I keep for the IRS, I set up a folder for each category on my hard drive (under a folder called 2009) and set up physical files by the exact same names. This makes it easier to find stuff later.

Your paper handling system

I get both hard copies of receipts from stores and electronic copies from online vendors. Since physical receipts can fade no matter how you store them, I feel the need to scan everything. And since I like having printed copies to work with when I do the taxes, I want to print everything, too. This calls for some pretty common sense organization, but it’s the discipline of actually doing it that can be tough:

1. When I get an email receipt, I print it immediately and put it in the physical file folder. Then I print it to PDF and save it into the corresponding folder on my hard drive.
2. When I get a store receipt, I scan it immediately and save the scan to the folder on my hard drive, and file the physical copy into the physical file.

Yeah, not rocket science. But when I’m so tired I don’t trust myself not to make a mistake, or I just don’t have time, I put it off. Then things mount up. You need to assume this is going to happen sometimes, and have a backup plan:

• I maintain a folder within the inbox of my email client called for my electronic receipts. Every email receipt goes in there the instant I receive it, and I follow Step 1 (above) with those items as soon as I have time and feel up to the task.
• Store receipts are trickier, because you have to store them in your purse, pocket or wallet until you get to your home or office. I keep a little folder (like a coupon book) in my purse for this, and every receipt goes in there. A pocket in your wallet will work, too. Every Saturday, if not more often, I go through the receipts and put any deductible ones into a wicker basket that serves as my receipt inbox. Then I process them according to Step 2 (above) whenever I can. (Helpful tip unrelated to taxes: have another inbox for receipts that aren’t deductible, but go with a recent purchase you may need to return, or have your partial credit card number on them. Once you’re sure the items won’t need to be returned and/or your credit card statement reflects the purchase properly, you can shred/recycle these.)

Bookkeeping

Your bookkeeping needs will vary depending on the type of business you have. If you sell stuff on Ebay or Amazon, for example, their invoicing and accounting systems may provide you with all you need to print, and then you just have to track your income and expenses in a spreadsheet. Or if you sell directly to the public, you may need a more sophisticated invoice tracking system – anything from QuickBooks to something really fancy. The very least you will need is to maintain a spreadsheet that shows incoming and outgoing expenses (I set up an Excel workbook with a different sheet for every category that’s in my filing system). How you organize the sheet is up to you – all one column, with negative numbers for outgoing, or two separate columns, year by year or month by month… whatever works for you, so long as another human can make sense of it.

The reason I’m bringing this up is: you might as well do your accounting WHILE you’re filing.

I maintain an Excel spreadsheet for this purpose. I enter my purchases at the same time as I process them for filing. But again, sometimes I just don’t have time for everything, and this is the step I tend to leave out when that happens. If I go ahead and file stuff before entering it into the spreadsheet, that means I have to go back through everything I’ve filed so far the next time I update the spreadsheet, and try to figure out where I left off with the accounting. There are a couple of ways to deal with this problem.

• Don’t file the physical copies until you’ve entered them into your accounting software. Put them in yet another inbox to save until you’ve entered them, then file them.
• My preferred method: make one additional folder on your hard drive called “Inbox.” Stuff into it all the scanned receipts you haven’t entered into your accounting software yet. Enter them later, then drag and drop them into the folders where they should be archived for posterity.

Either method works. It’s really a matter of whether you prefer handling paper or electronic copies.

Additional Notes

• You really don’t need to file your receipts into many separate categories. I prefer to, because it’s an easy way to see what I’m spending on this and that (which has nothing to do with taxes, but is helpful info for a business owner). But at the very least, separate your “entertainment” receipts – dinner meetings, hotel stays for conferences, etc. – from your other receipts. You can only deduct 50% of entertainment expenses, whereas things like office supplies are 100% deductible. Keeping these two groups separate is a big help at tax time – for you or your tax preparer who probably charges by the hour.
• To cut down on paperwork, get a business credit card or simply designate one of your personal credit cards as for your home business. Purchase every deductible item on that credit card. Then you could actually keep your credit card statements as confirmation of your scanned receipts: that way, if the IRS should question whether a receipt was doctored (unlikely, but possible), you can point to the same purchase on the credit card statement to show that it was not. A business checking account will also work (canceled checks in place of the credit card statement), so pick whichever system you prefer.

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Posted in Organization on March 9, 2009