3 Tips For Keeping Proper Tax Records For Your Home Business – And Keeping The IRS Happy!

The last thing most people think about when starting a business is doing taxes. But proper planning will make doing your taxes much easier - and keep the IRS happy!

Here are 3 simple tips for keeping proper records:

1. Whenever you buy anything for your business, keep the receipt!

Not only will this make record keeping a lot simpler, but if you are ever audited (having your tax return reviewed in detail by the IRS), you can prove your expenses, and save yourself money.

2. Write down all your expenses and income as they happen.

As your business grows, you'll have more and more activities to keep you busy. The last thing you'll want to do each April 15 is to organize your records for the year. So, it's a good idea to write down all your financial activities as they happen. You'll find preparing your taxes will take much less time if you are organized.

3. Learn how to save money on your taxes.

As you learn about taxes, you'll find that there are many deductions (expenses that reduce your income, and therefore your taxes) you can take that are not obvious. When using your home office, you may be able to deduct (at least partially) repairs you make around the house, utilities, your home's value at the time you start your business, and more.

The more you know about taxes, and the more organized you are in keeping records, the more time and money you'll save at the end of every year!

What happens if you don't keep proper records?

Individuals with small businesses are the most likely to have their tax returns audited by the IRS. If you don't have a receipt, you will likely lose the deduction and owe the IRS money.

And while an audit does not have to be feared, you should be prepared - the more organized your records, the easier it will be to prove your case.

If you don't have one, get a file box and some folders at your local office supply store (these supplies are deductible, so keep your receipts!) and create a filing system for your business. Put all your receipts in the proper folders, and put them in a safe place.

Another way to save yourself time is to record all of your business transactions - expenses and income - on a spreadsheet on your computer. Keep a column for income, advertising, supplies, etc. You don't need to be a computer expert. But keeping accurate, organized records will help you save time when you fill out your taxes at the end of the year.

And it can help you plan, by giving you a snapshot or your financial progress whenever you need it.

Which may come in handy when you need to place ads, borrow money - or take a much needed and well-deserved vacation!

What are the taxes on earnings?

Almost all governments across the globe are funded– in some form – by the taxation of its citizens. Certain of the taxes are collected at the time of sales or service whereas certain others in a 12 month period or at the end of what they call a fiscal year. Taxes on earnings or income tax is such a yearly beast. 

Taxes on earnings are essentially a bill from the federal and state governments, declaring the rules of taxation on one’s personal earnings through salaries and investment profits. It has been designed as a progressive tax in which the financial obligations of an individual increase with the rise in his/her reportable income.

In United States, taxes on earnings came to effect officially or in a full swing after the passing of national income tax law in 1914. At that time, the law was mainly aimed at the rich and the greediest among the population who owned a lot of wealth in contradiction to the majority of the people. Eventually in another few years, the tax on earnings would trickle down to the middle and lower working classes. In reality, even though the tax on earnings is progressive, big corporate and wealthiest individuals enjoy a lot of legal exceptions as of now at least.

Taxes on earnings are levied only on a positive income and not on net loss. The taxes on earnings structure has been designed in such a way that individuals can earn a certain non-taxable income, the standard deduction amount being decided by the state and federal governments and subsequently listed on the respective tax forms. It follows that if a person is not earning an amount that is above the specified standard deduction amount, then he/she need not have to pay the taxes on earnings.

In the case of wage earners, the department of payroll is obliged to cut a set percentage of the money from the pay checks for taxation purposes. The amount to be deducted is decided on the basis of some specific calculations based on the individual’s dependency and marital status. The amount deducted in this regard is shown in an official tax form called a W-2. The untaxed income will be reported on a form called a 1099.

The income tax season is from January to April 14 and during this period every individual should report their total income from wages and profits from investments to the government without fail. The amount to be paid as tax will be in give a chart provided with the form 1040.

If the amount deducted by the payroll department is higher than the amount specified by the chart, then the excess amount deducted will be refunded. If it is the other way around, the individual must pay the IRS accordingly.

For a middle class person, the taxes on earnings can amount to 15% of their gross annual income. By sighting expenses related to their profession, one can claim legal deductions from the tax to be paid thus reducing the amount significantly. Also charity donations can serve to offset taxes on earnings.

There is more than one provision by which one could save on the taxes on earnings while still remaining within the contours as mandated by the tax laws. A tax preparing firm or an experienced accountant could help one in using the tax concessions to the fullest.

The Ultimate Tax Planning Strategy

The taxes that are withheld from paychecks bulk to about 25% of your gross pay (including federal tax, accompaniment tax, amusing aegis tax and medicare tax). But these taxes that are withheld could be alive for you as investments if you apply what I alarm the ultimate tax strategy. This tax action consists of how you plan to pay no taxes aloof like all of the ample corporations. Ample businesses accept teams of accountants and attorneys activity over the tax cipher to accomplish best use of accepted deductions.

In my opinion, there is a distinct difference between an individual and a business in the U.S. tax code (others have called it the difference between the rich and the poor). Such as businesses are rewarded with tax deductions because they create jobs and engage in entrepreneurial activities that support individuals and government. But individuals are awarded few tax breaks because they don’t create jobs and don’t take risks that add substantial value to the economy. This is simply the fact and we just need to find a way to make the most of the few tax deductions that are available to wage earners as well.

When tax time comes around, the only substantial tax break most individuals have is a deduction for their home mortgage. This deduction is a social policy benefit to many people, but instead of helping people, it can motivate them to buy a larger home or higher mortgage than they would ordinarily afford. And unless you live in a neighborhood that continually appreciates, this is not a great strategy for you to target.

First, I need to make some big disclaimers about minimizing your taxes. There are many people in jail that have written books, tapes, websites and held seminars on how to never pay taxes. You can spot these people due to their focus on concepts that the IRS says are invalid; strained interpretations that haven’t held up in court, constitutional nonsense and a lot of straight fraud. Once the IRS audits these “patriotic educators”, the result is an invoice for back taxes, interest, penalties, and a jail or prison sentence. And illegal tax avoidance isn’t limited to wage earners. Nearly every month there is someone who tried to avoid taxes from a giant windfall (sold a company for millions, exercised stock options, received a large bonus) and paid some small shady offshore consulting company to create a fictitious tax loss to offset the big gain. The same thing happens; IRS files suit for back taxes, interest, penalties and possibly jail depending on the circumstances.

The ultimate tax planning strategy works when you buy investments that have a positive cash flow (before any tax consequences), and give you a legitimate tax deduction as an added bonus. Now it is just a matter of buying enough of these investments to reduce your tax liabilities close to zero. If you have too much of these investments, the IRS limits tax loss carry-forwards, and you may end up losing them.

The two legitimate deductions that I want to mention are real estate depreciation and oil well depletion. You are buying something that is going to put money in your pocket (or a very high probability of success), and because it is in alignment with government policy, they give you a tax deduction to take this risk.

To figure out how much of a deduction that you need, start with your 1040 federal tax form. Add together the Standard Deduction (which is around $3,000) and your itemized deductions from Schedule A. The difference between the number that you just calculated and your actual Adjusted Gross Income is the amount of depreciation you need to acquire for the ultimate tax strategy.

Investment real estate depreciation is calculated over 29.5 years right now, so take the amount of depreciation that you need and multiply it by 29.5 to calculate the purchase price you need to buy. (Note that depreciation is limited to $25,000 per year unless you meet the IRS qualifications as a real estate professional. The taxing authorities don’t like wage earners taking these types of deductions so there are many limits on them, including the Alternative Minimum Tax, to block you from taking excessive deductions).

Now even if you aren’t able to buy enough tax deductible investments to get your taxable income all the way down to zero, any investment that meets the IRS rules for a deduction, and is a positive cash flow investment, will increase your net worth, reduce your taxes and thus create more money available to you to spend or invest.

The Tax Payer as Gilligan

Let’s all sing a new version to the tune of the 60’s sitcom “Gilligan’s Island” … 

“Just sit right back and you'll hear a tale, a tale of mishandled use; that started with our nation’s past to form a fiscal noose.  The tax was a mighty hurtin’ vice, our wallets paid the price; working hard to pay our share, it’s not always fair, it’s not always fair.  The economy started heating up, so the Fed put on the breaks; if not for the courage of the consumer’s purse, things could’ve been ‘lot worse.  The yields hit bottom as we turned our focus to the source of political fate; with deficits, the Speaker too, the President and his wife, those movie stars, the terrorists and Al Greenspan; here and in every state.” 

(The opening credits fade and the scene is one we have all experienced) …     

The relationship between the tax payer and our government is a source of constant and sometimes entertaining debate.  Like Gilligan, the tax payer may feel “slapped around” and unappreciated by a larger, yet necessary, entity.  In this analogy, the Skipper represents our government.  The decisions made by our elected officials and others of higher political rank may contradict our own opinions.  What is the consequence of slapstick government spending and how does it affect you?

When it comes to the nation’s monetary policy, the Federal Reserve Bank (a.k.a. the Fed) manipulates the supply of money.  It adopts a tight monetary policy when the goal is to restrict the supply of money and an easy monetary policy when the goal is to circulate more money.  A tight policy may occur during times of inflationary concerns whereas an easy policy may occur to encourage business expansion.

Here’s where the laughter dies and we conclude there is no escape from the island.

The government has several methods to increase money supply and many reasons to do so.  Keep in mind, the reasons are generally non-partisan and no one political party is to blame.  One such reason, however, is to patch problems caused by government overspending. 

When the government is unwilling to act prudently with its expenditures, their bills must still be paid.  And when raising taxes is an unpopular alternative (as if anyone is ever happy to accept higher tax rates), printing money may become the default action.  Now, if you, a simple citizen of the United States, cannot pay your bills, printing money is not an option.  Such acts will land you on a metal bed in a shared cage we all call incarceration. Polite conversations with your spouse and friends will be substituted with arguments from your cellmate named “T-Bone” regarding the use of one shared toilet.  But, the government will print money to compensate for its overspending.  It then spends the new money and supply increases.

The joke is now on the hard working citizens of the United States and its set-up is familiar:  “The government and a U.S. citizen walk into a tavern.  The government points to the citizen and proclaims to all the patrons ‘the drinks are on this guy!’  Afterwards, the government finds a new citizen or tax payer and continues the trend.”

In reality, the joke is on us all in the form of inflation.  Simply described, with a greater supply of money, the dollar will be worth less than before.  Once the purchasing power of the dollar declines, fewer goods and services can be purchased.  Inevitably, consumers experience higher prices.  The economy seemingly has more dollars but loses its purchasing power.  A new character named “Inflation” finds its way onto our island.  And when this occurs, we hope it will only be around for a couple of episodes.

It is important to note, not all prices and wages correlate with periods of inflation.  Inflation may result in higher or lower levels of output and employment depending on the sector and type of goods or services.  Some may benefit from higher inflation.  The effects of inflation often include redistribution of wealth and income, changes in relative prices, and some saving restrictions for important goals such as retirement.

The inflation rate is measured by the Bureau of Labor Statistics (BLS) using the Consumer Price Index (CPI).  Today, the inflation rate is about 3.5%.  So how long should we expect to live on this low inflation island?  This is a difficult question to answer considering it is impossible to calculate inflation going out several years from today.  During the past decade, however, we have experienced low to moderate inflation.  Still, according to the BLS inflation calculator, $1000 in 1995 has the same buying power as $1258.53 in 2005.  Remember early 1979 through late 1981 when inflation rates hovered around 10 percent to almost 15 percent.  According to the same BLS inflation calculator, $1000 in 1979 now has the same buying power as $2641.87 in 2005.

It is arguably the uncertainty of inflation that causes the most damage.  Preparing for increases in the cost of living is an important aspect to financial planning.  Your financial planner can assist you in reviewing inflation trends, introducing inflation adjusted estimates for future income needs, managing tax efficient portfolios, and keeping an eye on government actions.  While you cannot control the weather of our economy, preparing your S.S. Minnow for potential rough sailing is important.

(As this episode ends and the closing credits roll, we rejoin the final verse of our amended Gilligan’s Island tune) …

“So this is the tale of our inflation rates, they're here for a long, long time.  You’ll have to make the best of things, it's an uphill climb.  Our law makers and bureaucrats will try their very best, to make the nation comfortable, with a fiscal mess.  No rights, no wrongs, no benefits, not a single guaranty, like generations before yours now, it's challenging as can be.  So join us here each year my friend, you're sure to pay your share; with every worker and our government, we make a solid pair.”