Lots of business owners are just too busy to enter all the bookkeeping records into QuickBooks or any other accounting software that they are using. But this is not all: even if all your records are entered into the accounting system, you still have to keep good records of the source documents. Some business owners even think that once the records are entered in the accounting software and all taxes are filed, there is no more need of the paper trail. Well, that is wrong. You still have to keep all your paper records for 3 years in case you get audited by IRS (all payroll records need to be kept for as long as 4 years). The paper trail and good records are your back up in case IRS questions some of your numbers.
Here are two examples of past IRS audits:
Example 1: Mr. X had a hauling business and took large deductions for gas, maintenance, insurance and other vehicle related costs. Mr. X had no documentation regarding these expenses, nor any support for the business miles driven. The court decided to estimate expenses under the Cohan rule (when there is insufficient supporting documentation, other sources may be used to estimate the expense amounts). Because of Mr. X failure to keep good records, only the least favorable estimates were used, allowing deductions only dor some categories. More than half of his deductions were denied.
Example 2: Mr. Y is in a sales business and does substantial business travel in his personal car. Mr. Y only documentation for the business use of his car was the odometer readings at the beginning and end of each month, with some extra info in some months, but no other data for business travel and no records of his mileage for personal travel. He used the standard mileage rate to write off his vehicle expenses. He also wrote off some business meals/entertainment. IRS disallowed most of his expenses because of insuficient records.
IRS has specific requirements for keeping data for the business use of a vehicle. The minimu requirements are:
1. The date
2. The place driven to
3. Purpose of the trip
4. Beginning and ending odometer reading
Other record-keeping tips:
1. Keep every single bill, invoice, receipt, etc.
2. In case of meals and entertainment - write down on the receipt who did you meet with and the purpose of the meeting
3. If a receipt does not give enough business purpose data, write notes on that receipt (ex: lumber to fix the fence behind the office)
4. For the business mileage - have a notebook in the car, where you write down each business trip with the information mentioned above.