8 Essential Recordkeeping Rules for the Self-Employed
Keeping good records is one of the most important responsibilities you have when you’re self-employed. Money Girl gives you eight rules to follow to stay compliant with the IRS and better understand your business now and in the future.
When you start a business, keeping great records probably isn’t at the top of your to-do list. Most new entrepreneurs are so focused on finding customers and building revenue that everything else takes a backseat.
But whether you like keeping records or not, it’s one of the most important responsibilities you have when you’re self-employed. The success of your business depends on how you manage data, account for financial transactions, and store and retrieve your records.
8 Tips for Entrepreneurs to Keep Good Records
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Separate your business from personal expenses
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Get a separate bank account for your business
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Find an accounting system suited to your business
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Have a backup plan
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Use recordkeeping to simplify tax preparation
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Always get receipts for business expenses
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Know how long to keep business records
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Get help from a professional
Follow these eight recordkeeping rules to stay compliant with the IRS and better understand your business now and in the future.
1. Separate your business from personal expenses
To properly track money that moves in and out of your business, all financial transactions should be kept in their own set of accounting records. This separation is essential so you can easily monitor the progress of your business, plan for the future, and create financial statements for a certain period, such as monthly or annually.
Down the road, if you want to work with partners and investors or sell your business, having correct financial records and reports will be essential. Additionally, you need good records for accurate federal, state, and local tax preparation.
Without a proper recordkeeping system, tracking the details of your business and complying with the law may be close to impossible.
Keeping precise business data allows you to identify sources of income, track tax-deductible expenses, and prepare various tax returns. The bottom line is that without a proper recordkeeping system, tracking the details of your business and complying with the law may be close to impossible.
2. Get a separate bank account for your business
The easiest way to keep your personal and business transactions separate is to have a bank account just for your business. It’s where you deposit your business revenue and withdraw all business expenses.
Be aware that most business accounts are designed to handle a large number of transactions. They also offer a variety of services, such as lines of credit and sweep accounts, which move balances over a certain amount into a separate account.
The easiest way to keep your personal and business transactions separate is to have a bank account just for your business.
The additional business banking services come with relatively high monthly fees compared to a personal checking account, which may be free. So, if you’re just starting a business, or you don’t have many business transactions, you might opt for a second personal checking account at your existing bank. Even if the account isn’t technically in the name of your business, you could choose to use it just for business.
Another option for solopreneurs, who typically have few business transactions, is to use your existing personal checking account for your business, but to be meticulous about labeling business items. That’s what I do. There’s one caveat—if you’re not extremely thorough about identifying business transactions, this method isn’t for you.
The same is true for using a credit card for business purposes. You can apply for a card in your business’s name to keep those expenses completely separate. Or you can purchase business items on a personal credit card as long as you make sure they get labeled correctly. Â
My bank and credit card transactions get imported automatically into bookkeeping software, where I regularly assign them to categories. All business revenue and expenses are clearly labeled so I can quickly run business reports and keep up with tax-related items.
3. Find an accounting system suited to your business.
Speaking of bookkeeping, I recommend that every business owner use a computerized system. If you’re starting as a solopreneur or a small business with a few employees, you probably need a simple program. As your business grows, you can expand it if you need additional features like more detailed tracking and reporting.
Freshbooks is a cloud-based system and app for any small business that allows you to automate tasks such as invoicing, organizing expenses, tracking time, accepting payments, and following up with clients. You can enroll in a starter package for about $10 a month.
Most small business accounting programs are easy to use, even if you’re not an accountant.
Quickbooks is a robust desktop or cloud-based software that comes in a variety of product versions. It’s suitable for small and medium-sized businesses. Quickbooks can handle any task, including budgeting, tracking assets, inventory, sales tax, and tracking auto mileage. Prices vary from $7 per month up to a top-end software version with lots of flexibility for just over $1,000.
Most small business accounting programs are easy to use, even if you’re not an accountant. They typically allow you to upload images of receipts and documents and to automatically import data from financial institutions.
Before making a big software purchase, make sure the program can handle all your needs, such as billing for project time, collecting and paying local sales tax, having multiple users, and accepting payments online.
4. Have a backup plan
One benefit of using a cloud-based system, instead of installing software on a local computer, is that you’re less likely to lose data. Online programs update and save automatically in the background. Plus, you can access your business records from anywhere you have an Internet connection.
The downside of an online accounting system is that you must pay a monthly fee to access your data. Plus, if you don’t have Internet access, you can’t get your data. Â
With software, you make a one-time purchase, and then you own the program and the data you’ve added to it. Just be sure to back up any bookkeeping software with a separate hard drive or using a remote server, such as Amazon S3. That makes it less likely that a computer failure or software glitch will cause you to lose your business data.
5. Use recordkeeping to simplify tax preparation
As I mentioned, having sound business records is critical for accurately filing and paying various types of federal, state, and local taxes. Every business must pay income tax, and some must pay additional types, such as estimated quarterly income tax, self-employment tax, sales tax, and employment tax. Not setting aside enough income to pay taxes is a common mistake that many new solopreneurs and small businesses make.
When you work for yourself, you’re responsible for paying 100% of your tax bill.
Remember that when you’re an employee, all your taxes, including federal and state income tax, Social Security, and Medicare, are withheld from your net paychecks. Plus, your employer pays a portion of them for you. But when you work for yourself, you’re responsible for paying 100% of your tax bill.
The IRS allows you to choose any recordkeeping system you like as long as it clearly shows your income and expenses. Many computerized systems include the ability to issue tax forms to vendors and run year-end accounting reports.
6. Always get receipts for business expenses
While being self-employed means you’re responsible for paying more taxes than an employee, the upside is that you get to claim many deductions. A tax deduction reduces the amount of your taxable income, which lowers the amount of federal and state tax you must pay.
If the IRS audits any of your tax returns, you may be asked to explain exactly how you calculated the taxes you paid.
But the proof that you have a valid tax deduction is on you. That means you must keep supporting documents, such as receipts, invoices, and payments to employees. However, you can store these crucial documents digitally, instead of as paper records, if you wish.
If the IRS audits any of your tax returns, you may be asked to explain exactly how you calculated the taxes you paid. So, anytime you make a business expense, be sure to label your paper receipt or add a description in your bookkeeping program to help you remember its business purpose.
In general, the IRS accepts credit card statements as proof of expense claims. But the more detail you have in your recordkeeping system the better. Try to get into the habit of taking photos of receipts and uploading them to your computerized program or storing them in an online filing system. Having a complete set of paper or electronic records will make a business tax audit go faster and help you avoid any penalties.
7. Know how long to keep business records
In addition to keeping good business records, entrepreneurs need to know the rules for keeping them. According to the IRS, small business tax returns must generally be kept for three years, with the following exceptions:
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If you have employees, keep records for four years
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If you underreport income, keep records for six years
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If you claim a loss from securities or bad debts, keep records for seven years
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If you file a fraudulent return, keep records indefinitely
Instead of getting hung up on different retention periods, I recommend that you cover all the bases by keeping all business financial records for seven years. If you digitize them, it’s easy to store them indefinitely on a hard drive or cloud-based storage system. If you get audited, the IRS can accept electronic records from most accounting software programs.
8. Get help from a professional
Most business owners should meet with a tax accountant or CPA to understand tax requirements and get help setting up an accounting and recordkeeping system. Find one who is familiar with your industry or the type of work you do.
If you don’t have time to manage your financial records, an accountant or bookkeeper can handle it for a monthly fee. Or you can pay an accountant for year-end tax preparation services, which is what I do.
Additionally, you may have other records or contracts to keep for legal purposes. You can check with an attorney for legal requirements and statutes of limitations in your state.
Like many administrative tasks related to running a business, managing your books and recordkeeping requires discipline. Even though you may not enjoy it, if you follow these rules, you’ll stay out of trouble, save time doing taxes, and have a smooth operation all year long.
About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.
