Income tax

You pay income tax on the money your business earns. Almost every type of company has to file an annual income tax return. (The exception is the partnership, which files only an information return.)

The important thing to know is that federal income tax is a pay-as-you-go system — the IRS doesn’t want to wait until the end of the year to receive its cut of your money. Instead, you must pay the amount of taxes that are due every quarter. Because you don’t always know the exact amount to pay in time to file by the IRS deadline (maybe an overdue invoice comes in at the last minute or a refund has to be issued), you can estimate the tax amount for each quarter and then submit that dollar amount. Table 4-1 lists the appropriate IRS form to submit when you’re estimating taxes, along with many other forms that the IRS says you need, according to the type of organization you create.

Employment tax

Your tax responsibilities don’t end, of course, with reporting your income. Employees play a role, too. Whether you have one person (even if that’s you!) or 100 people working for your company, if you hire employees to work in your online business, you’re responsible for paying certain taxes on behalf of those employees. Even if they work only part-time, you still have to keep up with the paperwork and pay up.

These obligations are commonly referred to as payroll taxes. You must file withholding forms (along with the accompanying payment) to both the IRS and your state treasury department. The types of taxes you pay on behalf of your employees include

• Medicare and Social Security taxes (as part of the Federal Insurance Contributions Act, or FICA)
• Federal income tax withholding
• Federal unemployment tax (FUTA)

Calculating the withholding amount can be complicated. You start with the information submitted by your employee on a Form W-9 and then use the tables in IRS Publication 15, Employer’s Tax Guide (Section 9), which is available at www.irs.gov/publications/p15/index.html. Withholding guidelines are updated sometimes, so it is important to review the tax guide. The most recent changes occurred in 2016. If you are still not sure how to calculate this amount or are uncertain of changes to requirements and how they might apply to you, your financial advisor (bookkeeper or accountant) can easily make the calculations for you.

With calculated withholding amounts in hand, you need to fork over payroll taxes every quarter. You must file Form 941, Employer’s Quarterly Tax Return, by the last day of the month that follows the end of the quarter. Table 4-2 shows the payroll due dates for both paper filing and electronic filing.

In addition to providing payroll dates, the IRS website for small businesses offers easy access to almost every other type of tax form you need to submit. The site even contains an online learning center so that you can further educate yourself about all tax and business start-up issues. You can see instructional videos online at www.irsvideos.gov/smallbusinesstaxpayer.

The rule of filing quarterly has some exceptions. Always check with your accountant or CPA to confirm that you’re filing properly. Otherwise, the IRS can slap you with hefty penalties and interest (never a good thing).

If you believe that your employment taxes are $1,000 or less (and your liability for Social Security, Medicare, and withheld federal income taxes is less than $2,500 for the year), you may be eligible to submit payroll taxes annually. To do so, request Form 944.

You might want to file electronically. (Come on — if you’re running an online business, you ought to be set up for filing online, right?) Although the process is fairly easy, some paperwork is involved. In other words, don’t assume that you can wait until the day before your taxes are due to sign up.

To start making online payments, go to the official Electronic Federal Tax Payment System (EFTPS) website at www.eftps.gov/eftps. EFTPS is a free service to business and individual taxpayers. Before you can file your taxes electronically, however, you must enroll online. Click the Enroll button at the top of the page and then follow the instructions to submit your information. Getting set up to make electronic payments generally takes 5 to 7 days.

Before you can complete the online application, you must have an employer identification number (EIN) and provide your bank account number and bank routing number.

Sales tax

Another tax responsibility is that of tracking and collecting sales tax from your customers and then submitting it to the appropriate state and local agencies. If you sell (or manufacture) products, you probably have to deal with this issue.

You may be wondering whether you can avoid sales tax because you’re selling products online and not in a particular state. As of 2016, it comes down to this guideline:

If you sell to people in any state where you have a nexus, or physical presence (a store, a warehouse, and sometimes that can also be the tiniest remote office), you must collect tax from customers originating from that same state.

As individual states are becoming more aggressive about collecting sales tax from Internet-based companies, the current ruling on when to collect tax may change. Keep in mind, some states do not collect any sales tax. That list currently includes Alaska, Delaware, Hawaii, Montana, New Hampshire, and Oregon. Other states may have exceptions for taxes collected on certain types of goods. In other words, it’s complicated! Our advice is to stay on top of the most current information at both the state and federal levels and to have your accountant continually keep you updated. Using a good shopping cart solution (which we discuss in Book 4) for your website may also help make it easier to keep up with which online customers to tax and when.

You’re also liable for filing and paying other state-related taxes (not just sales tax). Because the amount varies greatly across states, check with your accountant to find out which taxes apply to your online business. Or you can contact your state’s revenue department to learn more.

The Federation of Tax Administrators (FTA) website has a direct link to the appropriate agency websites for each state. Find the link at www.taxadmin.org/state-tax-agencies.

Determining periods and methods

Before you can walk, you have to crawl. When you’re starting a business, one of the first things you have to do is select your tax year, or the defined period that you use to provide an annual snapshot of the financial state of your business.

You can choose from several types of tax year:

• Calendar year: This method is defined by the wall calendar you buy at the beginning of every year. The 12 months start January 1 and end December 31. Your calendar-year accounting system follows the same pattern: Move from month to month and then start all over again on the next January 1.
• Fiscal year: Although this type of tax year also has a fixed 12-month period, it never ends on the last day of December — any other month, but not that one. For example, you could choose to run from October 1 to September 30 of the following year. Why bother? If you have a seasonal business, this method provides an opportunity to adapt your operational schedule to an accounting and tax schedule. If your peak season is at the end of the year, having to worry about reporting or paying taxes can be cumbersome.
• 52 or 53 weeks: In this variation of the fiscal year, you operate on a 52- or 53-week period rather than on a 12-month schedule. The catch is that your tax year must always land on the same day of the week (close to the end of a calendar month), thus requiring that an extra week be added to the period to end on the same calendar date each time.

A calendar year is probably the easiest reporting method for you to adopt. Depending on which type of business you form (an LLC or S corporation, for example), you may have difficulty getting the IRS to approve anything other than a calendar year. The IRS refers to it as a required tax year.

If you have good reason to think that the calendar year is a problem for your business, you must file a request with the IRS to change your tax year. For this request, you want to use the Application to Adopt, Change, or Retain a Tax Year. Unless an IRS code provides for automatic approval, be prepared to pay a filing fee for the change request.

Your next decision is to choose an accounting method for your business. You use this method to arrive at your income and expenses. Just as you choose your tax year, you select your preferred accounting method when you start your business. You’re then expected to stick with it, unless the IRS approves a change.

Here are the two most common accounting methods for a business:

• Cash basis: Simply put, you report earnings when they’re received and report expenses when they’re incurred. The IRS says that you cannot use the cash method if any of these conditions applies:

  • You’re a corporation (other than an S corporation) with average annual gross receipts of more than $5 million.
  • You’re a partnership that has a corporation (other than an S corporation) as a partner, and the partnership has average annual gross receipts of more than $5 million.
  • You’re a tax shelter.
  • You have inventory.

  Special circumstances and exceptions to the rules always exist. Be sure to check with your CPA regarding which basis is best for your business.

• Accrual basis: In this method, your revenues can be reported when you earn them rather than when you receive the money (cash). Likewise, your expenses can be reported on the date they’re owed, as opposed to the date on which you pay them. If you produce items or have inventory, accrual is considered the best way to provide an accurate picture of your financial status from year to year. Of course, that rule has some exceptions! You can use another method, even if you deal with inventory, if you are

  • A qualifying taxpayer who passes the gross receipt test (with less than $1 million in gross sales for each year of the test period)
  • A qualifying small-business taxpayer who passes the gross receipt test (with less than $10 million in average annual gross receipts for each year of the test period)
  • An eligible business as determined by the IRS

  Also, you must not be

  • A tax shelter
  • Prohibited from using the cash method

And now, your balance sheet

No matter which accounting method you choose, you need to know how to make sense of your company’s financial statements. A balance sheet, which is one of those statements, is a detailed summary of your business’s financial status.

To understand your balance sheet, here are some terms you need to know:

• Assets: Everything of value that your business owns. Assets typically include
  • Cash: Available money in your bank accounts
  • Accounts receivable (A/R): The money that your customers owe you
  • Inventory: The monetary worth of whatever merchandise you have on hand
  • Fixed assets: Land, buildings, furniture, and equipment
  • Miscellaneous: A catchall term for anything that doesn’t fit into any other category
• Liabilities: All the debts of the business. Liabilities can include
  • Accounts payable (A/P): The money that you owe suppliers, vendors, or credit card companies
  • Accrued expenses: Wages, payroll taxes, and sales tax, for example, that have been collected but not yet paid
  • Noncurrent: Notes payable to shareholders and the portion of long-term debt that isn’t yet due, for example
• Net worth or capital: The amount of your ownership or equity or the amount you invested in your company
• Revenue or sales: All the income your business has earned, usually recorded over a specific period
• Expenses: Everything spent by your business, typically recorded (or totaled) for a specified period

Now you know all the essential terms that relate to a balance sheet. The next important point is that when a balance sheet is put together correctly, the bottom line must “balance” by using the following equation:

Assets = liabilities + net worth

That’s it. See? It’s not that confusing! To help you grasp how a balance sheet should look, check out the sample shown in Figure 4-1.

A quick glimpse: The P&L

Unlike a balance sheet, an income statement (commonly referred to as a profit-and-loss statement, or P&L) provides a quick snapshot of your revenues and expenses. It’s made up of line items, a sequence of items providing a monetary total for every category of revenues or expenses. When you compile the statement, you can see how much money your business earned (or lost) for that specific period.

You can create P&Ls on a quarterly basis. Looking at P&Ls monthly is more useful, however, because you can more easily spot any unusual fluctuations in your sales or expenses.

Suppose that you earn $750 in a month, which is deposited in your checking account. Then you withdraw (or spend) $800 that month. The bank also charges you $40 in overdraft fees for two bounced checks that were paid from your account. You have lost $90 for the month (you were short $50, plus $40 in overdraft fees).

Your P&L shows you the same type of information as your bank statement. If you pull up a record of your bank account online, you can see a list showing where your money went that month. By looking at your initial balance, and the checks you wrote against your deposits, you see whether you ended up with a positive balance (a profit) or a negative balance (a loss) over that period.

Check out Figure 4-2 to see what a P&L statement looks like.

In the example shown in Figure 4-2, notice two important characteristics of a P&L:

• The dollar value for each line item is shown as a percentage of your gross revenues (total earnings before anything is deducted). Using percentages gives you a clearer picture of how much (or little) you’re spending from your total earnings. For example, if you find that you’re spending 32 percent for banner advertising and only 5 percent on keywords, consider whether that’s how you intended to spend your advertising budget.

  Regularly review your P&L statement to track whether you’re staying within your budget for the year.

• The total dollar amount and percentages from the preceding month and for the year to-date are included. It’s all on the same page. If the line item shows that your company’s water fee jumped 50 percent in one month, you might want to investigate. It could indicate a leak or other problem. Or the reason might be as simple as you having accidentally made a double payment. Don’t laugh: You might be surprised at how easily events like these can slip past you.

Think of a P&L as a tool for keeping track of your business. Like the balance sheet, it provides an important glimpse of your business, over a specific period. If you review your financial statements regularly, you can catch mistakes and identify positive trends and then use that information to make critical decisions about the financial well-being of your online endeavor.

Going online?

The first consideration for choosing software is whether you want to use a web, or cloud-based, service provider. Many vendors provide online accounting services. FreshBooks, Zoho Books, and Xero are some of the popular cloud-based options available today. Traditional accounting software providers also offer online versions of their products, such as QuickBooks Online and Sage One.

One big advantage of a cloud-based product is that the data is stored off-site and is easily accessible from any computer. Why does this matter? Well, if something happens to your office (such as a fire or a flood), you can still access your data from another location. Or if you travel, you can manage your accounting details while you’re on the road.

Another perceived advantage is pricing. Rather than pay several hundred dollars out of your pocket in one whack, you pay it out every month (sometimes as little as $10 a month). After a full year or two, of course, you’ve paid almost the full price of a box of software. But that monthly fee can also include support and other benefits that over-the-counter accounting software might not offer. Additionally, you have a pay-as-you-grow option. In other words, you can easily upgrade to the next level of service as your business grows or choose certain add-on services, as your needs change — instead of investing upfront for services that you may not need yet.

What size are you?

Speaking of a growing business, when you’re shopping for accounting software, one size doesn’t fit all. The amount of revenue your business pulls in, along with the number of employees you hire, has a lot to do with which accounting program you should choose. For that matter, solo entrepreneurs may not have any employees! If you run a small business, you'll want to find entry-level software that is designed for very small businesses. If you have a larger company, you may need an enterprise edition that has more robust features.

How much do you want to pay?

Ah, it’s everyone’s favorite question: How much do you want (or are you willing) to invest in your accounting program? You probably prefer leaning toward the lower side of the price scale. Luckily, most over-the-counter software packages suited to truly small businesses range from $30 to $400 for single users. The price fluctuation largely depends on these factors:

• Brand: As with most business products, you usually pay more when you’re using a more widely recognized brand of software. Our experience is that QuickBooks and Sage 50 are a little pricier than the Bookkeeper brand of software (by Avanquest Software), for example.

• Features and users: Price is affected by not only the number of features offered with various accounting software programs but also the complexity of those features. The number of licenses you need, or number of users with access to the program, often affects price. Keep these questions in mind:

  • Do you want software that easily integrates with your online banking system, even if it costs more?
  • Must the software communicate with your offline point-of-sale system, your online inventory system, or your payroll service? Or do you just want to track your invoices and expenses and spit out occasional reports to pass along to your CPA?

  The more you expect from your accounting software, the more you can expect to pay for it!

• Industry: Similar to the issue of the type of features that are offered, some accounting software is designed for your particular type of industry. Consultants, manufacturers, retailers, and construction businesses are examples of some of the most common industries that use specific software. If you want accounting software designed for your kind of business, you can probably expect to pay closer to $400 (or higher).

Do you need support?

Another important part of your purchasing decision is the issue of support. One advantage of choosing software that has been around for a while is that the company is usually capable of providing decent support, both online and by phone. Access to support is also an advantage of using a cloud-based solution. Not all versions of a particular product or solution include the same level or type of support, so it is important to understand what is included with your monthly fee.

Before purchasing your software, find out the terms for receiving ongoing support and compare the product across brands. Some software comes with unlimited online support, and others offer only 30-day support and then charge a fee after that.

In addition to being able to turn to your software vendor for support, you should know that your accountant and other financial advisors are better prepared to help you when you use software that they know how to use. For that reason, don’t hesitate to ask for their advice before making your final purchase.

Recognizing that it takes all types

Start by reviewing the types of professionals who can help you. They include

• CPA: These initials after a person’s name, which stand for certified public accountant, indicate that the person has passed a state-regulated exam and is recognized by the IRS as a paid preparer for submitting your tax returns. Typically, a CPA fully understands accounting methods and is well versed in tax regulations. Because tax laws are cumbersome and continually changing, a CPA might even specialize in a particular area. Examples of industry-based specialization are government, retail, and small business. Specialization can also be classified according to function, such as a CPA who specializes in mergers and acquisitions. Additionally, a CPA can legally conduct audits, whereas other accounting professionals cannot.
• Accountant: Except for the lack of a state-issued license or certificate, an accountant has the same basic skills as a CPA. Even so, an accountant can assist in preparing your taxes and file them, too. And like a CPA, a reputable accountant can advise you about financial decisions and should be up to date on changing tax laws.

• Bookkeeper: Someone in this category can manage the basic recordkeeping activities for your small business, including these tasks:

  • Make deposits
  • Log in accounts receivables
  • Handle account payables
  • Manage payroll
  • Send out appropriate forms, such as W2s and 1099s, to employees and contractors

  In addition to being able to keep the books, this person should be comfortable with creating an income statement and a balance sheet each month. Of course, bookkeepers come with all levels of experience and education. (Some are professionally certified with a college degree, and others aren’t.) A basic bookkeeper is usually the most affordable outside help.

• Tax consultant: This catchall term includes both independent advisors (who can range from accountant to CPA) and tax preparers, such as the folks at your neighborhood H&R Block office at tax time. Similar to a bookkeeper, this person’s range of experience, knowledge, education, and certification varies.
• Enrolled agent: This type of federally licensed professional understands both state and federal tax laws. In addition to completing an exam issued by the U.S. Department of Treasury, an enrolled agent has also passed a federal background check. He or she can also gain licensure after having worked for the IRS for at least 5 years. An enrolled agent is certified in the eyes of the IRS to
  • Prepare your taxes
  • Assist you in long-term financial planning
  • Represent you in dealing with the IRS
• Tax attorney: Most tax attorneys don’t handle general accounting functions. Instead, you hire an attorney specifically to deal with issues pertaining to the tax law — for example, to handle an audit requested by the IRS or to file corporate bankruptcy (which we hope you never do). Larger corporations might also keep a tax attorney on retainer or hire one in-house, if the company continually deals with complex tax issues. Your small business is less likely to need the services of a tax attorney regularly.

Attorneys, enrolled agents, and CPAs are the only professionals authorized to represent you with the IRS.

As a general rule, you need a full or part-time bookkeeper. If you’re up to the task (and many small-business owners like it this way), you can wear that hat, too. If you aren’t adept at follow-through or if numbers just plain scare you, consider hiring someone.

Depending on the experience (or inexperience) of the professional and the market rate in your community, you can hire a basic entry-level bookkeeper (often referred to as a bookkeeper clerk), for a fairly low hourly rate. (The rate can start in the range of $10 to $20 an hour, depending on experience.) A more experienced person, such as a professional full-time bookkeeper or a professionally certified bookkeeper, charges a much higher hourly rate — or a mid-to-upper-end management-level salary if you hire the person full time.

When you interview bookkeeper candidates, use the free Bookkeeper’s Hiring Test, available from the American Institute of Professional Bookkeepers, to qualify them. You can find and print the test at www.aipb.org/testrequest.php.

Knowing what to expect from your tax professional

In addition to having someone handle your daily financial recordkeeping, you should establish a relationship with a CPA, an accountant, or an enrolled agent. This type of professional should be available to assist you with these tasks:

• Prepare and file your taxes
• Set up your accounting system
• Advise you on the legal organization of your company (and other start-up issues)
• Compile (or review) financial statements
• Assist you in long-term financial planning for your business
• Address specific tax-law questions and concerns as they arise
• Ensure that the proper amounts and types of taxes are being filed
• Guide you in the completion of (or submit on your behalf) all quarterly tax documentation and other forms that might be required annually
• Answer questions and advise you about other general tax- and finance-related concerns

These professionals typically charge a high hourly rate. (A CPA’s rate can start at $125 an hour.) Make sure that you clarify how you’re charged for time. (Some professionals don’t charge for questions asked by way of e-mail, and others do, for example.)

Before you consult with an outside professional advisor, make a list of the specific questions or issues you want addressed. This list keeps you on track and ensures that you maximize the time spent with your advisor while avoiding running up steep bills.

Finding likely candidates

After you decide which type of professional you want to hire, your next step is finding one. Fortunately, you have lots of places to turn to for a head start on this task:

• Referrals: Ask business peers and family members whom they use or recommend. Ask for specific information, such as
  • What do you like about the way this person does business?
  • What expertise does the professional have?
  • How long have you known this person or used his or her services?
  • How much does this person typically charge?
• Local organizations: Area Chamber of Commerce chapters and other local business associations often make their membership databases available to the public. Although the organizations typically don’t endorse one member over another, they can suggest which professionals might be best suited for your specific requirements and tell you whether any complaints have been registered against them.
• Professional associations: Industry or professional groups are a terrific place to start your search for a CPA or other accounting professional. You can check out this list of organizations to get started:
  • American Institute of Certified Public Accountants: www.aicpa.org
  • National Association for Enrolled Agents: www.naea.org
  • American Association of Attorney-Certified Public Accountants: www.attorney-cpa.com
  • CPA Associates International: www.cpaai.com
  • American Institute of Professional Bookkeepers: www.aipb.org
  • AGN North America (a worldwide association of separate and independent accounting and consulting firms): www.agn-na.org

• Classifieds: When you’re hiring a bookkeeper or an accountant, feel free to place an ad in local newspapers, online career or job sites, or on social media sites, such as LinkedIn. These are all good resources for finding the best candidate.

  When you place a help-wanted ad, you'll hear from better-qualified candidates if you’re specific about the required job functions. We also recommend requesting that job candidates forward their salary requirements or salary history, along with their résumés.

• Phone book and search engines: If all else fails, the Yellow Pages usually has a substantial listing of potential financial advisors. And a quick search on Google or Yahoo! will also return a healthy list of local options.

Narrow the field of reputable contenders by skimming advertisements for professionals who list specific certifications, licensures, and memberships in professional associations.

Choosing the best person for you

After you create a short list of possible candidates, how do you decide which one is best suited for your business? In addition to checking for proper accreditations and confirming hourly rates, you have to consider a few other issues when you’re choosing a CPA, an accountant, an enrolled agent, or even a tax attorney:

• Experience: You want to know whether the person specializes in particular areas of accounting or tax law. You should also find out, however, what type of work now takes up the majority of the professional’s time and also the type of work performed in the past. Two critical questions to ask are

  • What areas do you most enjoy handling?
  • In which areas do you have the most up-to-date knowledge?

  Because definitive rules of taxation and the Internet are still somewhat up in the air, you’re not as likely to find a professional who specializes in this area. Instead, look for someone who’s eager and willing to stay informed on new issues and changes to the tax law. Preferably, choose someone who’s committed to tracking down the answers to difficult or lesser-known tax questions.

  Ask your CPA about changes in the tax law to determine whether you’re affected. The IRS provides a quick summary of those yearly changes on its website at www.irs.gov.

• Availability: A highly qualified independent professional often has a waiting list of clients. Although that’s a helpful situation for the accountant, it doesn’t help you. You need a professional who can work with you now. No matter what, it doesn’t hurt to ask what the person’s client schedule is like. For example, some professionals work part-time or have a 4 day workweek. Others are eagerly growing their businesses and are available to answer your questions 7 days a week. Nothing is wrong with either schedule; just find the one that you can live with as a client.
• Firm size: Size does matter, and sometimes a smaller firm is the better option. Even though some folks think that a large, recognizable accounting firm is the way to go, that’s not always the case. If you have a small company, you might find yourself at the bottom of the totem pole when the firm prioritizes its clients. Your company’s needs might get passed off to a junior accountant or other staff person. Unless your business is large enough to support individual departments (HR and marketing, for example), working with a large firm may mean less attention and higher rates. A smaller firm or an independent professional may give you more dedicated attention and be available immediately to answer your questions.
• Philosophy: Your financial advisors are ultimately your partners in business. Their professional views must complement yours. We’re referring to not only ethics but also strategic philosophies. For example, if you’re an aggressive risk taker in business, you may think that a conservative accountant will hold you back. Alternatively, you may prefer a conservative outlook as a means to provide a system of checks and balances to your liberal financial outlook.
• Work style: This term refers to how professionals interact with you and service your needs. For example, does the CPA insist that his firm file all required paperwork with the IRS, at a steep hourly rate? Or does he prefer to help you get started and then encourage you to take care of everything yourself to keep your expenses in check? What are his preferred methods of communication? If your tax professional isn’t a fan of e-mail, he might respond to your questions only by phone. Or an assistant might serve as a middleman, so the tax professional is rarely available to talk with you unless you schedule a formal appointment. Again, none of these issues has a right or wrong answer. Find a style that best meshes with your preferences.

Spending the time to determine these concerns means a lot to the future of your online business. After all, this professional plays an integral part in your business as a trusted financial advisor. That’s why we suggest taking your time to select the best match for you and your new business.

Dealing with all the paper

When we refer to records in the remainder of this chapter, we don’t mean your account logs. Instead, we’re talking about the physical records (the dreaded paper trail) that the IRS expects you to maintain. The thought of accidentally throwing out the wrong receipt or losing a copy of a questionable invoice can send chills up the spine of any well-meaning entrepreneur if the IRS comes calling. At the same time, your office space probably doesn’t come with unlimited storage space.

How do you balance the need to hang on to important receipts with the need not to be overrun by the growing mounds of paper? The good news is that the IRS now recognizes electronic versions of financial records. You can therefore scan copies of receipts, invoices, logbooks, and other proof of financial transactions and save them as files on your computer or, better, back up these files online (in the cloud) or to a DVD. Then you get to throw out the hard copies! That’s the easiest way to avoid the clutter that builds up with months and years of business transactions.

If you lose the electronic file and are audited, the IRS isn’t sympathetic. The loss could cost you thousands of dollars — and possible jail time (in the worst-case scenario). We highly encourage you to make multiple copies and store one or more sets at another location or in a fireproof safe, or have a backup copy saved online but off-site.

You can avoid the time it takes to scan and save critical documentation by hiring a company to do it for you. In addition to making electronic copies of your paper trail, these digital documentation specialists store the electronic files for you. You can also purchase digital documentation software that makes scanning records yourself easy.

Storing records: How long is long enough?

Whether or not you “go digital” with your recordkeeping, one critical question remains: How long should you keep records? We should have a straightforward answer for you, but we haven’t found one yet. That’s because the IRS states (in Publication 583):

You must keep your records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Generally, this means you must keep records that support an item of income or deduction on a return until the period of limitations for that return runs out. The period of limitations is the period of time in which you can amend your return to claim a credit or refund, or the IRS can assess additional tax.

Huh? Well, the IRS says that you should keep records for as long as there’s a possibility that it might audit you. We always heard that 7 years is a safe bet. However, the true issue isn’t the type of documentation; rather, it’s the type of situation you encounter with the IRS.

For example, if you have employees, the IRS says that those tax records must be kept for at least 4 years from the period the tax becomes due or is paid, whichever is later. On the other hand, records about assets, such as property, should be kept until the period of limitations expires for the year in which you dispose of the property. Even tangible guidelines such as those, however, could be null and void if you’re audited for a fraudulent tax return. In that case, all bets are off and you had better have ready access to all your records, from the beginning of time!

All these situations make up what the IRS refers to as a period of limitations. Table 4-3 gives you an overview of the rules for these time restrictions, as defined by the IRS.

To play it safe, embrace the philosophy “When in doubt, hang on to it.” This technique is especially manageable if you have limitless storage capacity for electronic documentation.

Businesses of all sizes may be eligible for certain deductions or tax breaks, specifically those designed to provide monetary incentive to help stimulate the economy through job growth and expansion. Tax incentives may be available for a limited time period or have exclusions and other stipulations. Take the time to discuss available deductions or incentives with your accountant or tax advisor. After all, these types of tax breaks could mean additional money in your business bank account!

We hope that you never have to worry about an audit from Uncle Sam (the U.S. government). The thought that it’s always a possibility, though, is certainly incentive enough to keep all your records in order!