INTRODUCTION:
In the early 1980s, my wife and I became involved in a home business and have pursed additional streams of income via a number of home businesses ever since. Some were network marketing organizations as well as other home-based businesses including newspaper and Internet advertising. We prepared packaged and mailed newsletters, information and sample packets and fliers. In all these years, I studied and tried out many ways to track and record expenses and income as well as becoming familiar with the necessary forms required for filing income tax returns. During this period, I also added a Masters of Business Administration degree to my engineering degrees. Part of this Masters’ course included two accounting courses.
The home business entrepreneur will also want to track income, cash flow and may even want to develop a balance sheet that keeps track of the assets and liabilities associated with the business. Forms and processes for these accounting aspects are beyond the scope of this article. I do provide an example of Capital Items Depreciation tracking form that I use in our home business.
I want to make it clear from the outset that I am not a professional tax consultant; however, I have thirty-plus years in corporate management and retired as a Senior Consultant from a world-class consulting company. I have applied the skills acquired during these business experiences in our home businesses. My goal in this publication is to share some insights and actual practical processes that will make your home business more effective, especially in the area of tracking and reporting expenses.
Some might think that they don’t need to spend any time tracking their home business expenses since at the end of the year they take the shoe box stuffed with business receipts to their accountant and let him/her figure it all out. This is certainly a possible approach to record keeping; however, if you pay your accountant by the hour or even by the job, it is quite possible that your accounting costs may be considerably less if you use the simple and effective system described below. Also, you might even have a happier accountant!
This is the first of two articles and it addresses Preparation. The next article s will discuss the Implementation tools and strategies that I use. It is certainly important that one takes the necessary actions to prepare, and after adequate preparation, move forward with actual implementation. I will also provide examples of the actual forms that I use so you can see how they will work for your home business. Let’s get started so you can learn how to “File it in a Plastic Bag!”
PREPARATION:
LEGAL STATUS OF YOUR BUSINESS:
There are many publications available on the Internet and in your local library that can help you to decide what legal form (entity) you would want to take for your home business. Our home business was treated as a “Sole Proprietorship” for years, but in 1996, we decided to have our business entity operate as an “S Corporation”. Some “experts” have suggested that when a home business achieves $1000 per month in income, it is time to address the legal status of one’s business.
The main reason we chose to incorporate was for my wife to become an employee of the corporation. Her salary would become an expense of the company and her Social Security deductions would be shared equally with our corporation. The downside of having our small home business operate as an S corporation is the filing of additional federal and state income tax forms and payments. The annual income from an S corporation is reported along with other personal income on the Federal 1040 form, and this additive income (or loss) is also reflected on State income tax forms.
If one wanted to incorporate, it is very easy to do this with reputable on-line companies such as www.legalzoom.com. The www.irs.gov website has a list of commonly filed income tax forms, and you can find similar lists for your state forms.
TRACKING EXPENSES:
For years, I tried various ways of tracking the expenses associated with running our home business. First of all, I had to better understand legitimate reportable business expenses. Then I reviewed our own business expenses and investigated tracking methods and forms that would apply to a home business. Then, once I better understood these expenses, I searched for the “perfect” tool for posting and tracking business expenses. I found that for our small home business, expensive income & expense tracking software programs didn’t add much value to the enterprise. Others might argue that a software program is the only way to operate and I say to them, “Go for it, and use what works the best for you!” With this in mind, I am in no position to recommend any small business software to be used for your home business. I AM in position to provide you copies of the paper forms and description of the procedures that I use to easily keep track of our expenses and tax filings. These worksheets are in such a format that I can easily transfer information from them to income tax forms. (I download Federal and State income tax forms in the Adobe format and enter our information when it is tax preparation time. Then, I submit our forms in a paper format after making copies for our files.)
One can study all of the possible expenses that might be tax deductible and choose to include these on a tax form. However, the only yardstick I use to determine if an expense is a reasonable home business tax deductible entry is the “Eyeball-to-Eyeball Auditor Test”. I have studied various government produced income tax publications as well a stack of income tax preparation guidebooks produced by “experts”. From these studies, I have listed the various expense categories that I think apply to a home business. As I look at each expense category, and each of our own business expenses posted, I ask myself this question: “If I had to sit across the table in a meeting with an IRS auditor, could I honestly explain the nature of this expense and why it was associated with our home business?” If the answer is “yes”, then that expense item is posted. If the answer is “no” or there is any grey area applied to the reasoning, I don’t post it. Others may want to push the envelope, but I don’t operate our business in this manner. The choice is for each of us to make.
SIMPLE PROCEDURES WILL MAKE A DIFFERENCE:
I learned as a Senior Consultant that when analyzing an enterprise; be it a Fortune 100 company or a one person home business, the focus of attention is on three major areas: people, process and technology. For your home business, YOU are the “people” part of this analysis. Your attitude and dedication to making your home business successful are critical success factors.
Likewise, you could be the most dedicated entrepreneur on the planet and experience disappointment in your home business due to poor processes and/or inadequate supporting technology. Even with great processes in place, supported by effective technology, the entrepreneur must dedicate time, effort, education and learning to the enterprise.
The tracking of your home business income and expenses will be much easier if you:
Save all of Your Receipts
The one rule that ALL should agree on is to DOCUMENT all of your expenses, and the best documentation of an expense is a receipt or a paid invoice! Get in the habit of saving all of your receipts and posting these receipts as soon as reasonably possible. (The same procedure should apply to the tracking of your business miles incurred while using your personal automobile.) Keep the receipts in a common place. I will provide you a very easy, low-tech procedure for keeping and tracking your expenses.
Set up a Separate Business Bank Account
All major business purchases should be paid for out of a separate bank account and/or a separate charge card. We have a separate business checking account that we use to write checks for distinct home business expenses. Our business account doesn’t pay any interest so we keep just enough money in it to cover monthly expenses. The net profit we make from our home business is deposited into an interest paying savings account. We also have a separate Visa card that we use solely for business expenses. When the Visa bill arrives, we pay for these charges by a check from our business banking account. The monthly check postings and charge card bill are excellent documents for cross checks with existing receipts.
Set up a Separate Charge Card
As I mentioned above, we have a separate Visa card that we use for specific business expenses. For example, since we use one of our vehicles primarily for business activities, we use the business Visa card for gasoline purchases as well as tire and maintenance expenses. (When I complete our income tax forms, I calculate the total business miles compared to the total miles the vehicle was driven during the year, and this percentage is applied to all vehicle expenses. More on this in the specific expense category discussion.)
Dedicate a Time to Post Your Expenses
All of us have a full busy life, and if you have a full time job in addition to your home business, it is very easy to find better things to do with your spare time than posting business expenses in a log. However, if posting expenses is a drag, then I will ask you, “Why did you get into a home business in the first place?” Many home businesses fail because the new entrepreneur doesn’t really treat the effort as a business. If part of your regular job includes the posting of your groups’ business expenses weekly, you would set up a specific time to complete the task and the task would probably be done in a quality and effective manner. In my supervisory jobs, I was either a “reviewer” or “approver” of business expenses, and the company had specific rules for which expenses required receipts. Their rules were primarily based on IRS rules. For example, all business meals over $25.00 had to have a receipt. On the receipt or a separate piece of paper, the purpose of the meal and names (and titles) of the meal participants were required. Also, as a reviewer or approver, I had to dedicate time to process the vouchers and bills or I would have some unhappy employees and/or suppliers! As an employee of a company, I had to document my trip expenses and submit an expense form and receipts in a timely manner. As an entrepreneur, you have to take keeping track of business expenses seriously.
To this day, my wife or I provide adequate documentation on every business meal receipt. Also, I suggest that you post your home business expenses at least once a week and have this task as a high priority. Posting home business income and expenses should not be the last thing you do in your busy day’s activities. You will need some brain activity to do this task, and if it is done in a tired, distracted or angry state of mind, errors will occur creating extra work at some later time. Your home business may be so small at the beginning that posting expenses bi-weekly or monthly will work; however, since you want your business to be successful and grow, getting in the habit of posting expenses on a weekly basis will eliminate a possibly painful transition as your business becomes more successful.
SUMMARY:
The next article will discuss the Implementation part of this simple procedure. You will learn about the use of five forms and the simple filing system for receipts has worked well for our home businesses. The forms provide a clear record as well as tools for analysis of the profitability of the business. Best of all, the receipts and forms are filed in a plastic bag!