A few years ago, I helped a real estate agent who hadn’t filed a tax return in several years. His family had been dealing with a host of health issues, but now that everyone was healthy again, they wanted to get current with their tax obligations. Determining how much income he’d received during the years in question was a piece of cake – that information came from a 1099 issued by his broker. The problem was, he didn’t know how to track business expenses.
We did the best we could to piece together expenses based on credit card receipts, bank statements and the few receipts he’d managed to dig up, but it wasn’t ideal. The family likely ended up owing a lot more money to the IRS than they would have if he’d kept track of expenses throughout the year.
How to track business expenses
Whether you’ve just launched or you’ve been in business for years, running a business involves expenses. Ordering business cards, paying for web hosting and a domain name, buying office supplies and client gifts and driving your vehicle for work. All of these expenses add up! But if you’re not keeping records of theses cost, they won’t make it onto your tax return.
The good news is, tracking business expenses is easier than ever. With the tools available today, you don’t have to spend hours a week on bookkeeping or lug a shoebox full of receipts to your accountant’s office. Here’s my easy three-step process for tracking business expenses.
1. Open a separate checking account for your business
One question many small business owners ask is, “Do I HAVE to open a separate checking account?”
If you structure your business as a Limited Liability Company (LLC) or corporation, the answer is definitely YES. Mixing business and personal funds can cause you to lose out on one of the main benefits of structuring your business as an LLC or corporation: protection from being held personally liable for company debts and lawsuits.
But what if your business is a sole proprietorship? In that case, you aren’t legally required to separate business and personal expenses, but it’s a really good idea. Keeping your transactions separate makes it much easier to have a clean record of business income and deductions at tax time, prepare an accurate tax return, and have a less stressful experience if the IRS selects your return for an audit.
One of the main arguments against opening a separate checking account for business is the monthly fee. I learned this the hard way when I started a bookkeeping and tax prep business years ago. I opened an account at Bank of America since that’s where I had my personal checking and savings accounts, but quickly realized the $12 monthly service fee was a killer.
Fortunately, there are plenty of options for fee-free business checking. You’ll want to do some research before setting up your account, as some banks require a minimum deposit to avoid the monthly service fee while others limit the number of transactions in your account each month.
My current favorite is Axos Bank. Their basic business checking has no monthly maintenance fee, requires only a $1,000 minimum opening deposit, and up to 200 free debits, credits or deposited items per month (after that, it’s $0.30 per item).
2. Use cloud accounting software
Now that you have your business bank account in place, it’s time to connect it to accounting software.
Small business accounting is about more than merely tracking business income and expenses. It gives you an accurate picture of your business’ financial health, including how much cash you have on hand, how much clients owe you and how long they take to pay invoices.
When your business is new and you have very few transactions, a simple spreadsheet might suffice. However, as your business grows, you’ll want to move beyond spreadsheets, which are prone to errors and easy to neglect.
There are a ton of options for cloud accounting software. I’ve used several, and here are my favorites.
- FreshBooks. FreshBooks is an excellent option for freelancers and sole proprietors with straightforward books. You can connect the software to your business checking account to easily track expenses. It’s also simple to record time spent on a project, invoice clients, track receivables and accept credit card payments.
- QuickBooks. QuickBooks is a better option for businesses that need more robust accounting features. Like FreshBooks, you can connect the software your checking account, record time spent on a project, invoice clients and track receivables. However, QuickBooks also offers inventory features, fully-automated double-entry accounting and bank reconciliations. If your business involves inventory, you want software for tracking your inventory from day one.
I’ve also tried Xero and Wave. I found Xero to be needlessly complicated. If you work with a bookkeeper or accountant that prefers Xero, it’s a fine way to go, but I don’t recommend trying to DIY your accounting through Xero. The benefit of Wave is it’s free (although features such as accepting credit card payments, ACH payments and payroll comes with pay-per-use or monthly fees). However, I still prefer FreshBooks and QuickBooks, as they’ve been around longer and offer more integrations.
3. Save receipts
Now you’ve got a business checking account that’s connected to your accounting software, so all of those transactions are being captured. You may wonder why you need to bother keeping receipts at all – won’t your bank statements and accounting reports suffice? Unfortunately not.
If the IRS decides to audit your business, bank statements and accounting reports are a good start. However, the auditor will also want to look at supporting documentation. That supporting documentation should include:
- The date of the transaction
- The amount paid
- To whom the amount was paid
- A description establishing that the purchase was a business expense
For example, say you spend $300 on a new printer, paper and ink cartridges from Target for your business. Your bank statement will show the date the transaction cleared your bank and the amount paid to Target. But three years later, if an IRS auditor is reviewing your bank statements, you won’t be able to prove whether you spent the $300 on business supplies or snacks. Without the receipt showing that the purchase was a valid business expense, the IRS may deny your deduction.
The good news is, you don’t need a shoebox full of receipts. Most cloud accounting software allows you to snap a picture of your receipt on your phone and attach it to the transaction. I’ve been doing that with FreshBooks for years and QuickBooks offers the same feature. Just take a picture, attach it to the expense in your software and recycle the receipt.
Another option for tracking business expenses
Does the above sound like too much trouble? In today’s gig economy, just about anyone can be a small business owner by driving for a rideshare app part-time, walking dogs through Rover or delivering food via DoorDash. If your side hustle is just a way to make some extra cash in your free time, opening a separate bank account and spending a few hundred dollars per year on accounting software might not make sense. But you still need a method for tracking business expenses.
I recently discovered an excellent option: Keeper Tax. Keeper Tax monitors your credit card and bank accounts, looking for potential write-offs. When the software finds one, it sends you a text to confirm whether the purchase was work-related. As you reply to confirm whether certain transactions are or aren’t business expenses, the software learns more about your business and automatically adds transactions to your list of tax write-offs. It can also track business miles and even help you file your tax return at year-end.
Keeper Tax will give you 30 days free. If you like it, it’s just $24 per month after that. That’s a very affordable option for side hustlers!
Tracking business expenses can be overwhelming without an organized system for capturing and recording your deductions. If you follow the advice above, what could be a tedious process involving manual spreadsheets and boxes full of receipts will be an easy, stress-free method for keeping your business finances on track.
How do you track business expenses?
