A Step-by-Step Guide to Tracking Business Expenses for Taxes

Tracking business expenses for taxes can be a daunting task, but it's essential for small business owners to get it right. According to the IRS, businesses can deduct expenses related to their trade or business, and keeping accurate records can help ensure a smooth tax filing process.

The first step in tracking business expenses is to set up a separate business bank account to keep personal and business finances separate. This will make it easier to identify business expenses when tax time rolls around.

To stay organized, consider using a spreadsheet or accounting software to track expenses, such as QuickBooks or Xero. These tools can help you categorize expenses and generate reports for tax time.

You'll need to track a variety of business expenses to prepare for tax season. This includes categorizing and recording expenses such as advertising and marketing, employee benefits and payroll, inventory costs, and office supplies.

For unreimbursed business expenses, it's essential to keep receipts and invoices for at least 7 years, as recommended by the department. This will serve as proof of purchase in case of an audit or to dispute any discrepancies on your tax return.

To accurately track business expenses, you should record the date of the purchase, the name of the vendor, the category, and the amount of the purchase. You can use a simple method like a tablet with one category per page for small businesses or electronic methods like Excel or QuickBooks for larger businesses.

When tracking business mileage expenses, it's recommended to keep a log detailing your mileage activity, including odometer readings on the first and last day of the year, and recording the date, starting location, starting mileage, end mileage, and total miles driven for business purposes.

Choosing an accounting system is a crucial step in tracking business expenses for taxes. You'll be choosing from two different accounting methods: cash basis accounting and accrual basis accounting.

The cash basis accounting method is more straightforward, where you record business income when you receive it and expenses when you spend money. However, this method doesn't always provide an accurate picture of your cash flow.

Accrual basis accounting, on the other hand, records income and expenses as they happen, not necessarily when money changes hands. This approach is referred to as double-entry bookkeeping and can be a more accurate bookkeeping method.

Here are the two accounting methods summarized:

Choosing the right accounting software is crucial for small businesses, as it can help streamline financial management and reduce errors. Today's accounting software providers offer a range of products, including cloud-based solutions that allow you to access your company data with a swipe of your finger.

Cloud accounting software can calculate sales tax and enable online payments, making it easier to manage your finances. Invoice2go, for example, offers advanced reporting tools that provide a snapshot of your company's accounting data.

Accounting automation software can revolutionize the way online sellers manage their finances by automatically downloading orders, fees, and expenses from online stores and marketplaces. This can significantly decrease common accounting errors.

Using accounting software such as QuickBooks Online or QuickBooks Desktop can help you track and manage your business expenses. These programs allow you to categorize expenses, create reports, and easily export data for tax purposes.

When choosing an accounting system, you'll need to decide between cash basis accounting and accrual basis accounting. Cash basis accounting records business income when you receive it and expenses when you spend money, making it a more straightforward method for small business owners.

Here are the key differences between cash basis and accrual basis accounting:

The accrual method is a more accurate bookkeeping approach since it takes into account when expenses occur, not just when payments are made.

As you're choosing an accounting system, it's essential to consider setting up payroll. If you're a solo entrepreneur, you might be able to skip this step for now, but think about how hiring in the future will affect your expense tracking strategy.

Small businesses usually need to withhold federal income tax, Medicare and Social Security taxes, state and local taxes, and unemployment taxes from their payroll expenses.

This withholding is why having payroll software can save you time and keep your business running smoothly.

Tracking business expenses is a crucial part of staying organized and ensuring you're taking advantage of all the deductions you're eligible for. To get started, you'll need to decide on the categories you'll use to track your expenses. Try to avoid a "miscellaneous" category as much as possible, since any expenses placed in this category will need to be reviewed individually later.

You can use a business bank account and accounting tool like QuickBooks Online to simplify the process. This will allow you to link your business finances to your accounting tool and automate many of the tasks involved in tracking expenses. For very small businesses, a simple tablet with one category per page can work well, but for larger businesses, electronic methods like Excel or QuickBooks are generally needed.

To ensure you're staying organized, it's a good idea to review and categorize your expenses regularly, such as monthly or quarterly. This will help you identify discrepancies, errors, or reasons to update your budget. You should also keep receipts for 7 years, and document the purpose of the business-related expense when it is incurred, as this will help support your unreimbursed business expenses.

Here are some common business expense categories to consider:

Variable expenses are those that don't remain constant, making them more challenging to track. They can include business purchases for meals, office supplies, or additional inventory.

Businesses with variable expenses often have to adjust their spending habits as their needs change. This can be due to fluctuations in sales, new projects, or even seasonal changes.

Variable expenses can be categorized into different types, including advertising and marketing, inventory costs, and shipping expenses. These expenses are often more flexible than fixed expenses, allowing businesses to make adjustments as needed.

Here are some examples of variable expenses:

Businesses with variable expenses should regularly review their spending to ensure they're staying within budget. This can help prevent overspending and reduce financial stress.

Interest expenses can be a significant business expense, so it's essential to keep track of them.

Interest can be fixed or variable, depending on the type of financing it's attached to.

Keeping tabs on your interest payments will help you see how efficiently your company is utilizing its loans.

By monitoring your interest payments, you'll be able to identify areas where you might be losing money through borrowing.

It's likely that interest payments will represent a significant portion of your budget, so it's crucial to stay on top of them.

Tracking small items can be a challenge, especially when it comes to categorizing and tracking them. A good way to start is to decide on the categories you will be using to track your expenses. For instance, you will likely need a category for office supplies, as well as for travel expenses.

To make it easier, try to avoid a "miscellaneous" category as much as possible, since any expenses placed in this category will need to be reviewed individually later when your tax preparer is working on your tax return. Use a simple tablet or a spreadsheet like Excel or QuickBooks to track your expenses.

Documenting every purchase, no matter how small, is crucial for accurate expense tracking. Include the date of the purchase, the name of the vendor, the category, and the amount of the purchase. Other details such as the specific item you purchased could be included, if helpful for later reference.

Here are some common small business expense categories to consider:

By categorizing your expenses regularly, you'll be able to stay on top of your business expenses and make informed financial decisions.

Tracking vehicle mileage expenses can be a challenge, but it's a crucial part of organizing your expenses. You should regularly input and categorize your vehicle mileage expenses throughout the year, rather than waiting until tax season.

Keep in mind that you can only deduct vehicle mileage expenses if you didn't receive a fixed-mileage allowance or a per-diem allowance from your employer. This is a common practice for many employees, so it's essential to check your employment contract.

If you did receive a fixed-mileage allowance, you can only deduct the actual expenses you paid while performing your job duties. You can't deduct the full amount of the allowance if your employer included it in your compensation.

For tradesmen, commuting costs include mileage for any job 35 miles or fewer from the closer of the union hall or personal residence to the jobsite. This is an important exception to keep in mind when tracking your vehicle mileage expenses.

Here's a summary of what you can deduct:

Remember to regularly review and update your vehicle mileage expenses to ensure you're accurately tracking your expenses throughout the year.

Filing your receipts is a crucial step in tracking business expenses for taxes. Staple them to the bank or credit card statement on which the charges appear, or use alphabetical file folders and file them according to the vendor name.

Be sure to include enough information on your expense tracking list to find the receipt later, such as the credit card used to make the purchase. This will save you time and hassle in the long run.

After tracking your expenses for several months or a year, you can easily add up the various categories and create a report of the income and expenses during that time period. This will give you a clear picture of where your business income is going.

You should keep your receipts and invoices for at least 7 years, as this is the recommended time frame for keeping records. Undocumented expenses can be denied, so it's essential to keep thorough records.

At the end of the year, you can take your entire list of categorized expenses or an annual summary to your tax preparer to use in preparing your tax return. This will make the tax preparation process much smoother and more accurate.

In Pennsylvania, you'll need to factor in the state's sales tax rate, which is 6% on most goods and services.

The state also imposes a 1% local sales tax, which can vary depending on the location.

Pennsylvania businesses are required to file a state tax return, known as the PA-40.

If you're a union member in Pennsylvania, you'll need to claim your union dues on your tax return. This can be a bit tricky, but don't worry, I've got you covered.

To claim your union dues, you'll need to provide a copy of a final pay stub for the year or a receipt from your union that confirms the amount being claimed.

In Pennsylvania, unreimbursed mileage expenses are subject to certain rules. You can only deduct expenses based on federal per-diem allowances if you actually paid for them while performing your job duties.

Public transportation costs and commuting expenses are also deductible. This includes mileage for jobs 35 miles or fewer from the closer of the union hall or personal residence to the jobsite.

You can't deduct expenses if you received a fixed-mileage allowance or per-diem allowance from your employer and it wasn't included in your compensation.

Keeping track of your business expenses is crucial, but it's not just about throwing receipts and invoices into a box. You need to organize them in a way that makes sense for your business.

Accurate records are essential for claiming tax deductions. The IRS recommends keeping a log of your mileage activity when claiming unreimbursed business mileage expenses. This can be done using any mileage log book, GPS programs, or other documentation you're already using.

You should record the date, starting location, starting mileage, end mileage, and total miles driven for business purposes. Log entries should also include a brief description of each trip. Only job-related mileage can be deducted, so make sure to subtract any personal errands conducted while on a business trip.

It's also important to keep track of reimbursement from your employer. If your reimbursement is more than your actual expenses, you must report the excess as taxable compensation on your tax return. A taxpayer and spouse must keep separate records and schedules for each job or position when claiming unreimbursed business expenses.

Here's a simple checklist to help you keep track of your business expenses:

By keeping accurate records, you can save time and effort during tax time, avoid penalties, and engage in smarter financial management.

Automating expense tracking can be a game-changer for small business owners. It reduces the hassle of manual data entry and eliminates common accounting errors.

Using accounting automation software, like QuickBooks Online, can automatically download orders, fees, and expenses from online stores and marketplaces, and post them to the business's accounting solution. This eliminates the need for manual data entry, saving hours of time and reducing errors.

Accounting automation can also sync order details, refunds, fees, and more from online stores and shipping platforms to QuickBooks, making it effortless to reconcile accounts or run an expense report.

The benefits of automation are numerous, including increased accuracy, reduced time spent on accounting tasks, and improved financial management.

Here are some key benefits of automating expense tracking:

By automating expense tracking, small business owners can stay on top of their finances, make informed financial decisions, and grow their business with confidence.