Handbook / Bookkeeping and cash

Bookkeeping for the self-employed: a simple system you will keep up

Bookkeeping is the habit that makes everything else in a small business easier: tax returns, estimated tax, pricing decisions, health insurance applications and simply knowing whether the business makes money. For a self-employed person it does not need to be complicated. It needs to be consistent. This guide sets out a system that works for most one-person businesses and explains what the IRS expects.

What the IRS expects

The IRS says good records help you monitor your business, prepare financial statements, identify sources of income, track deductible expenses and property basis, prepare tax returns and support what you report. It also says you may choose any recordkeeping system suited to your business that clearly shows your income and expenses, and that except in a few cases the law does not require any special kind of records.

What it does require is support. The IRS describes the responsibility to substantiate entries, deductions and statements on your return as the burden of proof, and says you must be able to prove certain elements of expenses to deduct them.

The supporting documents

IRS Publication 583 lists documents that show gross receipts, including bank deposit slips, receipt books, invoices, credit card charge slips and Forms 1099-MISC and 1099-NEC. For expenses it lists documents such as canceled checks, account statements, credit card slips, invoices and petty cash slips. Each document should show the amount and that it was for the business.

In practice, for a service business, keep:

• every invoice you issue
• every receipt or bill you pay
• bank and card statements for the business account
• Forms 1099 you receive
• a mileage log if you claim vehicle expenses

Step 1: separate the money

A separate account for business income and expenses is the single biggest simplifier. Every transaction in that account is business, so the bank statement becomes your first draft of the books. Mixed accounts force you to sort every line, every month.

Step 2: a simple ledger

A ledger is a list of transactions. For a small business, these columns are enough:

• date
• description: client, supplier or purpose
• income amount
• expense amount
• category
• document reference: invoice number or receipt file name

Publication 583 calls a system that tracks the flow of income and expenses through daily and monthly summaries a single-entry system, and describes it as simple and practical when starting a small business. A double-entry system uses journals and ledgers, includes assets and liabilities, and has built-in checks. Accounting software usually handles double-entry behind the scenes.

Step 3: categories that match your return

Sort expenses into categories that mirror the expense lines on Schedule C, such as advertising, car and truck expenses, insurance, legal and professional services, office expense, supplies, travel and utilities. At year end, category totals map almost directly onto the form. The guide on Schedule C lists the lines.

Step 4: a weekly routine

Thirty minutes a week usually keeps a one-person business current:

1. Record new income and expenses in the ledger or check software imports.
2. File receipts digitally with a name you can find, such as date and supplier.
3. Check which invoices are due or overdue and follow up.
4. Move a share of new income into your tax savings account.

Step 5: monthly reconciliation

Once a month, compare the ledger with the bank statement. Every transaction on the statement should be in the ledger, and the ending balances should agree once timing differences are accounted for. Publication 583 includes an example bank reconciliation. Reconciliation catches missed entries, duplicates and errors while they are easy to fix.

Then review the month: total income, total expenses, profit, and how it compares with the previous month.

Step 6: year end

At the end of the year:

• reconcile December
• total each category
• list Forms 1099 received and check them against your income records
• total business miles if you drive for work
• gather everything in one folder for your tax return or preparer

How long to keep records

The IRS says to keep records as long as needed to prove income or deductions on a return, and gives specific periods: generally 3 years, longer in certain cases such as 6 years if you underreported income by more than 25% of gross income, 7 years for some loss claims, and indefinitely if you did not file a return. Employment tax records should be kept for at least 4 years. Records connected to property are generally kept until the period of limitations expires for the year you dispose of it.

Software, spreadsheets or a bookkeeper

Choose the tool you will actually use. Software helps as transaction volume grows. A spreadsheet suits a simple service business. A bookkeeper can set things up, catch up a backlog or handle the routine if your time is better spent elsewhere. Whatever you choose, Publication 583 notes that computerized records must be able to support and verify entries on your return.

One account, one ledger, categories that match your return, thirty minutes a week and a monthly reconciliation: that is enough bookkeeping for most people who work for themselves.