There’s a Chinese proverb that goes “The best time to plant a tree was 20 years ago. The second best time is now.” Funnily enough, the same applies to having a stress-free tax season! The best time to get your bookkeeping organized was last year, but the second best time is now!
In this article, I explain the basics you need to know to get your bookkeeping sorted for tax season and share some tips you can implement right away in your business.
What is Bookkeeping?
If you’ve ever done personal or household budgeting to keep track of your spending vs. your income, bookkeeping is basically the same thing – but for your business. Simply put, bookkeeping is keeping track of all the financial transactions in your business.
You get paid by a client – record it.
You renew your subscription to Zoom – record it.
You receive a refund on the printer you bought for your business – record it.
Keep this up diligently and at the end of the month, you’ll have a bookkeeping record. It’s that simple!
Okay, maybe not.
As your business grows and becomes more complex, keeping track of income and expenses can also become more complicated. To make your bookkeeping easier, there are some tools you can use.
1. Bookkeeping Spreadsheets
Microsoft Excel and Google Sheets are excellent starter options to organize your business bookkeeping. You can create your own spreadsheet organized in a way you understand or use a template like The Exceptional Business Spreadsheet.
Every month, update this spreadsheet with all your income and expenses for that month. It can be a good idea to organize your expenses into different categories to make filing your taxes easier during tax season.
Some common expenses you may track as a business owner include:
- Travel (Flights, etc)
- Advertising (Facebook Ads, etc)
- Business Insurance
- Office Expenses
- Car Expenses (Repairs, etc)
- Utilities (Internet, etc)
- Dues & Subscriptions (Monthly Subscriptions)
- Legal and Professional Fees
- Merchant Fees
Keep in mind that only expenses that are “ordinary and necessary” in your business should be included in your books. Tracking your income and expenses in this way will make it a breeze at tax time when you have to report all of this information in your tax return.
2. Bookkeeping Software
There is a multitude of bookkeeping and accounting software available for small business owners these days. Free software like Wave and paid software like Quickbooks (*Affiliate link) both perform the same function – to make bookkeeping and accounting easier.
These bookkeeping platforms also have the advantage of streamlining your bookkeeping and accounting process so you save time and effort. By bringing all your business financial transactions such as invoicing, expenses, and payroll into the same platform and connecting to your bank accounts, they make the process of filing your taxes almost painless.
Deciding which bookkeeping software works best for your business depends on your specific needs. In a nutshell, Wave is an intuitive platform that works best for freelancers and entrepreneurs starting out but has limited services, while QuickBooks has a much wider array of services that can grow and scale alongside your business which comes with a much steeper learning curve.
*Affiliate Link: QuickBooks is our recommended accounting software and we use it with all our clients. If you sign up for this service using this link, we earn a small commission at no additional cost to you.
How to Reconcile Your Books
Now that you have a system for tracking income and expenses in your business each month, the next part of setting yourself up for a stress-free tax season is reconciling your books. To understand how to reconcile your books, it’s important to understand what it means.
What is reconciling?
Reconciling your books is a fancy way of saying “matching the income and expenses you recorded to your bank account records”. If you record an expense of $150 for Google Suite in your spreadsheet, there needs to be a deduction of $150 from your bank account. If there’s a client payment of $2,000 in your bank account, that $2,000 needs to be recorded in your books.
As long as your bookkeeping records match your bank statements, you can rest assured that your books are reconciled.
Reconcile Your Books: Track and Account For All Transactions
If you are using accounting software and have connected your business bank account to it, reconciling your books should only take a few minutes. If you are reconciling your books manually, ensure that the deposits in your bank account tally with the income you have recorded in your books. Then check that the withdrawals from your account correspond with the expenses you have recorded.
It is good practice to reconcile your books every time you get a bank statement or once a month at the minimum. Reconciling your books regularly will alert you to any discrepancies early on and help you avoid a headache at tax time.
Connecting the Dots – Bookkeeping vs Tax Return
If you are still puzzled about why your bookkeeping is so important for a stress-free tax season, let me connect the dots for you.
When you track your expenses in your business every month, you should be categorizing them (see Image A). Over the course of the year, you will eventually end up with different amounts spent on each category and a total figure for expenses.
When it’s time to fill out your tax return in Schedule C (Form 1040) (see Image B), you can easily put the amounts for each category in the corresponding field as well as the total amount of expenses. That’s why keeping detailed records of the expenses in your business is critical to a smoother tax-filing season.
Tips for Stress-Free Taxes
Now that your bookkeeping is organized and you’re staying on top of your books by reconciling them regularly, you’re almost set for a worry-free tax season. Here are a few more tips and reminders to wrap things up.
Separate Business from Personal Accounts
So many small business owners and entrepreneurs think it’s a hassle to open a separate bank account for their business and choose to run their business out of their personal bank account. When it comes to tax time, this can pose a huge problem if the IRS cannot distinguish your business expenses from your personal expenses – they may throw out all of your expenses, leaving you with a much higher tax bill!
Watch out for IRS Red Flags
Most small business owners avoid the dreaded IRS audit but keep an eye out for red flags that could trigger an audit. The IRS uses an algorithm designed to pick up certain cues or indicators that your tax return is normal. Anything that falls outside of the algorithm’s “normal” range gets flagged and you may find yourself at risk of an audit.
Make a Last-Minute Contribution to Retirement Accounts
While most of the tips shared in this article are for the upcoming year to get your business finances organized for a smooth tax season next year, this is a tip you can put into action for your 2022 tax return.
Depending on your filing status, you may still have time to make a last-minute contribution to your retirement accounts and reduce your tax bill. The IRS accepts contributions to both the Traditional and Roth IRA up till 18 April 2023 and this contribution can be used to reduce your taxable income.
Get Ready for A Exceptional Tax Season
With a few simple actions that you can take today, you can easily set yourself and your business up for an easeful tax season. However, if you are looking for support with your taxes right now, we’ve got you. Whether you need an intensive cleanup of your bookkeeping records or some extra support as you work through your books from last year, we can help.