Every business should keep their books updated on a regular basis. However, many business owners do not have enough time to actually keep their books current. Instead, they wait until the end of the year to pull their records together to give to their tax accountant. This is a mistake. It is essential that businesses update their books at least monthly. There are several reasons for keeping the company books updated throughout the year.
For a business to deduct its expenses in full, it must carry on operations with the intent to make a profit. This is true even if the business is operated through certain legal entities. The intent to make a profit sounds like an easy test to pass because everyone who owns a business wants to make a profit. However, just having the intent is not good enough. You must prove to the IRS that you have a profit motive. The IRS looks at many factors when determining whether a business is legitimately seeking a profit. One factor that the IRS looks at is whether the business operates in a businesslike manner. In a recent court case the tax court stated that the business did not operate in a businesslike manner because the owner didn’t maintain complete books and records. In another similar case, the court of appeals stated that the “most persuasive reason” for determining that the business was not engaged in for profit, is that the books were updated on an annual basis instead of monthly. As you can see, keeping the books updated on a monthly basis is essential to establishing the profit motive for your business.
In addition to showing the profit motive behind business deductions, the business must have documentation to prove the amount of its expenses. If a business is audited and it does not have proper documentation, the expenses will be disallowed, leading to interest and penalties. It has been our experience that business owners who keep their books at least monthly are more likely, than business owners who keep their books on an annual basis, to have the documentation necessary to backup their expenses in an audit. This forces them to gather all of their documentation, such as receipts, at the end of every month when expenses are still fresh in their minds. Waiting until the end of the year to gather information, makes it much more likely that you will not be able to find all of the required documentation. In total, searching for a year’s worth of information can be more time consuming than keeping the books monthly.
In addition to making it much more likely that the business owner will not be able to find documentation to prove the expenses, it makes it much more likely that legitimate business expenses will be forgotten entirely. Missing business expenses causes you pay more tax than you otherwise would. If you find the missing expenses later, after the return has been filed, it is possible to amend the return. However, if you use a tax professional to prepare the amended return, they will charge for the amendment which will reduce the benefit of deducting the expenses. Also, amended returns go through a screening process that originally filed returns are not subject to which may increase the audit risk. So, it is important to make sure all deductions are on the original return to make sure you get the full benefit of the deductions.
While you want to make sure you deduct all of the business expenses you pay, there may be a point where you will want to reduce your overall expenses. For instance, you may want to have additional funds available to trade with. Updating the business’s books every month can help with this as well. Keeping your books up to date every month allows you to see what your largest expenses will be by year-end. With this information you can focus your efforts on those expenses before they get unmanageable. If you wait until the end of the year to update the books, the damage will already have been done. One situation where we have seen this issue is with subscriptions that renew automatically.
The business owners subscribed to a service which they later decided they did not need. They forgot to cancel the automatic renewal. Since they didn’t review their records regularly, they didn’t realize the expense was still coming out of their account until they had paid for it for several months. In this situation it is difficult to get any of the charges reversed.
Related to reducing the business expenses, keeping your books updated can help reduce unauthorized charges on the business credit card. This can include being double charged for a legitimate expense or fraudulent charges after the business card has been compromised. If you are in the habit of paying the amount due without reviewing the statement, it is easy to miss unauthorized charges. However, if the books are kept monthly, you will review every statement which will help you notice unauthorized charges and have the charges reversed.
In addition to audits and internal management, updating the books at least monthly has tax planning benefits. If your entity is a standalone entity, such as a C Corporation, it will owe tax at the end of the year, if there is a net profit. If you expect to make a profit you will want to engage in tax planning so that you pay the lowest amount of tax possible. Tax planning is best done throughout the year and not just in December when it may be too late to take advantage of certain tax saving strategies. Having your books up to date every month makes it easier to understand your business and determine what strategies would be most beneficial to your business. Also, if you own a flow through entity, such as a partnership, having the books updated is important for your personal tax planning. When designing an appropriate tax planning strategy you will need to know all aspects of income or loss that will impact your personal return. Having a gain or loss flow through from your partnership can significantly impact your personal income tax. Therefore, it is imperative to have the business books up to date so you have a clear picture of the impact it will have on your personal return. This holds true even if you are using a tax professional for your tax planning.
If, after the tax planning strategy is implemented, the business is still expected to owe tax, quarterly estimated payments may be required. Paying quarterly estimates is essential as penalties will be assessed if the quarterly payments are not paid, or if not enough tax is paid each quarter. Updating the books on a monthly basis is essential for calculating quarterly estimated payments. Having the books updated, will make your estimates more accurate which will make your quarterly payments closer to the actual tax due. This is important because you will avoid underpaying the quarterly tax, saving you from penalties. Conversely, it will help you avoid giving the IRS an interest free loan by significantly overpaying the tax.
Another reason for keeping your books updated at least monthly has nothing to do with financial or tax purposes. By keeping your books up to date, you could be helping your loved ones. In the event something happens to you suddenly, your loved ones will be the ones who will have to close the business. If you have not been keeping the books up to date, instead of being able to use the books as a starting point, your loved ones will have almost no information to start with. This will make it more difficult for them to get the information they need to close the business in an already difficult time.
As you can see, keeping the business books up to date at least monthly is essential. If you do not have the time or knowledge to keep your own books, then hiring a professional to update the books monthly is a must. If done properly, monthly bookkeeping can save you from IRS interest and penalties, reduce your taxes, help with your financial planning, and even help your loved ones.