Bookkeeping is the method of keeping track of your business income and expenses. Whether you use, your head, a shoebox, or computer software, you are somehow keeping track of all this information. Many times, internet businesses use their marketplace accounts, like Paypal, Ebay or Etsy, to track their income while using their personal bank account to track their expenses. They may even have a shoebox full of receipts for business purchases, if they make it to the shoebox at all. I call this the Internet Startup Bookkeeping method.
Internet Startup Bookkeeping is a great way to do just what it says, get started. However, it is impossible to maintain this method as you grow. Many times internet startups are using another form of income to finance their startup. Usually, wages earned at a day job. This makes the situation much more complicated as you often have to sort through which expenses are personal and which are business.
At the end of the year, either you or a professional then gets twelve months of your bank statements, reports printed out of your marketplace accounts and the shoebox. That $200+ per hour accountant (or you if you have the time) sift through all those transactions trying to pull out business expenses. In the end, some expenses are lost, some are questionable but included in the tax return, and some the CPA just doesn’t want to deduct because they don’t think they could defend you in a tax audit. The time the CPA spends thumbing through your expenses costs you money and the expenses lost, questionable, and not included cost you money. You pay more in taxes and either lost time preparing your own tax return or a higher bill to your CPA.
A year or two of this and you should be looking at a better way to keep track of your business income and expenses. But the money and time spent on tax preparation and the tax bill aren’t your only costs due to the Internet Startup Bookkeeping method. The IRS is very particular when it comes to allowing business deductions. The regulation states business expenses have to be ordinary and necessary. This means that you have to prove to the IRS that they are legitimate business expenses that are needed to operate your business.
Transactions kept in a personal bank account are much harder to argue that they meet the ordinary and necessary requirements in an audit against an IRS agent. Expenses kept in an accounting software supply an additional layer of protection in the case of an audit. Business expenses under a formalized business with a registered name add another layer of protection. The more layers of protection, the easier it is to get the IRS to allow business expenses that would normally be considered personal.
A great example of this is a cell phone for a blogger. A blogger that buys their cell phone under a sole proprietorship and is accounting for expenses in their personal bank account is likely to get the cell phone purchase expense disallowed or at a minimum limited to some type of allocation, such as 50% is personal and 50% is a business expense. On the other hand, a blogger that has set up their business as an LLC, accounted for the purchase in Quickbooks and wrote the check out of a strictly business bank account will most likely not even get questioned on that expense. Even in the case of an audit, the same blogger will just have to provide a quick explanation of how the phone is a business expense.
As I have researched the internet, I find a lot of articles giving advice to internet startups saying that the tax codes are written for large, brick and mortar corporations. This is only slightly true. Yes, large corporations have the ability to lobby Capital Hill to get what they want, but if done right, those same benefits can be applied to internet startups. Any company of any size, organized properly, with correct records, can take advantage of the tax breaks that congress has allowed. The only difference is the number of zeros on the amount of the tax credits. But a $1,000 credit to an internet startup can be just as beneficial to the owner as the same credit worth $100,000 to a multimillion dollar corporation.
Another benefit of keeping proper records versus the Internet Startup Bookkeeping method is the accessibility and versatility of information provided. Proper bookkeeping is not merely a bank reconciliation to keep track of cash. It is a system meant to track all aspects of your business. A good accounting system is the basis for all higher level business functions, for example, providing historical information to aid in making future business decisions. From deciding when you need to order extra supplies for a busy season or determining if a product you are making is actually profitable.
Whatever method you use, bookkeeping can be a tedious problem. If done right, it can provide large rewards. If done wrong, it can sink your business into bankruptcy. And the job of keeping the books always seems to get in the way of actually running your business.
At Cyberspace CPA, we specialize in aiding the transition from the Internet Startup Bookkeeping method to a better accounting method that can work for you, instead of you working for it. Experts in working remotely with clients, we will be with you every step of the way while you learn your new system. Or if you'd rather have the problem of bookkeeping off your plate entirely so you can focus on operating your business, we will keep track of your books for you. Providing you with complete access to the information that helps you make informed business decisions. Email now for a free consultation.
Thank you for your interest and research as you decide how to best manage your business.