The Most Overlooked Way for Business Owners to Save Money on Taxes
Listen to the Podcast Here: 12. The Most Overlooked Way for Business Owners to Save Money on Taxes
It seems like business owners are always looking for ways to save money on taxes. Running a business takes a lot of time and effort and you want to keep as much of your hard-earned money in your pocket as possible. Business development, growing revenue, increasing profit margins, and identifying opportunities are top priorities for business owners to be successful. Unfortunately, that means that an extremely important part of proper business management is often ignored: bookkeeping.
Good bookkeeping, in my estimate, is the most overlooked way for business owners to save money on taxes. As a business owner, if you don’t do good bookkeeping, you could be paying hundreds or even thousands of dollars more in tax than you should.
Your business expenses directly reduce your taxable income. If you ‘forget’ about some expenses because you haven’t tracked well, then you’ll end up paying more in taxes than you need to.
The Overlooked Tax Strategy of Good Bookkeeping
When it comes to tax savings, sexy topics like tax credits, deductions, and strategic business structuring are what get all the hype.
Bookkeeping, on the other hand, seems like a mundane chore. It isn’t fun. It doesn’t have all the glitz and glamor of other tax saving strategies, so it isn’t shouted about on social media. However, ensuring that your books are in good order and that all expenses are being tracked properly can have a huge impact on your business.
By keeping a detailed record of your business expenses, you’re not just ensuring financial clarity and compliance – you’re also ensuring that you won’t pay more in taxes than you should.
The Connection Between Good Bookkeeping and Tax Savings
How does good bookkeeping help you save money on taxes? Let’s break it down.
While it’s important not to let the tax tail wag the dog and let the pursuit of write-offs dictate your spending decisions in your business, as I wrote in my article titled The Truth About Tax Write-Offs, the truth is that every legitimate business expense, whether it’s office supplies, travel, software, or anything else, helps to reduce your tax liability.
The caveat lies in how well you track your expenses through bookkeeping. The more thorough your record-keeping, the less likely you are to “forget” about crucial expenses that can chip away at your taxable income.
As a very high-level example, if you’re in the 24% Federal tax bracket plus 15.3% for self-employment taxes, every $1,000 in missed business expenses could cost you an extra $393 in taxes.
(It’s important to note that the tax calculation is much more complex than this example suggests, as various factors can impact the final tax amount. However, this simplified scenario is intended to help illustrate the potential consequences of not accurately tracking business expenses.)
The Trap of Forgetting Business Expenses
It’s not uncommon for business owners to overlook or neglect to accurately track business expenses.
Sometimes business expenses are accidentally paid for with a personal card. If this isn’t corrected and reflected correctly in the company’s records, then those expenses will not count towards reducing taxable income.
Even worse, some business owners run all business expenses through their personal bank accounts and credit cards. This is a recipe for disaster and for potential issues in the future if you’re ever audited.
Not only is it important to properly track business expenses, but it’s also important to have documentation to substantiate that those expenses were in fact “ordinary and necessary” for your business and that they weren’t for personal use.
Imagine a scenario where you “forget” to record certain expenses because they were forgotten during your busy day running your business. Seemingly trivial day-to-day omissions can snowball into paying more in taxes than you should, as we saw in the example above.
What seems like a simple oversight can lead to an inflated tax bill that could have been significantly reduced with good recordkeeping. It’s easy to forget about things at the end of a long day – as a business owner, you need a system in place to make it as easy on you as possible to ensure that all expenses are tracked.
The Ripple Effect of Good Bookkeeping
Let’s consider a scenario. A business owner fails to adequately track a series of deductible expenses throughout the year.
As tax season approaches, it’s time for the business owner to get organized and provide tax documents and business income and expenses to their tax preparer.
Since the business owner didn’t have good bookkeeping practices in place, business expenses slipped through the cracks, resulting in a higher taxable income than necessary. This, in turn, leads to a larger tax liability.
The financial impact ripples beyond just the immediate tax bill – it affects the overall financial health of the business. This is where the true value of good bookkeeping comes into play. Every detail recorded today lays the foundation for strategic tax planning tomorrow.
As you build a comprehensive record of expenses, you empower yourself with the knowledge to make informed decisions, identify trends, and optimize your tax-saving potential.
What Does Good Bookkeeping Look Like?
This is just an overview of why bookkeeping is important to your business and how it can help save you money on taxes.
There is so much more that goes into good bookkeeping such as whether you will (or need to, in the case of highly regulated industries) work off of single-entry or double-entry accounting, whether you will use cash or accrual basis accounting, if you have accounts receivable and accounts payable to manage, and if you have payroll to coordinate and manage.
As we’ve already stated, good bookkeeping can be monotonous and boring, but so important. The ‘easy button’ to bookkeeping would be to hire a qualified bookkeeping professional who you trust to do the job well.
If you’re not at the point where you feel you can afford to hire someone, or you just prefer to perform bookkeeping yourself, here are the 4 most basic steps to setup a bookkeeping process for your business to help you ensure you’re tracking business expenses correctly and saving money on taxes. Of course, you may need a more complicated system than this depending on the type of business you own, your industry, and various other factors.
1. Keep Personal and Business Expenses Separate
Your business, even if you’re a sole proprietor or just earning some extra money from a side hustle, should have its own bank account and credit card (if you want one). Only business expenses should be run through this account and/or credit card.
2. Use Accounting Software
You could track expenses manually in an Excel spreadsheet, but that’s going to make it even less likely that you’re going to be diligent about recording your transactions. Using a software such as QuickBooks or Xero can help you to automate your bookkeeping by linking to your business bank account, acting as your hub for invoicing, and generating income and expense reports.
3. Keep Track of Receipts and Records
Simply tracking your business expenses isn’t adequate. You also need to keep track of your receipts and records of business expenses to substantiate them in case you’re audited. Many accounting softwares allow you to upload receipts into them, you can keep pictures in a folder on your computer, or you can go old school and keep paper records.
4. Review and Reconcile Your Expenses Regularly
Having accounting software in place that helps you to automate your bookkeeping doesn’t mean that you can set it on autopilot and forget it. You still need to review your expenses regularly and reconcile them to your bank account and credit card statements. Transactions can be double-counted or not pulled into the software at all – reconciliation is an important part of the process to ensure records are accurate.