It is necessary to keep adequate records to find out how your business is doing and what sort of profit you are actually making after expenses. However, it is also necessary to keep records to satisfy the demands of the taxman. As a sole proprietor, you need to be ready to fulfill the demands of the IRS. This can be especially confusing, since for a sole proprietorship, your expenses for a business or often intimately intertwined with your personal expenses.
You need to distinguish what are legitimate business expenses that are tax deductible. Be sure that your record keeping system, whether manual or computerized, is set up to be able to fill out IRS Form 1040C. You want to be able to clearly state your gross sales, your profits, and your expenses and deductions. This is a necessary function. Many businesses are now using computer software to fulfill tax information and other functions. Software can also help you develop a business plan. If you are a relatively small business, you can use the cash method of accounting, and you won't have to account for future sales or inventories. For the IRS, "small" means a business whose gross sales are under $1 million. If you need to include your inventories in your calculations, you can use the cash valuation method.
Your tax deductions for expenses can come from many sources. If you need a car for business travel, you can deduct a portion of the depreciation of the expense of the car over each year. You can deduct office expenses and transportation expenses for tax purposes. There are also real estate expenses for the premises where you do your business. If you use a portion of your home for business purposes you can deduct these expenses. If you need to buy or rent real estate for your business, this is also deductible. You can deduct 50-percent of meal and entertainment expenses associated with your business. You can deduct sales tax, property taxes and many other taxes and fees that you pay to local, state and federal authorities, from your general tax bill as calculated from the 1040C form. This is one of the reasons why record keeping is so important for your business and a proper calculation of your tax expenses. Records generally need to be saved for at least three years. If you ever get audited on your taxes, you'll find out why.
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