Audit Proofing Your Income and Deductions

There are at least two good reasons for setting up and maintaining books and records for your business.

First, it's pretty difficult to manage a business properly without knowing where the money is coming from and where it's going.

Second, small business owners are more apt to be audited by the IRS than individuals. To ensure your deductions are not disallowed by the IRS due to insufficient documentation, you must have supporting information. Follow these four steps:

  1. Keep an accurate and complete set of books and records.
  2. Retain all documentation supporting your business transactions and items of income and deductions included on your tax returns.
  3. Keep your books and supporting documentation that apply to each tax year separately (never commingle documents and records of two or more tax years).
  4. Use a separate checking account for your business (never commingle business and personal transactions).

Following these four steps will make it easier to prepare financial statements, tax returns, and sail through an audit (heaven forbid this should happen).

Common Mistake Made By Self-Employed Persons

The first step in audit-proofing your business transactions is keeping your personal and business transactions separate. This means, at a minimum, you should open a separate business checking account. Using one credit card strictly for business transactions is also a good idea.


I've seen some websites advise that it's perfectly O.K. and very convenient to commingle business and personal transactions if you have a very small business. True, this can be done. But it's a sloppy and unprofessional way to operate a business and could be a real pain sorting through dozens of transactions at year-end to figure out which ones are business related which are not.


Important Records

  • Business checkbook
  • Daily summary of cash receipts
  • Monthly summary of cash receipts
  • Daily check disbursements journal
  • Monthly summary of check disbursements
  • Daily petty cash disbursements journal
  • Monthly summary of petty cash disbursements
  • Depreciation worksheet
  • Employee compensation record
  • Monthly bank reconciliation
  • Record of inventory purchased for resale
  • If you're a manufacturer:
    • Record of raw materials
    • Record of work-in-process
    • Record of finished goods

Documents Supporting Income

  • Sales slips
  • Invoices
  • Register tapes
  • Deposit slips
  • Credit card receipts
  • Credit card statements
  • Sales receipt book
  • Bank statement

Documents Supporting Expenses

  • Canceled checks
  • Receipts for petty cash disbursements
  • Invoices
  • Credit card receipts
  • Credit card statements
  • Debit card receipts

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Have an accounting or bookkeeping question? Email it to me.