You must keep records to account for your business income and substantiate your business expenses. You do not need to be working full-time to have income that results from a business activity. Business income includes payments you received from another business or employer that are correctly shown on IRS Form 1099-MISC, Miscellaneous Income. Business income can also be in the form of property or services.
Generally any income you receive that is connected to your business is business income. Income that is related or connected to your business is easy to determine - if you would not have received the payment if you were not in business, the income is derived from your business. The main sources of income are:
Business expenses (deductions) that you can substantiate can be deducted from your business income to reduce your taxable income. Some of the deductions you may claim include:
You are required to keep records to correctly determine your business income and expenses. It is important that you receive receipts, invoices and other records you need, and organize and file them on a frequent basis (at least weekly). Trying to organize records at the end of the year can be an unpleasant, monumental task. Keeping your records current is also critical to determine how well your business is doing. It helps you make decisions and have flexibility in making adjustments to meet unexpected changes in customer purchasing.
The following information will cover the income and expenses we identified above. The information is not all inclusive. There are other sources of income and expenses that may apply to your business; the following is some of the most common.
The main sources of business income discussed are gross income from sales, miscellaneous income, and cost of goods sold. The presentation will also cover some items that are not considered income to your business.
Gross income from sales is income you receive from the sales of merchandise to your customers. You only report the income you receive in the tax year you are reporting. You do this according to the accounting method you are using. Remember, if you are on the accrual method, income is declared when it is invoiced even if you have not received payment.
Normally, your income will be in the form of cash, debit card transactions, credit card charges, or checks. Bartering for goods or services is business income and you must report the fair market value of the item or service you receive. However, you may deduct the expenses you incur for the item or service you provided in exchange.
Businesses also have returns and allowances that need to be subtracted from your gross receipts. Returns and allowances can be:
You must also keep records for miscellaneous income your business receives. Here are sources of income that fit into this category:
Another area you may have to claim as income is cancelled debts. Generally, if a debt you owe is cancelled or forgiven, you must claim the amount in your gross income. The basis of this is that you probably received a benefit for assuming the debt, so cancellation of the debt is the same as transferring property to you free of charge. There are exceptions which we will not address. If you have any cancelled debts, check with your accountant or other professional for assistance.
A business with an inventory must calculate the cost of goods sold which is the change in inventory for the year. Your business income will be adjusted based on the cost of the goods you sold. Consequently, adequate inventory records are very important. Your records will include:
There are some items of income that you are not required to report as business income:
The accuracy of your records will ultimately determine the gross profit for your business for the year. You need to minimize you profits by subtracting your qualified business expenses, which are discussed in our nest section.
Your qualified business expenses are deducted from your gross profit (income) to determine the taxable income for your business. Any deduction you claim must be substantiated with accurate records. To claim deductions your documentation (records) must meet some basic guidelines:
Here is a list of the more common business expenses. You may have expenses that are not in the list:
These are generally personal expenses or expenses specifically exempted by congress.
An item is not deductible just because it is not listed. The deductibility of any expense requirements depends on the facts and circumstances of your business.
You must keep accurate records to substantiate your income and any deductions claimed on your return. Your permanent books and records must be able to determine the different types of income, gains, losses, costs, and expenses affecting the income tax liability.
Taxpayers and business owners must be able to prove two things to claim a deduction:
An invoice or receipt describing the item and its cost, and a cancelled check or credit card charge slip, are two items that prove the the amount and purpose of an expense. A cancelled check by itself is not proof.
There are also some expenses that are susceptible to cheating, and are subject to additional documentation rules. If you have no records to substantiate the following expense items , the deduction will be disallowed:
These expenses require receipts for any expense over $75, and for all lodging expenses regardless of the amount. Each expense must have documentation to substantiate:
For gift and entertainment expenses you must also give the business relationship of the person receiving the gift or entertainment. You can document this information on the back of the receipt or in an expense log.
For vehicles you must keep a mileage log.
