How Managing Business Expense Receipts Prevents A $130,000 Problem

What’s the best place to store your business expense receipts?

• A) In your desk drawers, cluttered among dozens of other documents
• B) The left pocket of your jeans, where they're likely to take a spin in the washing machine
• C) Lost in the endless abyss of your email inbox
• D) Neatly organized in a receipt management system

Many business owners know D is the right answer but still resort to makeshift solutions– from the classic 'shoebox method' to the 'I’ll sort it out later' pile on their desks. But while these may seem convenient in the short term, they work against you when you’re trying to build a solid financial foundation for your business.

Lose not, claim a lot (of tax deductions)

Years ago, we had a company come to us for bookkeeping help after having $130,000 of expenses disallowed because of missing documentation. When we began handling their bookkeeping, we set them up with QuickBooks Receipt Capture so they could easily and efficiently manage receipts. It’s been smooth sailing since then. This just illustrates the fact that one good system can save you many bad headaches.

If a picture is worth a thousand words, then a well-organized receipt could be worth a thousand dollars, metaphorically speaking. In the realm of tax deductions, receipts are the undisputed champions. They are the evidence that substantiates your business expenses, ensuring you can claim every deduction to which you're entitled. Without them, you're leaving money on the table.

You're a small business owner who travels frequently for work. Every hotel stay, flight ticket, and business meal is an expense that potentially lowers your taxable income. But at the end of the year, if you're missing receipts for these expenses, you can't prove these costs to the IRS. Consequently, those expenses may go unclaimed (or worse, disallowed during an audit), and you pay more in taxes than necessary.

Good bookkeeping means going to the source (documents)

At the core of good bookkeeping is evidence or, in the language of bookkeepers and accountants, source documents. Source documentation helps you prove transactions occurred and avoid many bookkeeping mistakes. Let’s say you're a contractor and you purchase materials for a project. If you don’t keep and organize your receipts, you lose the ability to track your expenses for the project so you can accurately bill your client. It’s riskier to claim the tax deductions since all tax deductions must be substantiated or based on evidence. The result is that you have unclear expenses, possible revenue reduction, and no way to justify your business expenses.

Keeping detailed records and managing your business expense receipts allows you to validate every transaction so you can reconcile and justify your numbers. With proper receipt management, you have a concrete record that backs up every entry in your ledgers. Receipt management is what proves your transactions are fact, not fiction.

Receipts or no receipts? That is the question (in audits)

Many business owners mistakenly believe they can get by in an IRS audit by showing their bank statements. This is a dangerous myth. The IRS clearly states which documents it may request during an audit on its “IRS Audits: Records We Might Request” webpage:

• Receipts: Present these by date with notes on what they were for and how the receipt relates to your business. In addition to providing the dollars paid or received for a service or product, certain kinds of receipts can prove mileage.
• Bills: Include the name of the person or organization receiving payment, the type of service, and the dates you paid them.
• Canceled checks: Group these with copies of the bills they paid and any applicable employer reimbursement.
• Legal papers: Include a description of what the case was about, when it happened, and how it relates to your business, credit, or deduction. Examples include divorce settlements with custody agreements, criminal or civil defense papers, property acquisition, and tax preparation or advice.
• Loan agreements: Include a copy of the original loan with names of the borrowers, location of the property, financial institution making the loan, amount borrowed, terms (the number of months to pay), settlement sheet, and if the loan was from an institution, include an end of tax year statement indicating interest paid. If the loan was not from an institution, provide a statement from the payee indicating the interest paid that year as well as the payee’s address and Social Security number. Provide a breakdown of how you used the money.

• Logs or diaries: These might show the dates and locations of your travel as well as the business purpose and mileage. They might also show gambling winnings and losses, as well as dates and locations of job-hunting activity and expenses.
• Tickets: Label travel tickets with the business purpose for the trip and group them with other receipts from the same trip. Lottery tickets help provide proof of profit or loss.
• Medical and Dental records: Include medical savings account statements, a copy of a handbook or other statements showing benefit and reimbursement policies, physician statements, capital improvement records for medical purposes including appraisals of the property before and after the improvements, and contracts for attendant care.
• Theft or loss documents: Include insurance reports detailing the nature of the loss or damage, copies of the fire department or police reports on the loss, theft, or accident, photos or video showing the extent of the damage (if available), an appraisal from a qualified adjustor showing the fair market value of the property before and after as well as an estimate of the damage, and a brief explanation of the loss.
• Employment documents: These might include uniform policies or dress codes, continued education requirements, W-2 reimbursement statements, or policies.

• Schedule K-1: These are used to report each shareholder’s share of income, losses, deductions, and credits when an S corporation files its annual tax return.

I’m sure you noticed that bank statements did not appear in the list above. This is because bank statements do not include the information that matters most to the IRS during an audit. ?

Receipt management keeps guesswork out of financial reports

Good bookkeeping isn't just about keeping your finances in order. It's about leveraging your financial data as a strategic asset. In this same vein, it’s crucial to think of receipt management as more than a defensive move against IRS audits. Good receipt management (and good bookkeeping in general) help you to:

• Create accurate financial statements: Each receipt contributes to precise financial reporting since having accurate records means you are working of a true understanding of your business expenses and revenues.

• Enhance your forecasting and budgeting: When your historical receipt data is organized and accurate, you can better predict future financial needs, allocate resources, and avoid incorrect estimates on budgets.
• Uncover spending patterns and saving opportunities: Do you know which areas of your business are profitable and which are wasteful? The real goal of business expense receipt management is to give you the data needed to correctly identify patterns in buying and purchasing so you can uncover sensible cost-saving opportunities. ?

Tip 1 ?- Don’t mix business with pleasure (or personal expenses)

One of the fundamental steps in effective receipt management is separating business and personal expenses. Using separate cards for business and personal transactions ensures that your financial records are unambiguous. This distinction is vital for accurate bookkeeping, making it easier to track business expenditures without them getting lost in personal expenses. Separating expenses also helps you in your tax compliance since personal expenses mistakenly claimed as business ones is a red flag for the IRS.

Tip 2 – Set up a system for managing business expense receipts

You have three options when it comes to managing your business receipts, including a physical folder, digital folder setup, or receipt management software. Here is a breakdown of each option.

Use a physical filing cabinet to store and manage receipts

A traditional yet effective method for managing business expense receipts is a filing cabinet with accordion folders. This option is the easiest to set up and usually costs less than other file management options. Still, a physical filing cabinet does require more storage space, which means it won’t work for small home offices. Here are some tips for building an efficient, organized filing cabinet system for your business receipts and other paperwork:

• Allocate a designated area in your office for the filing cabinet. If space is a concern, consider built-in shelves and cabinets or wall-mounted file organizers so you can keep your receipts and documents organized without taking up more space than necessary.
• Label each folder based on the type of receipt and its time period so you can easily locate specific documents.

• Do a monthly review of receipts and dispose of unused or unnecessary documents so you keep your filing cabinet uncluttered.

Create a digital folder system for your business receipts

If you’re interested in being economical with your space or if you just want to use cloud storage to manage your expense receipts, you can set up a digital folder system using your smartphone or a scanner. For example, you can use your Android or iPhone to scan documents and upload them into Google Drive. You can follow these tips for success:

• Define the categories for your folder structure, either by month or category like travel or supplies.
• Name your folders consistently and systematically so you can easily find files in a hurry. For example, decide whether you’ll use the YYYY-MM-DD or MM-DD-YYYY format for dates.

• Follow good digital security hygiene to ensure your sensitive tax information isn’t accessible to anyone else. Many cloud providers like Google Drive and Dropbox use bank-level encryption and are reasonably safe. But even the most secure cloud storage service can be compromised if you have poor security habits.

Use receipt management software

While digital folders and physical filing cabinets offer basic organization, receipt management apps like Shoeboxed, Fyle, and Expensify make the process easier by integrating business apps and providing expense tracking and financial analysis.

• Shoeboxed.com: Shoeboxed transforms physical receipt clutter into digital data, ideal for small businesses and entrepreneurs. Using this app, you can scan and categorize receipts, documents, and even business cards into a searchable cloud database, which streamlines expense management and proves invaluable when calculating deductible expenses.
• FyleHQ.com: Fyle uses AI and text recognition to simplify expense management, allowing you to submit receipts through text, email, or a Slack message. Using AI-driven data extraction and categorization, FyleHQ offers efficient, real-time analytics and audit-ready reports so you can track your finances easily and effectively.

Ready for Hands-Off Bookkeeping? Let’s Talk!

As I mentioned earlier, receipt management is critical to substantiating your tax return’s information with the IRS and other regulatory agencies. Managing your expense receipts does more than scratch your organization itch. Done well, it helps you stay prepared for IRS audits and makes it easier to claim all of the tax deductions and credits to which you’re entitled. Good receipt management is part of good bookkeeping, which is essential to building a strong foundation for financial reporting and finance-informed business strategies. ?

If you find yourself in need of bookkeeping services, get in touch with us and we’ll help you gain financial clarity. For example, we recently helped a nonprofit clean up its financial records and put an end to failed audits and lack of financial clarity. ?

We provide bookkeeping and accounting, corporate tax advisory services for business entities and shareholders, and fractional CFO or controller services to hundreds of companies throughout California and the rest of the United States. If you’re looking to take the burden of financial management off your shoulders and focus more on growing your business, we're here to help.

Note: This article first appeared here on the MBS Accountancy blog.