Publication 583
Starting a Business and Keeping Records
(Revised: 5/2002)

Bookkeeping System

You must decide whether to use a single- or a double-entry bookkeeping system. The single-entry system of bookkeeping is the simplest to maintain, but it may not be suitable for everyone. You may find the double-entry system better because it has built-in checks and balances to assure accuracy and control.

Single-entry.   A single-entry system is based on the income statement (profit or loss statement). It can be a simple and practical system if you are starting a small business. The system records the flow of income and expenses through the use of:

1. A daily summary of cash receipts, and
2. Monthly summaries of cash receipts and disbursements.

Double-entry.   A double-entry bookkeeping system uses journals and ledgers. Transactions are first entered in a journal and then posted to ledger accounts. These accounts show income, expenses, assets (property a business owns), liabilities (debts of a business), and net worth (excess of assets over liabilities). You close income and expense accounts at the end of each tax year. You keep asset, liability, and net worth accounts open on a permanent basis.

In the double-entry system, each account has a left side for debits and a right side for credits. It is self-balancing because you record every transaction as a debit entry in one account and as a credit entry in another.

Under this system, the total debits must equal the total credits after you post the journal entries to the ledger accounts. If the amounts do not balance, you have made an error and you must find and correct it.

An example of a journal entry showing a payment of rent in October is shown next.

Computerized System

There are computer software packages you can use for recordkeeping. They can be purchased in many retail stores. These packages are very useful and relatively easy to use; they require very little knowledge of bookkeeping and accounting.

If you use a computerized system, you must be able to produce sufficient legible records to support and verify entries made on your return and determine your correct tax liability. To meet this qualification, the machine-sensible records must reconcile with your books and return. These records must provide enough detail to identify the underlying source documents.

You must also keep all machine-sensible records and a complete description of the computerized portion of your recordkeeping system. This documentation must be sufficiently detailed to show all of the following items.

• Functions being performed as the data flows through the system.
• Controls used to ensure accurate and reliable processing.
• Controls used to prevent the unauthorized addition, alteration, or deletion of retained records.
• Charts of accounts and detailed account descriptions.

See Revenue Procedure 98-25 in Cumulative Bulletin 1998-1 for more information.

Microfilm

Microfilm and microfiche reproductions of general books of accounts, such as cash books, journals, voucher registers, and ledgers, are accepted for recordkeeping purposes if they comply with Revenue Procedure 81-46 in Cumulative Bulletin 1981-2.

Electronic Storage System

Records maintained in an electronic storage system are accepted for recordkeeping purposes if the system complies with Revenue Procedure 97-22 in Cumulative Bulletin 1997-1.

An electronic storage system is one that either images hardcopy (paper) books and records or transfers computerized books and records to an electronic storage media, such as an optical disk.

How Long To Keep Records

You must keep your records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Generally, this means you must keep records that support an item of income or deduction on a return until the period of limitations for that return runs out.

The period of limitations is the period of time in which you can amend your return to claim a credit or refund, or the IRS can assess additional tax. Table 3 on page 15 contains the periods of limitations that apply to income tax returns. Unless otherwise stated, the years refer to the period after the return was filed. Returns filed before the due date are treated as filed on the due date.

Keep copies of your filed tax returns. They help in preparing future tax returns and making computations if you later file an amended return.

Employment taxes.   If you have employees, you must keep all employment tax records for at least 4 years after the date the tax becomes due or is paid, whichever is later.

Assets.   Keep records relating to property until the period of limitations expires for the year in which you dispose of the property in a taxable disposition. You must keep these records to figure any depreciation, amortization, or depletion deduction, and to figure your basis for computing gain or loss when you sell or otherwise dispose of the property.

Generally, if you received property in a nontaxable exchange, your basis in that property is the same as the basis of the property you gave up, increased by money you paid. You must keep the records on the old property, as well as on the new property, until the period of limitations expires for the year in which you dispose of the new property in a taxable disposition.

Records for nontax purposes.   When your records are no longer needed for tax purposes, do not discard them until you check to see if you have to keep them longer for other purposes. For example, your insurance company or creditors may require you to keep them longer than the IRS does.

Sample Record System

This example illustrates a single-entry system used by Henry M. Brown, who is the sole proprietor of a small automobile body shop. Henry uses part-time help, has no inventory of items held for sale, and uses the cash method of accounting.

These sample records should not be viewed as a recommendation of how to keep your records. They are intended only to show how one business keeps its records.

1. Daily Summary of Cash Receipts
(Page 18)

This summary is a record of cash sales for the day. It accounts for cash at the end of the day over the amount in the Change and Petty Cash Fund at the beginning of the day.

Henry takes the cash sales entry from his cash register tape. If he had no cash register, he would simply total his cash sale slips and any other cash received that day.

He carries the total receipts shown in this summary for January 3 ($267.80), including cash sales ($263.60) and sales tax ($4.20), to the Monthly Summary of Cash Receipts.

Petty cash fund.   Henry uses a petty cash fund to make small payments without having to write checks for small amounts. Each time he makes a payment from this fund, he makes out a petty cash slip and attaches it to his receipt as proof of payment. He sets up a fixed amount ($50) in his petty cash fund. The total of the unspent petty cash and the amounts on the petty cash slips should equal the fixed amount of the fund. When the totals on the petty cash slips approach the fixed amount, he brings the cash in the fund back to the fixed amount by writing a check to Petty Cash for the total of the outstanding slips. (See the Check Disbursements Journal entry for check number 92.) This restores the fund to its fixed amount of $50. He then summarizes the slips and enters them in the proper columns in the monthly check disbursements journal.

2. Monthly Summary of Cash Receipts
(Page 19)

This shows the income activity for the month. Henry carries the total monthly net sales shown in this summary for January ($4,865.05) to his Annual Summary.

To figure total monthly net sales, Henry reduces the total monthly receipts by the sales tax imposed on his customers and turned over to the state. He cannot take a deduction for sales tax turned over to the state because he only collected the tax. He does not include the tax in his income.

3. Check Disbursements Journal (Page 20)

Henry enters checks drawn on the business checking account in the Check Disbursements Journal each day. All checks are prenumbered and each check number is listed and accounted for in the column provided in the journal.

Frequent expenses have their own headings across the sheet. He enters in a separate column expenses that require comparatively numerous or large payments each month, such as materials, gross payroll, and rent. Under the General Accounts column, he enters small expenses that normally have only one or two monthly payments, such as licenses and postage.

Henry does not pay personal or nonbusiness expenses by checks drawn on the business account. If he did, he would record them in the journal, even though he could not deduct them as business expenses.

Henry carries the January total of expenses for materials ($1,083.50) to the Annual Summary. Similarly, he enters monthly total of expenses for telephone, truck, auto, etc., in the appropriate columns of that summary.

4. Employee Compensation Record
(Page 22)

This record shows the following information.

• The number of hours Henry's employee worked in a pay period.
• The employee's total pay for the period.
• The deductions Henry withheld in figuring the employee's net pay.
• The monthly gross payroll.

Henry carries the January gross payroll ($520) to the Annual Summary.

5. Annual Summary (Page 22)

This annual summary of monthly cash receipts and expense totals provides the final amounts to enter on Henry's tax return. He figures the cash receipts total from the total of monthly cash receipts shown in the Monthly Summary of Cash Receipts. He figures the expense totals from the totals of monthly expense items shown in the Check Disbursements Journal. As in the journal, he keeps each major expense in a separate column.

Henry carries the cash receipts total shown in the annual summary ($47,440.95) to Part I of Schedule C (not illustrated). He carries the total for materials ($10,001.00) to Part II of Schedule C.

A business that keeps materials and supplies on hand generally must complete the inventory lines in Part III of Schedule C. However, there are no inventories of materials and supplies in this example. Henry buys parts and supplies on a per-job basis; he does not keep them on hand.

Henry enters annual totals for interest, rent, taxes, and wages on the appropriate lines in Part II of Schedule C. The total for taxes and licenses includes the employer's share of social security and Medicare taxes, and the business license fee. He enters the total of other annual business expenses on the Other expenses line of Schedule C.

6. Depreciation Worksheet (Page 22)

This worksheet shows the information used in figuring the depreciation allowed on assets used in Henry's business. Henry figures the depreciation using the modified accelerated cost recovery system (MACRS). He also chooses to deduct $24,000 of the cost of the tow truck purchased and placed in service in his trade or business during the year. This is the section 179 deduction. He also chooses to deduct the special depreciation allowance for the properties that qualify. The allowance is an additional 30% of the property's cost or other basis (after subtracting the section 179 deduction). Depreciation, the section 179 deduction, and the special depreciation allowance are discussed in Publication 946. Henry uses the information in the worksheet to complete Form 4562, Depreciation and Amortization (not illustrated).

Henry must take depreciation in the year it is allowable. He cannot deduct in the current year the allowable depreciation he did not take in a prior year. If he does not deduct the correct depreciation, he may be able to make a correction by filing Form 1040X, Amended U.S. Individual Income Tax Return, or by changing his accounting method. For more information on how to correct an incorrect depreciation deduction, see chapter 1 in Publication 946.

7. Bank Reconciliation (Page 23)

Henry reconciles his checkbook with his bank statement and prepares a bank reconciliation for January as follows.

1. Henry begins by entering his bank statement balance.
2. Henry compares the deposits listed on the bank statement with deposits shown in his checkbook. Two deposits shown in his checkbook - $701.33 and $516.08 - were not on his bank statement. He enters these two amounts on the bank reconciliation. He adds them to the bank statement balance of $1,458.12 to arrive at a subtotal of $2,675.53.
3. After comparing each canceled check with his checkbook, Henry found four outstanding checks totaling $526.50. He subtracts this amount from the subtotal in (2). The result of $2,149.03 is the adjusted bank statement balance.
4. Henry enters his checkbook balance on the bank reconciliation.
5. Henry discovered that he mistakenly entered a deposit of $600.40 in his checkbook as $594.40. He adds the difference ($6.00) to the checkbook balance of $2,153.03. There was a $10.00 bank service charge on his bank statement that he subtracts from the checkbook balance. The result is the adjusted checkbook balance of $2,149.03. This equals his adjusted bank statement balance computed in (3).

The only book adjustment Henry needs to make is to the Check Disbursements Journal for the $10 bank service charge. He does not need to adjust the Monthly Summary of Cash Receipts because he correctly entered the January 8 deposit of $600.40 in that record.

How To Get More Information

This section describes the help the IRS and other federal agencies offer to taxpayers who operate their own businesses.

Internal Revenue Service

The following describes assistance provided by the IRS. You can order free publications and forms, ask tax questions, and get more information from the IRS in several ways. By selecting the method that is best for you, you will have quick and easy access to tax help. See Free tax services, later.

Contacting your Taxpayer Advocate.   If you have attempted to deal with an IRS problem unsuccessfully, you should contact your Taxpayer Advocate.

The Taxpayer Advocate represents your interests and concerns within the IRS by protecting your rights and resolving problems that have not been fixed through normal channels. While Taxpayer Advocates cannot change the tax law or make a technical tax decision, they can clear up problems that resulted from previous contacts and ensure that your case is given a complete and impartial review.

To contact your Taxpayer Advocate:

• Call the Taxpayer Advocate at 1-877-777-4778.
• Call the IRS at 1-800-829-1040.
• Call, write, or fax the Taxpayer Advocate office in your area.
• Call 1-800-829-4059 if you are a TTY/TDD user.

For more information, see Publication 1546, The Taxpayer Advocate Service of the IRS.

Small Business Tax Education Program.   Small business owners and other self-employed individuals can learn about business taxes through a unique partnership between the IRS and local organizations. Through workshops or in-depth tax courses, instructors provide training on starting a business, recordkeeping, preparing business tax returns, self-employment tax issues, and employment taxes.

Some courses are offered free as a community service. Courses given by an educational facility may include costs for materials and tuition. Other courses may have a nominal fee to offset administrative costs of sponsoring organizations.

For more information about this program, call the IRS Monday through Friday during regular business hours and ask for your Taxpayer Education Coordinator. Check your telephone book for the local number of the IRS office closest to you or you can call 1-800-829-1040.

Your Business Tax Kit.   Your Business Tax Kit is an assortment of IRS forms and publications to help taxpayers who operate their own businesses. To order the kit, see Free tax services, later. The kit consists of the following items.

Forms:  

• SS-4, Application for Employer Identification Number
• 1040-ES, Estimated Tax for Individuals
• 9779, EFTPS Business Enrollment Form

Publications:  

• 509, Tax Calendars for 2002
• 583, Starting a Business and Keeping Records
• 594, The IRS Collection Process
• 910, Guide to Free Tax Services
• 1544, Reporting Cash Payments of Over $10,000 (Received in a Trade or Business)

Free tax services.   To find out what services are available, get Publication 910, Guide to Free Tax Services. It contains a list of free tax publications and an index of tax topics. It also describes other free tax information services, including tax education and assistance programs and a list of TeleTax topics.

Personal computer. With your personal computer and modem, you can access the IRS on the Internet at www.irs.gov. While visiting our web site, you can:

• Find answers to questions you may have.
• Download forms and publications or search for forms and publications by topic or keyword.
• View forms that may be filled in electronically, print the completed form, and then save the form for recordkeeping.
• View Internal Revenue Bulletins published in the last few years.
• Search regulations and the Internal Revenue Code.
• Receive our electronic newsletters on hot tax issues and news.
• Get information on starting and operating a small business.

You can also reach us with your computer using File Transfer Protocol at ftp.irs.gov.

TaxFax Service. Using the phone attached to your fax machine, you can receive forms and instructions by calling 703-368-9694. Follow the directions from the prompts. When you order forms, enter the catalog number for the form you need. The items you request will be faxed to you.

For help with transmission problems, call the FedWorld Help Desk at 703-487-4608.

Daily summary cash receipts

Employee compensation record, annual summary, and depreciation worksheet

Bank reconciliation

Phone. Many services are available by phone.
 
 

• Ordering forms, instructions, and publications. Call 1-800-829-3676 to order current and prior year forms, instructions, and publications.
• Asking tax questions. Call the IRS with your tax questions at 1-800-829-1040.
• TTY/TDD equipment. If you have access to TTY/TDD equipment, call 1-800-829-4059 to ask tax questions or to order forms and publications.
• TeleTax topics. Call 1-800-829-4477 to listen to pre-recorded messages covering various tax topics.

Evaluating the quality of our telephone services. To ensure that IRS representatives give accurate, courteous, and professional answers, we evaluate the quality of our telephone services in several ways.

• A second IRS representative sometimes monitors live telephone calls. That person only evaluates the IRS assistor and does not keep a record of any taxpayer's name or tax identification number.
• We sometimes record telephone calls to evaluate IRS assistors objectively. We hold these recordings no longer than one week and use them only to measure the quality of assistance.
• We value our customers' opinions. Throughout this year, we will be surveying our customers for their opinions on our service.

Walk-in. You can walk in to many post offices, libraries, and IRS offices to pick up certain forms, instructions, and publications. Some IRS offices, libraries, grocery stores, copy centers, city and county governments, credit unions, and office supply stores have an extensive collection of products available to print from a CD-ROM or photocopy from reproducible proofs. Also, some IRS offices and libraries have the Internal Revenue Code, regulations, Internal Revenue Bulletins, and Cumulative Bulletins available for research purposes.

Mail. You can send your order for forms, instructions, and publications to the Distribution Center nearest to you and receive a response within 10 workdays after your request is received. Find the address that applies to your part of the country.

• Western part of U.S.:
  Western Area Distribution Center
  Rancho Cordova, CA 95743-0001
• Central part of U.S.:
  Central Area Distribution Center
  P.O. Box 8903
  Bloomington, IL 61702-8903
• Eastern part of U.S. and foreign addresses:
  Eastern Area Distribution Center
  P.O. Box 85074
  Richmond, VA 23261-5074

CD-ROM. You can order IRS Publication 1796, Federal Tax Products on CD-ROM, and obtain:
 

• Current tax forms, instructions, and publications.
• Prior-year tax forms and instructions.
• Popular tax forms that may be filled in electronically, printed out for submission, and saved for recordkeeping.
• Internal Revenue Bulletins.

The CD-ROM can be purchased from National Technical Information Service (NTIS) by calling 1-877- 233-6767 or on the Internet at www.irs.gov. The first release is available in mid-December and the final release is available in late January.

IRS Publication 3207, Small Business Resource Guide, is an interactive CD-ROM that contains information important to small businesses. It is available in mid-February. You can get a free copy by calling 1-800-829-3676 or visiting the IRS web site at www.irs.gov.

Comments on IRS enforcement actions.   The Small Business and Agriculture Regulatory Enforcement Ombudsman and 10 Regional Fairness Boards were established to receive comments from small business about federal agency enforcement actions. The Ombudsman will annually evaluate the enforcement activities of each agency and rate its responsiveness to small business. If you wish to comment on the enforcement actions of the IRS, you can:

• Call 1-888-REG-FAIR (1-888-734-3247),
• Send an e-mail to ombudsman@sba.gov, or
• Download the appraisal form at www.sba.gov/ombudsman.

Small Business Administration

The Small Business Administration (SBA) offers training and educational programs, counseling services, financial programs, and contract assistance for small business owners. The SBA also has publications and videos on a variety of business topics. The following briefly describes assistance provided by the SBA.

Small Business Development Centers (SBDCs).   SBDCs provide counseling, training, and technical services to current and prospective small business owners who cannot afford the services of a private consultant. Help is available when beginning, improving, or expanding a small business.

Business Information Centers (BICs).   BICs offer a small business reference library, management video tapes, and computer technology to help plan a business. BICs also offer one-on-one assistance. Individuals who are in business or are interested in starting a business can use BICs as often as they wish at no charge.

Service Corps of Retired Executives (SCORE).   SCORE provides small business counseling and training to current and prospective small business owners. SCORE is made up of current and former business people who offer their expertise and knowledge to help people start, manage, and expand a small business. SCORE also offers a variety of small business workshops.

Personal computer. With your personal computer and modem, you can access the SBA on the Internet at www.sba.gov. While visiting the SBA web site, you can find a variety of information of interest to small business owners.

Phone. Call the SBA Answer Desk at 1-800- UASK-SBA (1-800-827-5722) for general information about programs available to assist small business owners.

Walk-in. You can walk in to a Small Business Development Center or Business Information Center to request assistance with your small business. To find the location nearest you, access the SBA on the Internet or call the SBA Answer Desk.

Other Federal Agencies

Other federal agencies also publish publications and pamphlets to assist small businesses. Most of these are available from the Superintendant of Documents at the Government Printing Office. You can get information and order these publications and pamphlets in several ways.

Personal computer. With your personal computer and modem, you can access the GPO on the Internet at www.access.gpo.gov.

Phone. Call the GPO at 1-202-512-1800. This is not a toll-free call.
 

Mail. Write to the GPO at the following address.
 
 

Superintendent of Documents
U.S. Government Printing Office
P.O. Box 371954
Pittsburgh, PA 15250-7954

List of Business Publications