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The Tax Season Is Upon Us - 2 Rules for Audit Survival

Penny-dollarI've been working to reconcile my 2016 taxes whenever a few minutes of sharp mental acuity arise.  Numbers are not my thing, but I like to have some financial awareness of the past year figured out before going too far into the new year. This year my records worked out to the penny! 

For sure, more expenses always seem to tally up than I anticipated.  Yet, the beginning of the year is when you need to know whether you made money in the last year so that you can be ready to pay income taxes while there is some money in the bank.  

I've been audited by the IRS twice in my career.  They red flag home-based businesses some times to check on abuse or sloppy records.  Fortunately, good record keeping and a few other tips allowed me to survive both times without any "extras" due.

So here are my top two super simple rules for artists and makers to keep their business accounting on the up and up -- separate your business accounts and keep receipts.  The rest of this post will explain what I mean, followed by a list of posts about accounting and my experience with the I.R.S., all written from my personal experience as an artist, not an accountant. 


RULE 1. Separate Accounts 

The first thing the I.R.S. will ask is if you co-mingle any personal and business money.  They do not allow any personal expenses to be written off as business expenses.  Therefore you should maintain separate credit cards for your business and personal expenses. You should also have separate bank accounts for business and personal money.  If you co-mingle personal and business accounts, the I.R.S. is going to dive much deeper into your records looking for inconsistencies in your records.

RULE 2. Receipts for every expense
The I.R.S. wants proof, not memories, of your itemized records.
 No fudge factors work here.  The I.R.S. will ask you to account for specific expenses in each category to the penny, and ask for specific receipts....such as "show me your advertising expenses for August 2016."  This is their quick way to look for sloppy records. If you don't have receipts for your records, the I.R.S. will dive deeper into your records looking for more inconsistencies in your records.

Track each expense in the appropriate expense category. You MUST have a receipt for every single expense. Period. Then take your receipts and itemize each expense in the appropriate category for your records.   For example, printing business cards would go in advertising, while shop supplies has it's own expense category. It turns out that the I.R.S. has "formulas" for the total of each category in each business. 

Track your revenue exactly.  I use a separate Excel page for each revenue stream so that the totals are a lot easier to figure out. (In the past I used different columns for various revenue streams. Sure, in theory that should work, but finding an inconsistency in my numbers took hours and hours.) Now a separate page for each revenue stream seems so much easier.

I know that the I.R.S. has many more rules.... but the overarching advice is that you must "Act like a business."

Besides the usual overarching goal of making money, I try to keep my record keeping simple and straight forward.  I track my business activities on a CASH basis to record "cash out" expenses and "cash in" revenue.  I don't buy an accounting program, but use my own Excel document which I can improve and modify each year. I am not going to spend money on some "powerful" accounting program when the real work is writing in every expense and revenue item.

I know that the 2 rules above seem so obvious....but I hear stories about people making up numbers for their business, or they approximate their expenses and revenue.  These won't get you through an IRS audit.  I was scared to death when I was first audited.  Fortunately I had separate accounts and all the receipts.  The headache of regular record keeping is minor compared to having an IRS agent sift through more and more accounts due to inconsistencies.

Previous posts about accounting for artists and makers:

I Covered My Expenses” and Other Forms of Delusion & Denial 

Time, Effort, Knowledge, Recognition, Appreciation

Hobby or Business? Criteria for the I.R.S.

She Sells Wholesale. She Sells Retail. Is She Selling Wholesale at Retail?

Avoid the Red Flag of IRS Form 1099

TAX TIME, Tick Tock, The Tax Clock is Ticking

Video Workshops from the I.R.S. - Am I a Business or a Hobby? - OR - Make Your Business More Business-like!

I.R.S. sign

Morning Heartburn with the I.R.S.

Surviving an I.R.S. audit - Avoid Problems and Penalties - A Final Word.

Surviving an I.R.S. audit - Withdrawing Inventory Items for Personal Use? Very scary!

Surviving an I.R.S. audit - Is Your Travel for Business or Leisure?

Surviving an I.R.S. audit - What Is an Acceptable Receipt for a Business Expense?

Surviving an I.R.S. audit - Cost of Goods SOLD and Jail House Orange - A Fashion Accessory Nightmare

Surviving an I.R.S. audit - What Is Included in the Cost of Finished Good besides your best guess?

Surviving the I.R.S. - Cost of Goods Sold, Are you ready? Watch my head explode!

Surviving an I.R.S. audit - No change!

My morning coffee with the I.R.S. MAN - Tips to prevent or smooth your audit with the I.R.S.

This post was updated on December 13th, 2021.