Accounting is a vital tool that every business must use to keep track of its revenue stream and expenditures, as well as the income that it earns by deducting expenses from incoming funds. The accounting process for any business is complicated by the fact that not every item that costs a business money counts as a legitimate tax deduction. Some items, such as commuting miles, are not considered business expenses at all, while other expenditures, such as payments of principal on business loans represent expenses that have already been deducted. The process of reconciling accounting to taxable income involves keeping track of both sets of financial figures, and then calculating the difference.
1. Keep a ledger that tallies all of the expenses that your company incurs for business related expenses. Divide your ledger into columns that represent different categories of business expenses, such as supplies, materials, rent and payroll. Also keep track of loan payments that your business makes, dividing them according to the portions of the payments that represent principal and interest. Keep a checking account register that records payments that your company makes, including owners' cash draws, which are not tax deductible, and expenses for business meals, which are partially deductible. Include information about capital flowing into your business as well, from sales revenue as well as business financing.
2. Review each category of expense in your ledger, and divide them into items that are tax deductible and those that are not. For example, it is important for your business to keep track of amounts spent on business meals, even if this amount is not fully deductible. Calculate the difference between the amount you have actually paid and the amount that the IRS allows you to write off to reconcile your ledger with your taxable income.
3. Choose between the cash and accrual accounting methods. Your annual business tax forms will ask which accounting method you use, and this decision will affect the process of reconciling your accounting with your taxable income. If you use the cash method, then you will report each transaction as revenue when you are paid for it. If you use the accrual method, then you report each sale as revenue when you provide the product or service, even if you allow your customers lag time before requiring them to pay. Whether you use the cash or the accrual method, keep track of outstanding balances, and categorize them according to whether or not your business still owes tax on this income.
Items you will need
- Business ledger
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