The IRS expects you to prove the majority of the expenses you claim on your tax return. This means that you have to provide records and evidence clearly showing the amounts being claimed: estimates of costs are not acceptable in most cases and will be very quickly rejected if you are ever faced with an audit.
What is a receipt?
A "receipt" is defined as a written notification of a purchase. Depending on the method of payment and item bought, this notification can be provided as a paper document or as an email. Remember with every purchase you make to ensure you receive a receipt - walking out of a shop without this effectively renders your purchase non claimable, especially so if you pay with cash.
For a receipt to be valid in the eyes of the IRS, it must contain at a bare minimum:
- The vendor's name and address
- The date the transaction occurred and
- The total amount paid
The IRS only expects records if the dollar amount of the items purchased and deducted exceeds $75. For items of less than $75, credit card and bank statements can be supplied in lieu of documentation. However, given that you need to maintain a system for your receipts anyway, it is strongly recommended to keep records of all expenses to ensure no issues with supplying any detail the tax authorities request.
Digital receipt tracking
Given that the IRS has since 1997 allowed electronic tax receipts as proof, it's a good idea to start tracking your expenses digitally.
Why track digitally? Essentially, keeping your expenses in digital format means that you can create unlimited and accessible backups of your records. If you are temporarily in a different location to your records and need to review them, they can be instantly at hand if online.
Having an online system also means your expenses are searchable: locating a purchase made sometime in early February can be a time consuming task if your filing system comprises of a box of haphazard paper slips, whereas utilising file creation dates and folder naming means you can narrow down your search much faster.
How to digitise your receipts
In the past, there was really only one way of making digital copies of paper documents: a scanner. Nowadays, due to improvements in mobile cameras and software, a simpler and quicker option is to use the capabilities of your iPhone or Android phone to snap and convert your receipts to digital. The easiest option is to just use your phone's camera to snap a picture of the receipt, if you want extra options like character recognition (converting images to text) there are a number of great apps available.
Be aware that thermal paper can be affected by heat which some older scanners can generate, so ensure that you test your scanner on a non-essential receipt before using this method. If in doubt, using a camera based scanner can be a safer option.
Once you have your document in digital format, ensure that you also note for each receipt exactly what you purchased and why it was bought if it isn't detailed on the receipt.
Timely bookkeeping = no headaches come tax time
The IRS recommends timely recordkeeping: this is to ensure your memory is fresh on the reasons for the purchase. Without making good notes, you may looking back sometime later at a receipt and not be entirely sure what the reason for the purchase was: this makes it much more difficult to categorise come tax time and also makes it harder to explain if need be.
This is doubly important if you manufacture goods as you'll be needing to track your materials as inventory and COGS - i.e. not as indirect expenses. To read more about the reasons behind this, take a look at our blog post: Why claiming materials as expenses is a really bad idea for your craft business.
You can add extra information about the purchase to the digital file using file or folder names creatively, or alternatively excel spreadsheets and online bookkeeping packages can be used for this purpose. Most bookkeeping systems have expense file tracking built in so there is really no need to create your own system nowadays.
For crafters, inventory and bookkeeping systems like Craftybase are great in particular for material expense and inventory tracking: as the system links material records with their complete purchase history it can provide an instant audit ready report if ever required. Craftybase also has multi-site backups and encrypted access included as part of every subscription.
Backups are important!
If the system you choose doesn't have a built in backup process you'll need to create your own: the IRS expects this if you are using digital copies as proof and will not accept accidental loss or deletion of records as an excuse. The simplest way to achieve this is to store one copy of the file on your computer and another somewhere in "the cloud" Dropbox, iCloud and Google Drive are all good examples of cloud based services that can host your files.
It's wise to also keep all paper documentation on hand just in case. For hardcopies, store in archive quality boxes clearly labelled with the tax year. If you live or work anywhere where there is a chance of flooding, further protecting in waterproof plastic is a smart idea. Generally, records need to be kept for a period of 3 years after the date you claimed the deduction: after this time it is usually okay to securely dispose of them.
Please note that tax laws change frequently. This information is for educational and informational purposes only should not be construed as tax or legal advice. Please consult a licensed financial expert in your area with specific questions or concerns.
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Topics covered include:
- Do I have to file if I’m just a hobby business?
- Common business structures
- Annual Income Tax
- Quarterly Estimated Taxes
- Sales Taxes
- State Income Taxes
- Bookkeeping Software
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