Things get away from all of us from time to time. You get busy, the year seems to be flying by, and you vow to get your books in order. Before you know it, tax season has arrived again, and you’re looking at a mountain of paperwork that needs attention - it happens!
If you’re a sole proprietor, and you want to get your financial situation cleaned up for tax season, then this guide is for you. It tackles what you can do immediately to spring clean your financial life and keep it in order. It’s also focused on your unique situation as a business owner - the fact that your personal and business financial goals are usually combined. If you’re ready, let’s get started.
Get a clear picture of your finances
The first step in any financial clean up is understanding what you’re currently working with. For many sole proprietors, it looks something like this: financial documents are scattered between paper files and electronic storage, making it difficult to get a clear overview.
Bank statements have piled up - waiting to be reviewed - sometimes for months. Receipts are crammed into a box, and it’s hard to pinpoint unnecessary expenses, recognize spending patterns, or even know where to start with tax prep.
Maintaining structured financial accounts doesn’t always make it to the top of the to-do list, and even if it does, knowing where to start can be challenging. Let’s change that with a few straightforward steps.
1. Review your financial documents
Gather all invoices, receipts, bank statements, credit card statements, and credit reports for the financial year. If your records are split between digital and physical formats, bring everything together in one place to avoid overlooking important details.
An accounting platform like QuickBooks Online is ideal for your financial situation, where you can record all your transactions and separate them into business and personal expenses. With even their basic subscription, you will be able to scan physical documents with the mobile app and get cloud storage, where you can keep all your financial documents in one place.
Create simple categories for classifying your business transactions. Basic categories could include office supplies, travel, marketing, or client-related expenses. This categorization will help you see patterns in your spending and identify potential tax deductions.
2. Get a snapshot of your financial commitments
You need to know how healthy you are financially, and one way to do this is to get a free credit report. Credit reports show your personal financial information, including:
Bill payment history: This is a record of how well you have paid your debts, and to whom. Financial institutions check your credit report when you apply for insurance policies, open accounts, and use it to determine a competitive interest rate for you.
Loans - This section provides information on multiple loans, current credit limits, and shows the status of the loan.
Current debt: This shows the total amount of debt that you have, and how you’ve used credit in the past.
Bankruptcy history: Show whether you’ve filed for bankruptcy at any time and the outcome of the filing.
As a sole proprietor, your personal credit status affects your business dealings. Any financial advisor worth their salt will tell you to carefully manage this rating so that you can make the most of credit opportunities, and good interest rates. If your credit score isn’t that good, get the help of a CPA, who will help you with your accounting function, taxation, and to increase this score.
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Save yourself a lot of financial stress in the long term by booking a free consultation to discuss your financial needs with Hall Accounting Company.
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3. Track down missing information
As you review your documents, take note of missing documentation or incomplete information. You may find that you are missing receipts, or that certain debts are not clearly recorded (this includes credit cards). If you want a clearer picture of your financials, then you need to take everything into account.
4. Assess your current financial situation
Once all your documents are in order and captured into one system such as QuickBooks Online, you can begin to do a deep clean. By drawing financial reports such as your total expenses, you can begin working on your spending habits. Work systematically through the information you see and make a list of financial goals you would like to reach, like reducing living expenses or putting money into an emergency fund.
Ensure your records stay accurate and up-to-date
It takes effort and time to get your finances cleaned up, so once you’ve achieved this goal, you want to keep it orderly and up-to-date. You can do this by setting one day a month aside to deal with financial transactions, bank recons, and analyzing your financial reports.
Use this time wisely, ensuring you are always thinking about your business objectives, but also about tax planning and preparation. Take specific note of potential tax deductions you may be eligible for.
Tax planning is a critical task for a sole proprietor. The ability to claim deductions, credits, and exemptions as a private taxpayer, can greatly assist you in managing your business finances.
If you’re uncertain about how this works, take advantage of the services of skilled tax experts, such as Hall Accounting Company. Their tax associates will help plan you effectively for the future, making use of current tax legislation which is to your benefit.
Get fully prepared for tax season
Once you have all your financial documentation and records cleaned up, it's time to turn your attention to your tax returns as a sole proprietor. Take the following steps to get ready.
Gather essential tax documents | Income Records: Collect all sources of income documentation and 1099-NEC forms. This is for income received from clients who paid you $600 or more. If you’ve sold products or services online, gather 1099-K forms. |
Expense documents: Ensure all business expenses are separated from personal expenses and recorded. This will serve as evidence of allowable expenses. | |
Mileage and travel logs: If you use your vehicle for business purposes, have a record of business mileage for potential deductions. | |
Prepare year end financials | Generate a profit and loss statement which will summarize your income and expenses for the financial year. This is a helpful reference for completing Schedule C. |
Prepare a balance sheet listing your company’s assets and liabilities. | |
Complete relevant IRS forms | Schedule C (Form 1040) As a sole proprietor, you’ll complete this section as part of your personal tax return. |
Schedule SE: This is for calculating self-employment taxes (Medicare and Social Security). Self-employment tax is separate from individual tax so make sure you remember to complete this schedule. | |
Form 8829: For home office claims | |
Form 4562: This form is used to claim the purchase of new assets and depreciation of assets. | |
Mark important tax deadlines | If you expect to owe more than $1,000 in taxes for the year, the IRS expects you to make quarterly payments. These payments are due in April, June, September, and January, by the 15th of the month. |
Other issues for consideration
The steps we’ve listed can be followed by the majority of sole proprietors to clean your finances. However, there are times when you have a unique situation you must attend to. Here we discuss some of those issues.
Cleaning up cash flow
Unlike traditional employees with steady paychecks, you often experience cash flow fluctuations. Highs and lows throughout the year make it difficult to predict how much cash will be available for both personal and business expenses.
One way of ensuring you have cash available is by setting up an income reserve account to save where you deposit a portion of earnings during high-income months. This reserve can help cover expenses during lean months and allow you to make consistent contributions to quarterly estimated taxes.
Cleaning up health insurance and medical expense deductions
Sole proprietors often have a hard time correctly recording and claiming health insurance and medical expenses, since these expenses can only be deducted if they exceed a certain percentage of adjusted gross income. Furthermore, health insurance deductions are claimed as an adjustment to income and not an itemized deduction. In years of unusually high medical aid expenses, ensure you keep all the invoices and practice numbers for submission to the IRS.
And finally
You’re done with your financial clean-up. During this discussion, we’ve suggested that cleaning up your finances as a sole proprietor takes some effort, but that it can be done by diligently following the steps we’ve outlined. We’ve also made you aware of potential pitfalls and issues for your consideration that you can plan for upfront.
Cleaning up your finances is about having a structured approach to collecting and recording financial information, understanding the big picture, and then setting financial goals that will help you make the best use of your income as a sole proprietor.
Finally, we covered tax season preparation, which is a big reason for doing a financial clean up. But we realize that you may have questions or a unique situation that needs expert help. If this is the case, you can call us today, and one of our senior tax associates will work through your accounting and taxation needs with you. Alternatively, you can get a quote from us before you make that call.
With tax season just around the corner, we look forward to hearing from you.