Tax Basics for Startups: Setting Up Your BooksPart two in a three-part series to help you build your business on a strong foundation.

Getting Started Part 1: Tax Basics for Startups Part 2: Setting Up Your Books

Now that you've started your new business, you realize you'll need systems in place to track your income and expenses. Back in the day, that required ledger sheets, sharp pencils and a green eyeshade. But today we have software packages to help us. Just remember that having the ability to navigate your way around QuickBooks, Quicken or Mint.com doesn't qualify you as an accountant. It's a good idea to hire a competent accounting professional to help you set up and use whichever accounting software you choose.

Once you decide which bookkeeping software to use, you should have the following documents ready:

• Check register
• All business bank statements you've received so far
• Credit card statements for all credit cards used in the business
• Loan documents for all business loans
• Lease papers for all equipment, property, shop, retail or office space, and vehicles
• Receipts for all business expenses paid for with cash or from your personal accounts
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• Receipts for all major asset purchases
• Insurance policy to prorate insurance expenses

Here are some tips to help you make the most of your accounting software and keep your books in order.

1. Set up a filing system.
   Create a file for each vendor and a miscellaneous file for one-time purchases. At the end of the year, remove all vendor files to storage tubs marked with the tax year and create new vendor files for the current year. If you are audited, your files will be well-organized, and it will be easy to provide the auditor with the documents he needs to perform a proper examination of your tax return.
2. Pay bills using your accounting software.
   Rather than handwriting checks and posting them later to the books, you can create a check on the computer screen and print a check using your own check stock. The payment will automatically post to the proper expense account. Consider using the check format that contains the check and two stubs below. The top stub goes to the vendor and should contain invoice and account number information. The bottom stub is torn off and stapled to the paid invoice. No more writing date paid and check number information on the invoice itself.

Making the Right Deductions
Now that you know the best method to organize and track your expenses, you may be wondering exactly what expenses the Internal Revenue Service allows. In truth, there is no set list of expenses. You are pretty much allowed to deduct all "ordinary and necessary" business expenses, depending on your industry. The best rule of thumb is to consider whether you would have spent the money on an item or service if you weren't in business. When your bookkeeper or accountant sets up your books, they will design a Chart of Accounts. A canned chart of accounts contains expense items commonly allowed but may not include everything.

Some things to keep in mind when making deductions:

1. Follow the rules on meals and entertainment.The main ones to keep in mind are thatbusiness meals and entertainmentmust take place in an environment conducive to conducting business, there must be a substantial business discussion before, during or after the meal or entertainment, and the cost should never be extravagant. You should discuss these rules with your tax pro to make sure you understand how they work and are clear on how to best maximize these deductions. Some new business owners run into trouble because they don't report travel expenses correctly. Travel expenses, especially to vacation destinations, should be documented with the business purpose.
2. Be careful with ambiguous expenses.If the expense seems at all personal in nature, you may be up against a fight with the IRS on whether the deduction should be allowed. For example, you may think that cute business suit is deductible because you needed it for an important business meeting. If your clothing is street-appropriate, the IRS is not going to allow the deduction. About the only clothing that can be deducted is uniforms and protective gear. Promotional clothing can be deductible. For example, if you emblazon the name of your construction company across some T-shirts, you've got a write-off.
3. Deduct insurance policies correctly.Expenses for long-term insurance policies cannot usually be deducted in the year of purchase. The total cost must be broken out and expensed for each month in service. If, for example, you purchased a liability policy effective from October 1, 2010, through September 30, 2011, and paid $12,000 today for the policy, you may only deduct $3,000 as an expense for 2010. Your tax pro can show you how to record this properly on the books.

If you're still not sure how to handle deductions, make a list of the types of business expenses you worry over. Then discuss the deductibility with your tax pro. Sometimes an expense that may not seem like a deductible expense can be documented to prove business intent.