One of the most important uses of your financial records is to help you comply with federal and state tax laws and prepare tax returns. A good bookkeeping system will help make dealing with Uncle Sam relatively painless. If you keep good records and operate your business in a professional manner, you should find tax compliance pretty easy. Moreover, if you ever get audited and have to prove some or all of the items on your tax return, you'll find it easy to do so with up-to-date, orderly records.

You already keep accounting records so that you know how your business is doing financially. These same books and procedures are used to keep your tax records. You don't always have to use the same accounting rules for tax purposes as you do for financial reporting. However, we highly recommend that you do use the same rules for both tax and financial purposes. Your life will be complicated considerably if you try keep two sets of records for your business.

For example, the federal government has very specific rules on how much depreciation you can deduct each year on equipment, vehicles, and buildings. You can use depreciation methods for your own financial reporting purposes that differ from Uncle Sam's tax rules. But using two separate depreciation methods will either cost you a lot more time keeping track, or will cost you more money as you pay your accountant to keep track of them for you.

Another example is the use of the cash or accrual accounting methods. Most small businesses can use the cash method for tax purposes. However, some businesses must use the accrual method. We recommend the accrual method for all businesses, for both tax purposes and financial reporting. The accrual method gives you a clearer picture of the financial status of your business, and it's just too expensive, in terms of time and money, to keep two separate sets of books. If you are thinking about using the cash method of accounting for tax purposes, you should discuss these rules with your accountant.

If you do use the accrual method, one adjustment you'll have to make to your books for tax reporting purposes involves your treatment of bad debts. For tax purposes, bad debts may be written off only when they become uncollectible. Therefore, if you've set up a reserve or allowance for estimated bad debts during the year, you'll have to adjust this figure to reflect only the debts that you actually wrote off in this period, for purposes of computing your taxable business income.

Regarding some of your day-to-day expenditures, there are a few things to keep in mind that will help you at tax time:

• Auto expenses. If you use your car for both personal and business use, you need to keep a written mileage log. You can pick up a mileage log in any good office supply store, and use it to keep track of all your personal and business miles. For your business miles, make a notation in your log as to what the business purpose of each trip was. You should keep this log in your car, and complete it on a daily basis. Don't try to reconstruct a mileage log at the end of the year.
• Entertainment expenses. If you have business-related meal or other entertainment expenses, keep a detailed written log of each occurrence, as well as the actual receipt from the event. Your record of entertainment expenses should list who, what, when, and where. Who was there, what was the business purpose, when did it take place, and where did it occur? Such a log will be invaluable if your business is ever audited.