Cash Basis Accounting

• Sole proprietors report income and expenses on the cash basis. This means reporting all the cash you received as income and all the expenses you paid in cash during the calendar year. Exact numbers imply good record-keeping. Rounding implies estimates, which will cause an IRS auditor to question your record keeping more closely. If your office expense is $2,339, don't round up to $2,340.
  
  

Account For All 1099s

• The IRS has a matching program in which they match reporting forms, including 1099s, to an individual's income tax return. Make sure your total income is at least as much as the total of the 1099s you receive from customers. If you receive cash payments, checks, money orders or other forms of payment not covered by 1099s, you must also report this income.
  
  

Receipts for Expenses

• Keep all credit card statements detailing business expenses, all receipts, invoices, statements and other documents that back up your business purchases and expenses. Organize them by expense category and run an adding machine tape totaling the expenses in each category. Paperclip or staple all the receipts together in each category, and attach the adding machine tape to the front of the bundle to verify the total amounts you enter on your Schedule C. This makes it easier for an IRS auditor to verify your expenses and makes an audit faster and smoother.
  
  

Home Office Deduction

• Don't be afraid to take a home office deduction if you work from home and don't have a business office in some other location. A home office is a space in your home used exclusively for business. Measure the square footage of this area, whether it's an entire room or just a portion of a larger room. Then measure the square footage of your entire house or apartment. Divide the square footage of your home office area by the square footage of your entire house. This gives you a percentage of your home used as a business office. You are entitled to deduct this percentage of mortgage interest, property tax, rent, utilities, homeowners insurance, and repairs and maintenance to your home as a business expense. Report all of your home office information on Form 8829 of your tax return, and take the total deduction on Schedule C.
  
  Take photographs of your home office area from different angles. In the event of an audit, this photographic record aids in verifying that your home office is a legitimate business deduction.
  
  

Automobile Expenses

• If you use your vehicle in business, you can take a deduction for automobile expense. You are required to keep a contemporaneous record of all of your business miles. This means keeping a daily log of the miles you drive for business with the date, the number of miles driven and the business purpose for the trip. If you work from a home office, include all business miles from your home office to your business destination and back again. Use Form 2106 to report your vehicle information and business mileage, and enter the expenses under vehicle expense on your Schedule C. In an audit, vehicle expenses are denied unless documented by a good contemporaneous record of business miles driven.