How to Document Cash Income for the IRS

Nobody wants to receive a notice of intent to audit from the Internal Revenue Service. Of course, accurate records make it more likely that you’ll survive an audit without too much trauma — even if that audit happens to be an examination into the cash income you receive. Learn to set up a system and maintain a paper trail that tracks every cent of your cash income to turn even a worrisome trip to the IRS into a mere inconvenience.

Understand that you’re a tempting target. In her “Kiplinger” article, “IRS Audit Red Flags: The Dirty Dozen,” reporter Joy Taylor spells out the most often-abused tax ducks taken by business owners. “Running a cash business” made the list of 10. Whether you’re in a position to pay workers in cash or you’re on the receiving end of the income, your goal should be finding the right system for tracking every cash payment you receive as it arrives in your wallet and setting up files that safeguard accompanying receipts and pay stubs.

Define “cash income.” Collins’ English Dictionary describes cash income as “income received in the form of cash during a specified period, esp., that of rural and farming households.” The Brookings Institute’s Tax Policy Center divided cash income into two categories, based on an updated IRS definition in 2004: Cash income and economic income. In 2007, the IRS added four categories to its cash income definition: “cash earned from side jobs, barter exchanges of goods or services, awards, prizes, contest winnings and gambling proceeds.” In 2012, both the U.S. Treasury and Brookings updated the definition to include “tax-exempt employee benefits, income earned within retirement accounts, food stamps and corporate retained earnings.” Expect more changes in the future.

Choose a manual tracking system if you’re computer/software averse: Pick up a ledger or accounting pad with ruled columns at an office supply store and get into the habit of recording every bit of cash that comes your way in payment for services rendered. Record the date, reason for the payment and amount. Cash income record-keeping can seem daunting at first, but it becomes habit. When April rolls around, you -- and/or your accountant -- will likely be overjoyed that you took the time to track each cash income amount. Make life easy by tossing receipts into a file, and if you want to double down on proof for the IRS, match up manual ledger entries with bank deposit slips as further proof to the IRS that you’re applying due diligence each time you post your cash income.

Opt for a Software Program. There’s no shortage of software programs on the market capable of tracking your cash income. Some are free. Others, not so much. If you’re from the “you get what you pay for” school of thought, you may wish to pass on the Excel program that came bundled with your Microsoft Office Suite and freeware like Mint.com. Dazzle the IRS using sophisticated tools for documenting cash income like My Invoices & Estimates, Netsuite and Bookkeeper. Evaluate myriad software programs rated on the 2012 Best Online Tax Software Reviews and Comparisons site. Some come with hefty price tags, so if you’re running a simple operation, don’t over-think your choice just to offset IRS paranoia.

Turn to a smartphone application. Lucky is the business owner who's armed with computer software that’s compatible with a smartphone. Lots of people tracking cash income use the free aforementioned Mint.com. If your needs exceed a simple cash income payment-tracking solution, consider the top three picks named by “PC World” magazine. Touted as being affordable and easy to use, according to writer Angela West, these apps are: iXpenseit, only for iPhones, Expensify -- compatible with myriad phone brands and easily synched to QuickBooks -- and Concur.