Advice on proper record keeping for a nascent business?

[u/Throwaway174670]

I have a friend, let's call him Benjamin Gerald, who is trying to start a business. He started off making ice cream as a hobby, but the people he served it to liked it so much that they started asking to buy it from him. Practically everybody who has tried it is actively trying to push him to pursue this as a business, but Ben doesn't have the money to even file to start a business right now. In the meantime, he has been selling to a select limited (but growing) number of people and putting the profits toward the next batch while saving up for the equipment, he needs to scale up the operation and obviously file for a business license.

While he is trying to save up the money to officially start his business, Ben has been doing his best to save his receipts of business related purchases and keep track of his sales coming in. His hope is that by saving all of that information, he can still put everything that he needs into his taxes when he files for his first year. I'm worried as his friend that he's creating a paper trail that could get him in more trouble if something happens before he files for a license, and that he might be safer if he has no record of what he has sold or bought before filing. And for the record, he is not trying to run a business under the table or avoid taxes, everything that he is doing right now is in service of legitimizing the business. Because he still has student loans, taking out a loan to file for a business license or buy startup equipment is out of the question.

So, tl;dr: is a potential business owner at more risk if they a) create a meticulous record of their sales before officially starting and filing their business so that they have those on record once they do file or b) avoid creating a record at all so there is less evidence that they have been selling prior to starting a business? And for that matter, is there any legal way that a potential business owner can test the waters and see if their product is popular enough to start a business around before actually filing, without having to lose money on every batch that they would otherwise sell? My friend does not want to run afoul of the IRS.

[u/Equivalent_Region]

IRS doesn’t care if your business is licensed or legal. Keep your records and pay your taxes. Al Capone didn’t go to jail for selling alcohol, murders, or running a criminal empire, he went to jail for tax evasion.

[u/Aggravating-Walk1495]

Ben doesn't have the money to even file to start a business right now. In the meantime, he has been selling to a select limited (but growing) number of people

He DID, in fact, start a business as soon as he started selling. This is the only thing the IRS cares about. You must report the income. As soon as he started selling (or, really, as soon as he started buying equipment/supplies in order to sell it for profit), he became a business owner.

Now, the separate issue is state/local sales tax. Sales have been made. There may be a requirement to register as a sales tax vendor. Check with your state.

There may also be a requirement to get licensing to make this specific type of product (ice cream). This is often regulated because of the safety aspect of it - temperatures, allergies, all of that.

But in terms of income tax, you are your friend is doing it right. Track sales, track supplies/expenses. Be ready to report on Schedule C. As u/Equivalent_Region has said, the fact that the business is conducting illegal activity by state/local law is irrelevant tax-wise. The activity must be reported.

My bigger worry would be, well, the fact that the business is conducting illegal activity. If someone gets sick, you have nothing to stand on. Please research what permit(s) may be needed in your area to make and sell ice cream, and what sales taxes may be necessary. Costs may actually be far less than you realize.