According to the IRS, “You must keep records so that you can prepare a complete and accurate income tax return.” But the Internal Revenue Code doesn’t require any specific kind of records or record keeping system. So how do you know what to keep and for how long to keep it? Read on for some tips on business recordkeeping.
WHAT RECORDS TO KEEP
You should keep all supporting documentation that clearly shows your business income and expenses. That is, any and all documents that contain information you would use to record income and expenses in your books.
These types of supporting documents include the following:
Income – cash register tapes; bank deposit slips; credit card charge slips; receipt books; customer invoices; Forms 1099-MISC
Expenses – canceled checks; cash register receipts; account statements; vendor invoices; bills; credit card sales slips; petty cash slips
In order to be considered documentary evidence of an expense, a receipt must contain:
- The name and location of the business providing the receipt,
- The date of the transaction,
- The amount of the purchase, and
- The essential character of the expense (item or items purchased).
But what if you don’t have a canceled check or a specific receipt? The IRS will accept certain account statements as documentary evidence as long as they are highly legible and contain, at a minimum:
- Check number,
- Amount,
- Payee’s name, and
- Date of the transaction (or date the amount was posted to the account).
Documented evidence that a payment has been made (for example a written receipt or cancelled check) in and of itself is not considered by the IRS to be proof that you are entitled to a tax deduction. You should also keep other documents – such as a bill of sale, invoice, bill or credit card sales slip – to show that you incurred the cost for business purposes.
HOW TO MAINTAIN YOUR RECORDS
Maintaining your business records involves two things: how you will account for your income and expenses and how you will store your documentary evidence.
First, is how will you account for your income and expenses? You should set up your recordkeeping system in a manner that will be easy and convenient for you to use. Your record keeping system should consist of a business checkbook, daily/monthly summary of cash receipts, daily/monthly summary of sales, summary of expenses incurred, employee compensation records, listing of money borrowed and other liabilities incurred, listing of fixed assets purchased, and depreciation worksheet.
A basic manual accounting system consists of books called journals and ledgers. A journal is a book where you record each business transaction shown on your supporting documents. You may have to keep separate journals for transactions that occur frequently. A ledger is a book that contains the totals from all of your journals. It is organized into different accounts.
If you don’t have any training in bookkeeping or prefer to use an automated system, there are computer software packages available that are relatively easy to learn and use; they require very little knowledge of bookkeeping and accounting to maintain. If you use a computerized system, you must be able to produce sufficient legible records to support and verify the entries made on your tax return and determine the correct tax liability.
Second, is how will you store your documentary evidence? Most people maintain their records in paper form and store them manually in filing cabinets and boxes. This is fine if you have the room for a lot of cabinets and boxes or don’t really handle a lot of paper. But if you’re like most small businesses, the pounds of paper add up to tons very quickly.
An electronic storage system is any system designed to store your records either by electronic imaging or by transfer to an electronic storage media. The electronic storage system must index, store, preserve, retrieve, and reproduce the electronically stored documentary evidence in legible format. All electronic storage systems must provide a complete and accurate record of your data that is accessible to the IRS. Electronic storage systems are also subject to the same controls and retention guidelines as those imposed on your original hard copy books and records.
HOW LONG TO KEEP YOUR RECORDS
You must keep your business records available at all times for inspection by the IRS and for as long as they may be needed for the administration of any provision of the Internal Revenue Code. Generally, this means that you must keep records that support the income and expenses on a tax return until the period of limitations for that return runs out.
The period of limitations is the period of time in which you can amend your return to claim a credit or refund, or the IRS can assess additional tax – meaning, they could select your return for audit. Unless otherwise stated, the years shown in the table below refer to the period after the return was filed. Returns filed before the due date are treated as filed on the due date.
| PERIOD OF LIMITATIONS | |
| IF you…. | THEN the period is…. |
| 1. Owe additional tax | 3 years |
| 2. Do not report income that you should report and it is more than 25% of the gross income shown on the return | 6 years |
| 3. File a fraudulent return | No limitation |
| 4. Do not file a return | No limitation |
| 5. File a claim for credit or refund after you filed your return | Later of: 3 years or 2 years after tax was paid |
| 6. File a claim for a loss from worthless securities or a bad debt deduction | 7 years |
There are two additional time frames to be aware of:
- If you have employees and pay employment taxes, you must keep all records related to the employment taxes paid (e.g. employee time records, Forms W-4, pay rates, etc.) for at least 4 years after the date the tax becomes due or is paid, whichever is later. (For more information about recordkeeping for employment taxes, see IRS Publication 15.)
- Records related to the purchase of fixed assets should generally be kept for as long as you have the asset plus three years from the filing date of the tax return for the year of disposition (i.e. sale or disposal).
If you decide to use an electronic storage system (like scanning your documents to a cloud storage system), the original hard copy books and records may be destroyed as long as the electronic storage system has been tested to verify that the hard copy books and records are being reproduced in compliance with IRS requirements for an electronic storage system (as referenced above) and that procedures are established to ensure continued compliance with all applicable rules and regulations.