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Here's How Your Business Can Leverage Record Keeping to Avoid Headaches at Tax Time


Recordkeeping doesn’t sound like much fun. In fact, the word recordkeeping sounds like it might require a lot of brain power and pawing through a bunch of papers in a shoebox marked with the word “RECORDS.”

But Good recordkeeping can make all the difference in the success of your business (not to mention, it makes tax time much less of a headache), so it’s important that you develop a process. At the end of the day, good recordkeeping isn’t about working harder; it’s about working smarter.

If you want to justify an expense, you’ll need a document that states what it is and when it happened, like a receipt. But even though receipts are increasingly digital, not every financial document is, and even if it is, it still needs to be earmarked as what kind of document it is.

This sounds difficult, but all you need is an app (or a shoebox).

What is recordkeeping and why should I do it?

Recordkeeping is the practice of saving records and documents to support your financial decisions.

The reason you should have a process is that good records will help monitor the success of your business by helping you prepare accurate financial statements, identify sources of income, keep track of deductible expenses, monitor payroll, keep track of your basis in property and of course, prepare the most accurate tax returns and even support the items reported on your tax returns.

What is the burden of proof?

The burden of proof is the responsibility to substantiate the claims you have made on your tax returns. To prove certain elements of each expense, taxpayers must generally meet their burden of proof by keeping adequate records, such as receipts, canceled checks or bills to support any expenses or purchases.

What kinds of records should I keep and how do I do this?

Except in a few cases discussed below, the law does not require any specific kind of recordkeeping. You can choose whatever kind of system that works for you and your business. As long as documents are kept in order, you can organize them however you’d like, but the most helpful method is likely arranging them by year and type of income or expense, such as gross receipts, inventory costs, operating expenses and asset costs. Gross receipts typically aid in supporting documents for the income you receive. Gross receipts can include:

· Cash register tapes
· Bank deposit slips
· Receipt books
· Invoices
· Credit card charge slips
· Forms 1099-MISC
· Forms 1099-NEC

Inventory documents report the cost of your inventory. Typical records of inventory include:

· Canceled checks
· Cash register tape receipts
· Credit card sales slips
· Invoices

Expenses need supporting documents to show proof for your claimed deductions. Common expense documents include:

· Canceled checks
· Cash register tapes
· Account statement
· Credit card sales slips
· Invoices
· Petty cash slips for small cash payments

Assets are the property, such as machinery and furniture you own and use in your business. Records must be kept to verify certain information about these assets. You will need records to figure the annual depreciation and, therefore, gain or loss for when you sell the assets. Records for assets should show the following types of information:

· When and how you acquired the asset
· Purchase price
· Cost of any improvements
· Section 179 deduction taken
· Deductions taken for depreciation
· Deductions taken for casualty losses, such as losses resulting from fires or storms
· How you used the asset
· When and how you disposed of the asset
· Selling price
· Expenses of sale

You may have noticed a few classic items missing from these lists, such as travel, transportation and gift expenses. These expenses have their own recordkeeping rules that are generally more stringent due to the nature of the expenses. For more information on these specific types of expenses, please see IRS Pub. 463, Travel, Gift, and Car Expenses.

For employment recordkeeping, there is a list of specific employment tax records that must be kept for at least four years. For a list of the items that the employment records must include, please see IRS Pub. 15, (Circular E), Employer’s Tax Guide.

As far as how to keep records, there are many business apps that can keep track of most, if not all, of these items. The only caveat is that the app must be able to give you sufficient records to support and verify entries made on your return. Many of these apps let you label and categorize these documents right away as you get them, making recordkeeping much easier than if you were collecting and organizing paper documents.

How long do I keep records?

You must keep records that support items on your return for as long as “they may become material in the administration of any provision of the Internal Revenue Code,” which generally means until the period of limitations expires for that return.

Period of limitations for assessment of tax:

· 3 Years – For tax owed, this period is three years from the date the return is due.

· 6 Years – If you don’t report income that should have been reported and it’s more than 25% of the gross income on the return and is more than $5,000, the time to assess the tax is then six years from the date the return is filed.

· No limit – There’s no period of limitations to assess tax if you file a fraudulent return or if you don’t file a return.

Period of limitations for refund claims:

· The later of 2 or 3 years after tax was paid – Generally, taxpayers have the later of two or three years from the date the original return was filed.

· 7 years – For filing a claim for an overpayment resulting from a bad debt deduction or a loss from worthless securities, the time to make the claim is seven years from when the return was due.

You can see why recordkeeping is so important for you and for your business, and it’s much easier when you have a system and know what important documents to file as you go along. But you don’t have to do it alone. An expert at a Block Advisors office can help you get your papers organized and help you make sense of those important documents, even if you keep them in a shoebox.

Photo courtesy of Ketut Subiyanto via Pexels.

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