Taking care of business: recordkeeping for small businesses
May 7, 2019
Small business owners should keep good records. This applies to all businesses, whether they have a couple dozen employees or just a few. Whether they install software or make soft-serve. Whether they cut hair or cut lawns. Keeping good records is an important part of running a successful business.
Here are some questions and answers to help business owners understand the ins and outs of good recordkeeping.
Why should business owners keep records?
Good records will help them:
- Monitor the progress of their business
- Prepare financial statements
- Identify income sources
- Keep track of expenses
- Prepare tax returns and
- support items reported on tax returns
Monitor the progress of your business
You need good records to monitor the progress of your business. Records can show whether your business is improving, which items are selling, or what changes you need to make. Good records can increase the likelihood of business success.
Prepare your financial statements
You need good records to prepare accurate financial statements. These include income (profit and loss) statements and balance sheets. These statements can help you in dealing with your bank or creditors and help you manage your business.
- An income statement shows the income and expenses of the business for a given period of time.
- A balance sheet shows the assets, liabilities, and your equity in the business on a given date.
Identify sources of your income
You will receive money or property from many sources. Your records can identify the sources of your income. You need this information to separate business from nonbusiness receipts and taxable from nontaxable income.
Keep track of your deductible expenses
Unless you record them when they occur, you may forget expenses when you prepare your tax return.
Keep track of your basis in property
Your basis is the amount of your investment in property for tax purposes. You will use the basis to figure the gain or loss on the sale, exchange, or other disposition of property, as well as deductions for depreciation, amortization, depletion, and casualty losses.
Prepare your tax return
You need good records to prepare your tax returns. These records must support the income, expenses, and credits you report. Generally, these are the same records you use to monitor your business and prepare your financial statement.
Support items reported on your tax returns
You must keep your business records available at all times for inspection by the IRS. If the IRS examines any of your tax returns, you may be asked to explain the items reported. A complete set of records will speed up the examination.
What kinds of records should owners keep?
Small business owners may choose any recordkeeping system that fits their business. They should choose one that clearly shows income and expenses. Except in a few cases, the law does not require special kinds of records.
You may choose any recordkeeping system suited to your business that clearly shows your income and expenses. The business you are in affects the type of records you need to keep for federal tax purposes. Your recordkeeping system should include a summary of your business transactions. This summary is ordinarily made in your business books (for example, accounting journals and ledgers). Your books must show your gross income, as well as your deductions and credits. For most small businesses, the business checking account is the main source for entries in the business books.
Some businesses choose to use electronic accounting software programs or some other type of electronic system to capture and organize their records. The electronic accounting software program or electronic system you choose should meet the same basic recordkeeping principles mentioned above. All requirements that apply to hard copy books and records also apply to electronic records. For more detailed information refer to Publication 583, Starting a Business and Keeping Records.
Supporting Business Documents
Purchases, sales, payroll, and other transactions you have in your business will generate supporting documents. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. These documents contain the information you need to record in your books. It is important to keep these documents because they support the entries in your books and on your tax return. You should keep them in an orderly fashion and in a safe place. For instance, organize them by year and type of income or expense.
The following are some of the types of records you should keep:
- Gross receipts are the income you receive from your business. You should keep supporting documents that show the amounts and sources of your gross receipts. Documents for gross receipts include the following:
- Cash register tapes
- Deposit information (cash and credit sales)
- Receipt books
- Invoices
- Forms 1099-MISC
- Purchases are the items you buy and resell to customers. If you are a manufacturer or producer, this includes the cost of all raw materials or parts purchased for manufacture into finished products. Your supporting documents should show the amount paid and that the amount was for purchases. Documents for purchases include the following:
- Canceled checks or other documents that identify payee, amount, and proof of payment/electronic funds transferred
- Cash register tape receipts
- Credit card receipts and statements
- Invoices
- Expenses are the costs you incur (other than purchases) to carry on your business. Your supporting documents should show the amount paid and a description that shows the amount was for a business expense. Documents for expenses include the following:
- Canceled checks or other documents that identify payee, amount, and proof of payment/electronic funds transferred
- Cash register tapes
- Account statements
- Credit card receipts and statements
- Invoices
- Petty cash slips for small cash payments
Travel, Transportation, Entertainment, and Gift Expenses
If you deduct travel, entertainment, gift or transportation expenses, you must be able to prove (substantiate) certain elements of expenses. For additional information, refer to Publication 463, Travel, Entertainment, Gift, and Car Expenses.- Assets are the property, such as machinery and furniture, that you own and use in your business. You must keep records to verify certain information about your business assets. You need records to compute the annual depreciation and the gain or loss when you sell the assets. Documents for assets should show the following information:
- When and how you acquired the assets
- 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
The following documents may show this information.
- Purchase and sales invoices
- Real estate closing statements
- Canceled checks or other documents that identify payee, amount, and proof of payment/electronic funds transferred
- Employment taxes
There are specific employment tax records you must keep. Keep all records of employment for at least four years. For additional information, refer to Recordkeeping for Employers and Publication 15, Circular E Employers Tax Guide.
How long should businesses keep records?
How long a document should be kept depends on several factors. These factors include the action, expense and event recorded in the document. The IRS generally suggests taxpayers keep records for three years.
The length of time you should keep a document depends on the action, expense, or event which the document records. Generally, you must keep your records that support an item of income, deduction or credit shown on your tax return until the period of limitations for that tax return runs out.
The period of limitations is the period of time in which you can amend your tax return to claim a credit or refund, or the IRS can assess additional tax. The information below reflects the periods of limitations that apply to income tax returns. Unless otherwise stated, the years refer to the period after the return was filed. Returns filed before the due date are treated as filed on the due date.
Note: Keep copies of your filed tax returns. They help in preparing future tax returns and making computations if you file an amended return.
Period of Limitations that apply to income tax returns
- Keep records for 3 years if situations (4), (5), and (6) below do not apply to you.
- Keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later, if you file a claim for credit or refund after you file your return.
- Keep records for 7 years if you file a claim for a loss from worthless securities or bad debt deduction.
- Keep records for 6 years if you do not report income that you should report, and it is more than 25% of the gross income shown on your return.
- Keep records indefinitely if you do not file a return.
- Keep records indefinitely if you file a fraudulent return.
- Keep employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.
The following questions should be applied to each record as you decide whether to keep a document or throw it away.
Are the records connected to property?
Generally, keep records relating to property until the period of limitations expires for the year in which you dispose of the property. You must keep these records to figure any depreciation, amortization, or depletion deduction and to figure the gain or loss when you sell or otherwise dispose of the property.
If you received property in a nontaxable exchange, your basis in that property is the same as the basis of the property you gave up, increased by any money you paid. You must keep the records on the old property, as well as on the new property, until the period of limitations expires for the year in which you dispose of the new property.
What should I do with my records for nontax purposes?
When your records are no longer needed for tax purposes, do not discard them until you check to see if you have to keep them longer for other purposes. For example, your insurance company or creditors may require you to keep them longer than the IRS does.
How should businesses record transactions?
A good recordkeeping system includes a summary of all business transactions. These are usually kept in books called journals and ledgers, which business owners can buy at an office supply store. All requirements that apply to hard copy books and records also apply to electronic business records.
A good recordkeeping system includes a summary of your business transactions. Business transactions are ordinarily summarized in books called journals and ledgers. You can buy them at your local stationery or office supply store.
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.
Electronic Records: All requirements that apply to hard copy books and records also apply to business records which are maintained using electronic accounting software, point of sale software, financial software or any other electronic records system. The electronic system must provide a complete and accurate record of your data that is accessible to the IRS.
Whether you keep paper or electronic journals and ledgers and how you keep them depends on the type of business you are in. For example, a recordkeeping system for a small business might include the following items:
- Business checkbook
- Daily and monthly summary of cash receipts
- Check disbursements journal
- Depreciation worksheet
- Employee compensation records
Note: The system you use to record business transactions will be more effective if you follow good recordkeeping practices. For example, record expenses when they occur, and identify the sources of income. Generally, it is best to record transactions on a daily basis. For additional information on how to record your business transactions, refer to Publication 583, Starting a Business and Keeping Records.
What is the burden of proof?
The responsibility to validate information on tax returns is known as the burden of proof. Small business owners must be able to prove expenses to deduct them.
The responsibility to prove entries, deductions, and statements made on your tax returns is known as the burden of proof. You must be able to prove (substantiate) certain elements of expenses to deduct them. Generally, taxpayers meet their burden of proof by having the information and receipts (where needed) for the expenses. You should keep adequate records to prove your expenses or have sufficient evidence that will support your own statement. You generally must have documentary evidence, such as receipts, canceled checks, or bills, to support your expenses. Additional evidence is required for travel, entertainment, gifts, and auto expenses.
How long should businesses keep employment tax records?
Business owners should keep all records of employment taxes for at least four years.
Keep all records of employment taxes for at least four years after filing the 4th quarter for the year. These should be available for IRS review. Records should include:
- Your employer identification number.
- Amounts and dates of all wage, annuity, and pension payments.
- Amounts of tips reported.
- The fair market value of in-kind wages paid.
- Names, addresses, social security numbers, and occupations of employees and recipients.
- Any employee copies of Form W-2 that were returned to you as undeliverable.
- Dates of employment.
- Periods for which employees and recipients were paid while absent due to sickness or injury and the amount and weekly rate of payments you or third-party payers made to them.
- Copies of employees’ and recipients’ income tax withholding allowance certificates (Forms W-4, W-4P, W-4S, and W-4V).
- Dates and amounts of tax deposits you made.
- Copies of returns filed.
- Records of allocated tips.
- Records of fringe benefits provided, including substantiation.
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