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Tax & AccountingSeptember 13, 2021

Tax Planning: Recordkeeping for Small Businesses

By: CCH AnswerConnect Editorial

Taking Care of Business Involves Keeping Good Records.

Small business owners should keep good records. This applies to all businesses, whether they have a couple of 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.

Consider each of the questions below to be client planning opportunities

Why Should Business Owners Keep Records?

A business owner needs good records to monitor the progress of their business. Records can show whether business is improving, which items are selling, or what changes you need to make. Good records can increase the likelihood of business success. 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

What Kinds of Records Should Owners Keep?

An owner may choose any recordkeeping system suited to their business that clearly shows income and expenses. The business they are in affects the type of records they need to keep for federal tax purposes. The recordkeeping system should include a summary of a business’ transactions. This summary is ordinarily made in the business books (for example, accounting journals and ledgers). The business’ books must show gross income, as well as 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 a business owner chooses should meet the same basic recordkeeping principles mentioned above. All requirements that apply to hard copy books and records also apply to electronic records.


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Supporting Business Documents

Purchases, sales, payroll, and other transactions in a business will generate supporting documents. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. These documents contain the information an owner needs to record in their books. It is important to keep these documents because they support the entries in the books and on the tax return. An owner should keep them in an orderly fashion and in a safe place. For instance, organize them by year and type of income or expense.

Gross receipts are the income you receive from your business. A business owner should keep supporting documents that show the amounts and sources of 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 a business buys and resell to customers. If the owner is a manufacturer or producer, this includes the cost of all raw materials or parts purchased for manufacture into finished products. The 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 incurred (other than purchases) to carry on a business. The 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

Assets are the property, such as machinery and furniture,  owned and used in the business. The business must keep records to verify certain information about the business assets. The business needs records to compute the annual depreciation and the gain or loss when the assets are sold. 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

Documents such as purchase and sales invoices, real estate closing statements and canceled checks or other documents that identify payee, amount, and proof of payment/electronic funds transferred may show this information.

Travel, Transportation, Entertainment, and Gift Expenses. If a business deducts travel, entertainment, gift or transportation expenses, the business must be able to substantiate certain elements of expenses.

Employment taxes. There are specific employment tax records you must keep. Keep all records of employment for at least four years.

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How Long Should Businesses Keep Records?

The length of time a business should keep a document depends on the action, expense, or event which the document records. Generally, a business must keep your records that support an item of income, deduction or credit shown on the 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 the 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

  1. Keep records for 3 years if situations (4), (5), and (6) below do not apply to the business.
  2. Keep records for 3 years from the date the business filed the original return or 2 years from the date the business paid the tax, whichever is later, if the business files a claim for credit or refund after the business files the return.
  3. Keep records for 7 years if the business files a claim for a loss from worthless securities or bad debt deduction.
  4. Keep records for 6 years if the business does not report income that it should report, and it is more than 25% of the gross income shown on the return.
  5. Keep records indefinitely if the business does not file a return.
  6. Keep records indefinitely if the business files a fraudulent return.
  7. Keep employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.

How Should Businesses Record Transactions?

A good recordkeeping system includes a summary of your business transactions. Business transactions are ordinarily summarized in books called journals and ledgers. The owner can buy them at your local stationery or office supply store.

A journal is a book where you record each business transaction shown on the supporting documents. The business 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 the business keeps paper or electronic journals and ledgers and how the business keeps them depends on the type of business.

What is The Burden of Proof?

The responsibility to prove entries, deductions, and statements made on your tax returns is known as the burden of proof. The business owner must be able to 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. The owner should keep adequate records to prove the expenses or have sufficient evidence that will support the statement. The business 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?

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.

Learn more about recordkeeping and access the Key Primary Resources for this article for free on CCH AnswerConnect.

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Comprising of industry’s most trusted experts, the Wolters Kluwer CCH AnswerConnect Editorial Staff are knowledgeable and highly qualified to analyze and offer guidance on the latest, important tax topics. They ensure every topic is thoroughly researched and meticulously broken down so you receive the most up to date and accurate information available. Read more of their insights on CCH AnswerConnect.

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