As I drive through town passing gas stations, I make mental notes of which are least expensive. At the grocery store I watch the checkout line monitor, comparing the price scanned to the one listed on the shelf, occasionally catching a few discrepancies.
I was not always good at this. I can recall leasing a vehicle and paying a little extra up front to get additional mileage per the two-year term. When the time came to turn the vehicle back over to the dealer, I was astonished to learn that I owed additional money for extra miles I had put on the vehicle! The salesperson had taken my signed contract and scribbled my initials in the area that acknowledged I was waiving the opportunity to purchase more miles at the time of the lease. Unfortunately, I did not get a copy of the contract that day; the dealer had a malfunctioning printer and promised to mail my copy. They never sent it, and I never followed up.
That hard lesson comes to mind when I think about keeping business records. It is always wise to have backup documentation in the event you need it some day. It’s one of the common topics I discuss with clients during a planning meeting.
Records can come in all shapes and sizes as well as many formats. You may have a settlement statement from the purchase of a building sitting in your filing cabinet or you might thumb through your desk drawer and find some recent meal receipts you kept from business lunches. Either may have been scanned and saved in the cloud or in your accounting software as an attachment to the associated transaction.
Why Good Record Keeping Is Important
Good records are more than just backup for an IRS audit you may have to endure someday. But in that event, they certainly may save your business from having an expense disallowed. During an audit a common target will be the meals and entertainment expense account. Auditors will look for unreasonable expenses and question them.
Additionally, good records provide an opportunity to trace events that occurred in the past. It’s not uncommon for a business owner to lose a large sum of money due to an employee theft. The owner with good records will be able to trace transactions and prove that he is the victim of a business crime.
Good records help you monitor the progress of your business and create financial data for you to analyze. They can be used to identify and isolate for analysis the various sources of your income. Some businesses receive income from typical sales, but also have other income not common to their daily routine. The records help track the various streams. Or you may have multiple rental properties and need to identify the correct property which to allocate income or expense. With careful categorizations in your records you can view an income statement broken down per property basis; this detail will help you easily discern how each property is performing.
Nowhere are records more important than in the acquisition or disposition of real estate. You may have purchased a building several years ago and are now looking to sell it. The sale brings up a question of the total gain or loss. Reviewing the settlement statement will confirm the original cost that should have been recorded at the time of purchase. Further, sometimes a business determines that a cost segregation will help accelerate expenses. Having a settlement statement or the AIA documents from the purchase of the building will be critical to help the cost segregation company identify shorter life assets.
Congress introduced the CARES Act during the COVID-19 pandemic. The Paycheck Protection Program was part of the CARES Act and allowed small businesses to seek loans from the Small Business Administration. As part of the program, a loan forgiveness component allowed borrowers to request loan forgiveness on the portion of qualified expenses spent during the initial 8-week or 24-week period of their loan. Borrowers were required to submit records such as payroll details and cancelled checks of rent, utilities and interest payments in order to receive loan forgiveness. Imagine missing out on having a $200,000 loan forgiven because you were unable to provide support.
What Records Should You Keep?
Purchases, sales, travel, transportation, entertainment, gifts and capital assets are all items that produce supporting documents. Banks, PayPal, Venmo, QuickBooks or other vendor sources are helpful in providing the supporting documents. A good rule of thumb is to review your financial statements and have support for every balance sheet account so that you can easily trace the balance at the end of the year back to source documents.
A bank reconciliation should be performed monthly. Support for the reconciled balance would be the month end bank statement including copies of any checks and deposits. In addition, there may be A/R and A/P invoices included as part of the support.
Deducting a business meal generally requires support in the form of receipt for any meal exceeding $75. In addition, the recorded transaction should include a description of the business purpose discussed along with the participants involved. Costs under $75 should still be recorded in a log or have a description provided in the memo section of your accounting transaction to provide support. This is often overlooked and can cause grief during an audit when the agent requests support for the meal.
Save any support for the purchase of an asset. Large ticket items such as vehicles, buildings, machinery, furniture, etc. may be sold in the future and/or will require deprecation once placed in service. Having a copy of the invoice, settlement statement or purchase agreement is helpful to have handy at the time of purchase and sale.
How Long Should You Keep Records?
You don’t necessarily have to be a packrat when it comes to saving documents. It’s a good idea to have a process in place so that you can purge documents on a regular basis. Keeping records around could also become a problem due to hackers trying to gain access to them. Therefore, plan how you will store your documents safely and how often you will destroy old ones.
There is a time period you can use as a guide to help with this decision. The IRS provides the following statute of limitations which applies to 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.
Also, it’s a good idea to keep records indefinitely from the purchase of property. It can be purged once you dispose of the property, but there is an exception. You may have exchanged the property with a new like-kind property to defer the gain. In that situation, the basis of the new property becomes the same as the basis of the old property. Therefore, you should keep all documents from the old property until you dispose of the new one.
There are occasions where an insurance company or creditor may require you to keep a document for a longer time period than the IRS requires. Therefore, you should make sure there are no non-tax reasons to keep the document before discarding it.
Where Should You Store Records?
I can recall several years ago – long before the internet – when a local news investigator trying to prove a point climbed into dumpsters of local financial institutions to obtain records containing personal information of their customers. And Mother Nature can wreak havoc in an area and records be lost from flooding or being blown away.
Technology has provided a much easier way to store records. Accounting software allows users to attach records to actual transactions that can be stored on a local server or on the cloud. You can also use the tried and true method of cabinet storage. I can think back to days when my work created rows upon rows of cabinets. The best advice for where you should store your records is to make sure they are safeguarded properly.
Business owners have plenty to worry about when running a business. Sometimes the mundane part of the business, such as keeping records, can go overlooked because it seems to be more hassle than benefit. Do you take the call from your A+ customer to discuss delivering more product, or spend the time with your records? It’s an easy decision but opting for the former could cause the latter to come back and bite you in the rear someday if ignored. It’s all about making money. And saving it too.