Small BusinessTax

Small Business Record Keeping in Case of an IRS Audit

Small Business Record Keeping in Case of an IRS Audit

No one likes to think about the possibility of an IRS audit when completing their taxes. However, this is one case where it definitely pays to be prepared just in case. Even in the digital age, records are king when it comes to successfully navigating an IRS audit. At the same time, people realize there must be a limit to how long they should be expected to keep documents and receipts pertaining to their taxes.  Here is a guide to use for your small business record keeping.

IRS Guidelines on Small Business Record Keeping

With that question in mind, it is helpful know some of the guidelines set by the IRS regarding how many years you should keep complete records in the event of an IRS audit in the future. The IRS does give some guidance about record keeping, but there are some gray areas that can leave businesses more than a bit perplexed. For any document that can support any income, deduction, or credit you reflect on your tax return, you are asked to keep adequate documentation until the period of limitations for your particular situation runs out.

Which documents should you keep for your Small Business?

The IRS accepts several forms of documentation to prove business expenses. Ideally, this would include bills, invoices or receipts. What is most important is that you have record of the payee, amount and a description that proves the transaction relates to business.

Since we don’t live in a perfect world, there’s a chance you haven’t kept every single receipt. Certain purchases are worth paying closer attention to since there is a fine line between what can be considered business vs. personal expenses. We typically recommend to our clients keeping at the minimum the following items:

  1. Financials (Income Statement and Balance Sheet)
  2. Meals & Entertainment related expenses that are greater than $75 (no need to keep a receipt for purchases less than $75)
  3. Travel related expenses that are incurred during a business trip
  4. Purchase of fixed assets (property that you purchase for the business) greater than $500.  i.e. Computer purchase
  5. Ambiguous Purchases:  i.e. Items purchased off Amazon since you can buy almost anything from the website including personal items.

Any business or tax deductible expense must be justified in the event of an IRS audit. Whatever documentation you have to support this entry on your tax return should be kept and stored until the period of limitations in your case runs out.

How long should you keep your small business records?

The IRS further defines a period of limitations as the time period during which you are permitted to amend your return in order to claim either a tax credit or refund (IRS Regulations). It is also the time period during which the IRS can determine that an additional tax should be assessed.

The IRS provides guidance in some key areas that you will want to be aware of when making a determination of how long to keep your tax records. As a general rule, the period of limitations will run out in three years from the time you file your return. However, the following is a list of exceptions which require you to retain your records for a longer period of time:

  • Keeping your records for six years if you neglected to report any earned income on your tax return, and that failure amounts to 25 percent of the overall gross income that is reflected on your return for any given year.
  • If you did not file a return for some reason (and remember that this is never advisable), you will want to keep your records indefinitely.
  • If you discover that you filed a fraudulent return, your records should also be kept on an indefinite basis.
  • Any employment related tax documents should be retained for a minimum of four years after the date that any tax was due or was paid.
  • Tax records should also be kept seven years if a claim is filed for any securities or bad debt related loss that you record as a deduction on your tax return.
  • You only need to keep your documents for three years from the date that you file a return, or two years from the date that you actually pay the tax, whichever is later. This is applicable if you filed a claim for a credit or refund after you sent in your return.

Once the period of limitations is up for your specific situation, it is safe to eliminate your documents as an IRS audit would not be possible.

How Should You Store Your Tax Records?

You might remember hearing stories of people lugging in car loads of boxes to their IRS auditors, each one containing a mountain of paper receipts and tax documents. While you are certainly welcome to keep track of your documents in this way, the IRS now accepts electronic transmissions for most audits.

If you have a bunch of receipts that you need to legitimize deductions, you can take those and scan them into you home or office computer. The IRS accepts digital copies of your information as long as the information is accurate and identical to the paper copies. However, you may need to provide paper copies upon request.

Options to store them electronically includes keeping them in a secure dropbox or Google drive. If you’re trying to store many documents, you might want to invest in a scanner for your business and upload them that way. It is always a very good idea to keep secondary copies of all of your tax-related paperwork. You can store these on a secure zip drive, on a password protected external hard drive, or in a secondary cloud storage.

Remember, the key is to have some type of proof that the IRS will accept when questioning any portion of your tax return.

 To Sum It Up

Know that IRS audits are not to be feared if you make a legitimate effort to file a correct and proper tax return. As well as have a good handle on the rules of small business record keeping. Be sure to retain all of the necessary documentation to justify any deductions and you will likely come out just fine in the end.

If you have more questions on small business record keeping, please do not hesitate to reach out to us via our contact page. We look forward to hearing from you.