Maintaining a complete and organized set of records for tax purposes is one of the most important aspects of your small business bookkeeping. Not only does it let you optimize tax deductions, it helps streamline the audit process and prevent costly tax penalties. Simplifying your business tax record keeping comes down to one fundamental task: gathering, documenting, filing, and reporting the right paperwork.
Business Tax Record Keeping Basics
While the IRS is less concerned with whether business records are stored digitally or as paper hard copies, they do require that all documents - from canceled checks and credit card slips, to employee payroll forms – be legible.
Here are a few additional points they advise keeping in mind when organizing your tax records:
- Documents supporting income, deductions, or credits claimed on a tax return must be kept until “the period of limitations” expires on that return. This varies, but refers to the period of time after filing a return during which you’re entitled to submit an amendment, and they’re entitled to assess additional tax.
- It’s a good idea to keep copies of previously filed tax returns with your original documents. Not only will they help in the preparation of future returns, they’ll provide ease of reference should you need to file an amended return.
- Even when your records are no longer required for income tax reasons, you may still need to keep them for insurance or loan purposes.
Remember: when audited, the burden of proof for any tax-related claims lies with your business. Make sure you have the records to back up those claims, that they’re complete and easy to access, and that you resist reporting deductions – no matter how legitimate – without proper supporting documentation.
Common Source Documents for Business Tax Purposes
Source documents are the key to both simplifying your business tax record keeping, and being able to substantiate your expenses and income. To that end, it’s vital that you set up and enforce policies and procedures in every area of your company to ensure essential documents are being gathered or generated.
Let’s take a brief look at some of the most common sources of tax-related documents.
The IRS states that your business income may include:
- monies received from the sale of products or services,
- fees received from the regular practice of a profession,
- rents received by a person in the real estate business, and
- payments received in the form of property or services (which must be reported at fair market value)
Regardless of the source however, to prove business income you’ll need a system that allows you to track and manage company sales invoices and receipts, cash register tapes, bank deposit slips, fee statements, and client contracts.
As the biggest source of tax deduction claims, the records supporting your business expenses demand careful attention. Documentation should identify payees, and payment dates and amounts as a minimum, but may take the form of:
- canceled checks,
- supplier invoices, statements, and payment receipts,
- cash register tapes,
- credit card receipts and statements, or
- petty cash slips
If you’re still relying on paper files, you should consider storing back-up copies of documents in a secure location separate from your regular place of business.
It goes without saying that many of today’s commercial transactions are conducted electronically. If you make purchases or pay bills with credit cards, debit cards, or electronic fund transfers (EFTs), the statements issued by your bank and other financial institutions can serve as source documents.
As with all expense records, these statements should clearly outline who your company made payment to, the amounts that were charged or transferred, and the transaction dates. But remember that proof of payment alone does not entitle your business to claim an expense as a tax deduction.
In general, ordinary business expenses exclude personal expenses, capital expenses, and expenses that contribute to your Cost of Goods sold. So if you’re unsure what qualifies as a deductible expense, speak with your accounting professional.
When your business employs other people, your record keeping obligations increase as a result of having to report, withhold, and remit accurate tax amounts to the government on your employees’ behalf.
The source documents involved in employment tax record keeping are often extensive, and according to the IRS, must be kept for a minimum of four years. From amounts and dates of wage and pension payments, to records of sick pay and fringe benefits, you’ll find the full list of potential payroll documents here.
Remember, the ability to complete and file an accurate tax return year after year is a function of the efficiency of your record keeping system. For best results, simplify your approach by making sure you’re using the right accounting software for your business, and by outsourcing tax-related accounting duties to a professional with proven expertise in your industry.