Starting your own business is an exciting first step into the world of entrepreneurship. It’s also the beginning of your relationship with the IRS.
You are legally obligated to keep financial records on-hand for the IRS’ sake. But which ones should you hold on to, and which ones are just extra office clutter?
At online bookkeeping service Bench, we’re experts when it comes to the finer nuances of tracking your financials. In this guide, we’ll look at which records you need to keep, how long you need to keep them, and a few efficient methods you can use to keep your records organized.
What tax records do I need to keep?
If you are self-employed or own a small business, the IRS requires you to keep documentation supporting the claims of income, deductions, or credit appearing on your tax return form. This proves that you’ve earned what you told the IRS you earned, or purchased what you told the IRS you bought.
Generally, the documentation you should keep includes:
- Bank and credit card statements
- Canceled checks
- Proof of payments
- Financial statements from your bookkeeper
- Previous tax returns
- W2 and 1099 forms
- Any other documentary evidence that supports an item of income, deduction, or credit shown on your tax return
Keep in mind, this isn’t a comprehensive list. The nature and legal structure of your business will affect which records you need to keep for the IRS.
The burden of proof is on you, the business owner, to provide all the necessary documents. So, when you begin record keeping, obey this simple principle: Keep everything.
In the case of an audit, your first line of defense is receipts and tax records. Storing all of them will maximize your level of protection. Also, keeping your receipts guarantees you will be able to claim any tax deductions you are owed.
A possible exception: The $75 rule
There are some expenses for which you are not legally required to keep receipts. For instance, the IRS doesn’t require you to keep receipts for travel (minus lodging), entertainment, gifts, or transportation, so long as the following applies:
- The expense, not including lodging, is less than $75
- The expense is for transportation, and a receipt is not readily available
However, keep in mind that in the event of an audit, any expense can be called into question—even those under $75.
For more information, look into the IRS’ guidelines on proving expenses under $75.
How long to keep your tax records
The three year rule:
Plan to keep your tax records for three years after the date you filed the return, or from the due date of said return (whichever is later). If you file your return early, it’s treated as though it has been filed on the due date.
This three year rule comes to us via the Statute of Limitations, which is the period during which you, the taxpayer, can amend your tax return—or in which the IRS can audit said tax return. Once the period of limitations expires, you’re no longer required to keep tax records for that period.
Exceptions to the three year rule:
As always, there are exceptions to this rule. In some cases, you’ll need to hold on to records longer than the three year Statute of Limitations demands. Exceptions include:
Bad debts and worthless securities: If you deducted the cost of either of these on your tax returns, keep the record for seven years.
Omitted income: If you fail to report income to the IRS, and it is more than 25 percent of the gross income stated on your return, keep records for six years after the date you filed or the due date of the return—whichever is later.
Employee records: Records of employment should be kept four years after the relevant payroll taxes become due, or are paid—whichever is later.
Fraudulent returns: If you fill out a return fraudulently, you’d better hold on to it. There is no statute of limitations on returns that mislead the IRS.
Property records: You should keep records connected to the holding of property for the duration of the statute of limitations—three years—after said property leaves your possession.
Regarding property records, you need to hold on to documentation such as deeds, titles, and cost basis records. This lets you calculate any depreciation, amortization, or depletion deduction, as well as factor the gain or loss when you sell or dispose of the property.
How to store receipts and tax records
Once you’ve determined which records you need to keep and for how long, it’s time to set up a system for organizing them.
Thankfully, the IRS accepts digital documents so long as they are complete, accurate reproductions of the originals. Upon request, you should be able to produce a readable, printed copy of any given document.
This means that the days of using a creaky filing cabinet to store your tax records are over; there are a number of digital solutions you can use to go paperless and keep your records in order.
Secure cloud storage options such as Dropbox, Evernote, or Google Drive allow you to store your documents safely online. Once your business is established, if you find you are dealing with a lot of paperwork, consider investing in an automatic, high-speed scanner to make their transfer online more efficient.
It’s also a good idea to keep a backup copy of your documents, either on a password-protected physical storage device or in a secondary cloud account.
Keeping records for non-tax purposes
Once you no longer need to hold on to a document for tax purposes, double check that you definitely don’t need them before shredding them. Your creditors, lawyer, or insurance company may need you to keep them for longer than the IRS does.
If you use online storage, rather than delete documents you no longer need, you can archive them permanently.
Learning to navigate the gray areas of small business record keeping—and setting up a paperless system of organization—will save you from the perils of office clutter, while making sure that you’re always playing by the rules.