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Record Keeping: What Tax Docs Should Individuals & Small Businesses Keep?

Not only is detailed and organized record keeping essential to the preparation of your income tax returns, but keeping all of the tax and financial documents that were used to complete your tax returns is crucial should you ever become subject to an IRS audit. Large companies are not the only entities that need to worry about maintaining thorough records; in fact, the IRS can audit individuals and small business entities for a number of reasons. Thorough record keeping is also important should you ever have to file amended tax returns.

The IRS typically selects taxpayers for audit by random selection, a process in which your tax return would be compared against the IRS-defined “norms” for similar returns, and related examinations, which occur when your tax returns involve transactions or issues with other taxpayers whose returns were selected for audit.

Period of Limitations
The statute of limitations for IRS audits and assessment of tax owed is an important component in deciphering how long you should keep certain documents. Generally speaking, three years is the rule of thumb, as the IRS usually has three years to decide whether to examine (audit) your return if you are considered a “typical” taxpayer. The IRS recommends that you keep your records for three years from the date you filed your original return, or two 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; that you keep records for 7 years if you file a claim for a loss from worthless securities or bad debt deduction; and that you keep records for 6 years if you do not report income that you should report and which is more than 25% of the gross income shown on your return. Records should be kept indefinitely if you do not file a tax return.

Items that are frequently the focus of IRS audits for individuals include information reported on Schedule C “Profit or Loss from Business,” cost basis in property and other assets, charitable donations reported, and, occasionally, some seemingly more minor considerations such as child care expenses. Some states also examine certain things as part of their audit process, so it’s important to be aware of the rules in the state in which you file (i.e. New York State examines tax-exempt income).

The cost basis of securities (stocks and bonds) that you purchase is the purchase price plus any commissions or transfer fees. Copies of purchase confirmations and brokerage statements listing the acquisitions should be retained until the securities are sold so that you have proof of the cost basis and don’t end up paying tax on the full prices.

The cost basis of real estate that you purchase is land and anything built on it, and it includes settlement and closing costs paid in connection with the purchase. You should retain copies of closing statements and final versions of the signed and executed contracts as proof of the cost basis, as well as copies of cancelled checks for all of the settlement and closing costs. Certain improvements are also part of the cost basis of the real estate, so keep copies of invoices, checks, and account statements for construction and renovation costs related to your purchase.

Items that could be at the core of an IRS audit of your business include deductions that are not proportionate with your income, numbers that appear to be rounded or averaged for your reported income, home office deductions, vehicle use deductions, and consistent loss claims each year. To ensure you are keeping track of all appropriate documentation, small business owners should have an organized system in place to maintain records of gross receipts, purchases and expenses, as well as certain deductions and business assets.

Gross receipts are the income you receive from your business. You should keep supporting documents exhibiting the amounts and sources of your gross receipts, including:
• Deposit information (cash and credit sales, statements from online payment services like PayPal, Apple Pay, Square, Venmo, etc.)
• Invoices
• Forms 1099-MISC (for service industry businesses)
• Records showing the situs of the sale (where the income was earned) for sales tax and state income tax purposes

Purchases are the items you buy and resell to customers. If you are a manufacturer or producer, this includes the cost of all raw materials or parts purchased for the manufacturing of finished products. Your supporting documents should show the amount paid and specify that the amount was for businesses purchases (not for personal use). Such documents include:
• Canceled checks or other documents that identify payee, amount and proof of payment
• Credit card receipts and statements
• Invoices

Expenses are the costs you incur (other than purchases) to run your business. Your supporting documents should show the amount paid and a description to show that the amount was for a business expense, not personal use. Documents for expenses include the following:
• Canceled checks or other documents that identify payee, amount and proof of payment
• Account statements
• Credit card receipts and statements
• Invoices
• Petty cash slips for small cash payments

Travel, Transportation & Gift Expenses
If you deduct travel, gift or transportation expenses, you must be able to prove certain “elements of expenses” as defined by the IRS. Until recently, with the enactment of the new tax law, the “business expense” category has historically included “entertainment” expenses (those activities that are considered amusement- or recreation-based). However, after December 31, 2017, this category of business expense will no longer be deductible for employers. For additional information about the recent changes to business deductions, please click here for our “Business Deductions” blog. To see what relevant business expenses are deductible, please see IRS Publication 463: “Travel, Entertainment, Gift, and Car Expenses.”

Assets are the property (i.e. machinery, furniture) that you own and use for your businesses. You should keep records to verify certain information about such business assets, as you would need these records to compute the annual depreciation and gain or loss when you sell the assets. Documentation of business assets includes the following:
• When/how you acquired the assets
• Purchase price
• Cost associated with 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 related to sale

The above information is often shown in purchase and sales invoices, real estate closing statements and canceled checks or other documents identifying the payee, amount and proof of payment.

Although the “standard” statute of limitations on an IRS audit is typically 3 years, the IRS recommends that employment tax records be kept for at least four years from the due date of the tax or when the tax is paid (whichever is later).

Whether you’re keeping records as an individual or a business owner, you should be aware of any and all scenarios and periods of limitations that will govern how and when you might become subject to an IRS audit and, effectively, how long you should keep your tax and financial documents. You should be organized when filing your historical documents, ensuring that you have a system in place to index, locate, retrieve and reproduce them when and if needed. The IRS has been accepting scanned (electronic) receipts since 1997, so if storage space is a concern, storing your tax records electronically is always a good method—as long as you have a secure way of electronically maintaining them.

When in doubt, save any and all documents that might be important until you can ask your accountant or tax advisor for further guidance. For more information on this topic, or our services, please contact us at info@fffcpas.com or 212-245-5900.

JG HeadshotJohn Gontijo, CPA, MBA, is a Tax Manager at Farkouh, Furman & Faccio. He has over 11 years of experience with high net worth individuals, small businesses, and international taxation. Prior to joining FF&F, he worked for a niche CPA firm in NYC which specialized in inbound U.S. tax matters for German, Swiss, and Austrian clients, including Offshore Voluntary Disclosure Programs.