If the IRS asked you to produce invoices
from 2004, could you access them quickly? What about an appointment calendar from 2006 or paid bills you wrote off as
business expenses in 2005? Retaining a
paper trail or electronic library of your
business’s financial activity is critical for
tax reporting purposes, and also for benchmarking and tracking your performance.
If tax season is the only time you think
about your records, it’s time to establish a
system so you can furnish “proof” if your
records are under question.
“The typical business owner makes one
of two mistakes,” says Harry W. Hunter III,
CPA, associate director, SS&G Financial
Services, Inc. in Solon. “They don’t keep
records at all, or they keep records dating
back to 1962. They either keep nothing, or
they are pack rats and keep every scrap of
paper.”
Smart Business asked Hunter which
records to keep and for how long, as well
as tips on where to keep records so you
can access them should the IRS inquire.
How does a business owner decide what
records to keep?
First, decide what your record-retention
policy is geared toward: taxes or performance comparison. For taxes, you must follow IRS guidelines for record retention,
which include how long you must keep
invoices you send out, your bank records,
your leases, asset purchases, etc. There are
different criteria for each item. However, if
you are retaining records to compare how
you did this year versus five years ago, this
is informal and there are no set policies.
The best resource for record-retention
guidelines and guidance is your accountant. He or she can provide you with a
checklist to review so you can organize
your records.
What are some records that business owners
will retain?
Everything from invoices to all paid bills.
It’s a good idea to keep your appointment
calendar, all bank records, fixed-asset depreciation schedules, payroll records,
real estate records, trusts and estates, and
virtually all financial transactions that take
place. The list goes on, and your record-retention system will depend on the complexity of your business. Ultimately, everyone must retain records to prove accuracy
of tax filings.
For how long?
This also depends on the business and
type of record. Time frames are called
statutes of limitations. For a typical business, the time period is three years after
the date of filing. If you are suspected of
substantial underpayment, that statute
extends to six years after filing. For fraud,
there is no statute of limitations.
Meanwhile, keep in mind that you must
retain depreciation records until three
years after your schedule expires. So you
may hold on to those records for 40 to 50
years.
How should these records be stored?
You are allowed to keep them in any form
you want. My clients vary in the way they
retain records. I consult solo medical practitioners who keep all of their information in a desk drawer and large practices that
store all records electronically. There are
others who box their paperwork and store
it all off-site. I can’t tell you one way is better than the other because you should
design a system that is most practical for
you. But here are some tips: If you keep
papers stored in a different location, be
sure boxes are not on the floor. If your
records are damaged by water backup, you
might as well not have them. Also, once a
year, or at least every other year, go
through records and thin them out. There
is no need to keep cancelled checks from
18 years ago. You’ll never need those.
Again, refer to a checklist or advice from
your accountant.
What about electronic records?
As long as scanned records are complete,
the IRS will allow electronic versions of
any record. It is much easier to keep
records electronically these days, but
remember, your records are only as good
as your backup and your computer. That
said, back up at least every day. Also keep
a copy of your backup off-site in case of
emergency. Finally, you must be able to
prove that you follow a backup procedure,
and you must evaluate your system for
security so unauthorized individuals cannot access electronic back-files.
What circumstances can business owners
face if they cannot produce records upon
request?
The IRS could potentially disallow all
expenses against the income. You are playing with fire if you disregard retention policies and just start deleting information.
HARRY W. HUNTER III, CPA, is associate director of SS&G
Financial Services, Inc. in Solon. Reach him at
[email protected] or (800) 869-1834.
