Tax Records that Businesses Must Maintain

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Most businesses are not informed and make tax record-keeping mistakes. Here’s what you need to know to save on underpayment penalties due to non-compliance.

By: Baljeet Singh

There are many benefits for businesses to keep records that include identifying source of receipts, preparing financial statements, monitoring business progress, obtaining financing among others. From income tax prospective keeping proper records helps businesses to prepare tax returns, keep track of the deductible expenses and support income/expenses reported on the tax returns. In fact, the U.S. tax law requires businesses to maintain records, provide substantiation to deductions claimed on the tax return and provide special substantiation to certain deductions. If there is an underpayment of taxes that results from failure to keep adequate books or records or to substantiate items properly, it could result in a penalty of 20% of the underpayment.

Here are a few simple tips for businesses to comply with many of the record-keeping requirements from tax prospective to avoid penalties.

What are all the record that should be maintained?

  • You should maintain a complete and separate set of books and records for each business that you operate.
  • Except in a few cases, the law does not require any special kind of records. You may choose any record-keeping system suited to your business as far as it clearly shows your income and expenses.
  • The broad categories that your books of accounts should be set up with are income, expenses, assets, liabilities and equity. Specific sub accounts should be created to track expenses under other various heads.
  • All incomes reflected and deductions claimed on the tax returns must be supported by evidence such as sales invoices, purchase invoices, deposit slips, cancelled checks, time sheets.
  • There are specific record-keeping requirements for deductions claimed for certain expenses that include travel expenses, car expenses, gift expenses, assets and charitable contributions. In general, information related to amount, time, place and business purpose or business relationship with the person involved should be noted in a diary, log book, or similar document. In addition to the notation, the deductions should be supported by written evidence like receipts, canceled checks or bills.
  • Any expenses incurred towards travel should have breakdown under various sub categories like travel, meals, lodging or any other expenses. In addition, information should be available on dates of travel, place, days spent for business purpose, business purpose of travel.
  • If business discussion and meal expenses are incurred either before or after the business discussion, then there should be records in place giving information on date and duration of discussion, place of business discussion, business reason/benefit expected from business discussion. In addition, the records should include information on name, occupation or other identifying information of person who took part in business discussion.
  • Till recently when entertainment expenses were deductible, there has been a requirement to classify expenses under various sub categories and should be totaled on daily basis like meals, travel etc. Further, the records should have information on date, business purpose, location and place, and type of entertainment if it is not apparent from the relevant receipt or invoice. Under the Tax Cuts and Jobs Act (TCJA), entertainment expenses incurred or paid after December 31, 2017 are nondeductible unless they fall under the specific exceptions in Code Section 274(e). One of those exceptions is for “expenses for recreation, social, or similar activities primarily for the benefit of the taxpayer’s employees, other than highly compensated employees”. (i.e. office holiday parties are still deductible). Business meals provided for the convenience of the employer are now only 50% deductible whereas before the Act they were fully deductible. Taxpayers should consider creating separate general ledger accounts for entertainment, meals, and employee holiday parties in order to have the expenses correctly categorized.
  • Car expenses should be backed up by records maintained on total miles driven as supported by odometer readings, miles driven for business purpose, and the person visited. Further, expenses incurred for gas, oil, parking, toll and other expenses should be noted.
  • There is an exemption from keeping receipts, canceled checks, bills, or other proof when you incur travel expenses if either standard mileage/per diem rate is used or expenses are less than $75 except that this does not apply to lodging expenses or there are transportation expenses for which receipts are not readily available like taxi.
  • Expenses on gifts should be supported by information on date of gift, description, cost, business reason or business benefit from the gift, name and occupation or other identifying information of person receiving the gift and business relationship with him/her.
  • If you have some capital assets in the business for which you claim depreciation on the tax returns, the records should be maintained to support the cost of assets, any additions/improvement to assets and depreciation/deductions claimed for the assets over the years. If assets are sold, the records should be available showing information to support sale and expenses of the sale.
  • Any cash charitable contribution should be substantiated by a bank statement, credit card statement or written acknowledgement from the charity. If cash contribution exceeds $250, written acknowledgement from the charity is required. Further, an appraisal is required from a certified appraiser if there is donation of property that is valued more than $5,000.
  • There are certain deductions and tax credits that cannot be claimed fully in current year but are carried over to future years. To claim such deductions, the records should be maintained showing the deductions already claimed and unused portion. Examples of such deductions are charitable contributions, capital losses.
  • If business has employees, the records must include employee’s name, address, SSN, gross payroll, amount of payroll subject to withholding and tax withheld among other details required by IRS. A copy of employee withholding certificates (generally form W4) should be maintained.

How long should the records be maintained?

  • Generally, the records should be maintained for at least the period covered by statute of limitation which is 3 years after the due date of the tax return or 2 years after the date the tax was paid, whichever is later.
  • There are certain deductions for which records should be maintained for longer like records for unreported income that is required to be reported, loss claim for worthless securities or bad debt, depreciation, and carryovers. The records related to employees should be maintained for at least 4 years after the due date of the tax return or after the tax is paid whichever is later.
  • Certain records should be kept indefinitely. There is no statute of limitation if tax return for particular year is not filed or filed fraudulently and hence such records should be kept indefinitely. Other records that should be kept indefinitely include accounting records, financial statements, certifications like audit, review or compilation reports, IRS letters, private rulings, corporate resolutions.

How to deal with record-keeping requirements?

Though it might not seem an easy task to maintain the books and records; acceptance by IRS of computer generated records and maintaining them using an electronic imaging system make things a lot easier. IRS does accept computer generated records and maintenance using electronic imaging system as long as the system provides necessary information including desired retrieval of the records, required system documentation and controls are in place. Most of the information that businesses need to maintain for certain expenses like travel with respect to date, time, place etc. can be done simply by keeping the receipts, invoices, credit card statements and making additional notations on them itself, if needed. Maintaining a separate credit card for businesses is a great way to track business expenses separately. Most of the documentary evidence required to be maintained for fixed assets can be done simply by keeping purchase and sales invoices, real estate closing statements and canceled checks.

Conclusion

The bottom line is that it is the responsibility of the business to maintain the required books and records and to keep them safe. By simply setting a proper system in place for bookkeeping, keeping documentary evidence, keeping a diary or log book and taking notations in the diary and/or other documentary evidence, businesses can comply with most of the record-keeping requirements and avoid the potential underpayment penalties.