“I owed the government $3,400 in taxes. So I sent them two hammers and a toilet seat.” — Michael McShane
Keeping “Books and Records” are a requirement for every business owner. If you ever received a letter that starts with
“putting all business and other reasons aside we command you to produce your books and records on Monday, 21, xxxx……
you know that sinking feeling wondering “do I have books and records? What are books and records’ Most business owners just call their accountant not realizing that they only have part of their books and records. Books and records tell the complete story of your business starting with the date of the organization all the way to your last business transaction. Books and records include:
- Tax returns
- Bank and credit card statements
- Invoices and receipts
- Legal agreements and loan documents
- Financial reports including a/r, a/p, g/l, Income Statement, and Balance Sheet
- Canceled checks
- Journals, minutes and resolutions
- Any other type of information that substantiates business transactions.
Record-Keeping has become a real challenge for business owners. Technology has made it a lot easier to access information but the information is everywhere. It’s in our email, on Amazon or Paypal, on our phones and then there are still actual paper records. The issue is that many times business owners believe they have all their receipts until they are asked to produce them. A good, centralized record-keeping system is essential in running any organization. Printing out all digital records to create a paper filing system does not make economical sense and it’s highly inefficient. A digital filing system that incorporates processes that ensures the document is saved and labeled correctly. I will discuss more in the section on Paperless Filing Systems.
IRS Publication 583 - Starting a Business and Keeping Records is a good source of information for record keeping requirements. PUB 583 Keep in mind that IRS is not the only entity interested in your books and records. Federal and States Departments of Labor for one require you to keep some payroll records longer than tax receipts. Legal and insurance documents may have other sets of rules. What’s most important is that you understand what books and records are and creating policies and procedures for creating and keeping them.
Below is part of Pub 583 covering why they want you to keep records:
This part explains why you must keep records, what kinds of records you must keep, and how to keep them. It also explains how long you must keep your records for federal tax purposes. A sample recordkeeping system is illustrated at the end of this part.
Why Keep Records?
Everyone in business must keep records. Good records will help you do the following.
Monitor the progress of your business. You need good records to monitor the progress of your business. Records can show whether your business is improving, which items are selling, or what changes you need to make. Good records can increase the likelihood of business success.
Prepare your financial statements. You need good records to prepare accurate financial statements. These include income (profit and loss) statements and balance sheets. These statements can help you in dealing with your bank or creditors and help you manage your business.
- An income statement shows the income and expenses of the business for a given period of time.
- A balance sheet shows the assets, liabilities, and your equity in the business on a given date.
Identify source of receipts. You will receive money or property from many sources. Your records can identify the source of your receipts. You need this information to separate business from nonbusiness receipts and taxable from nontaxable income.
Keep track of deductible expenses. You may forget expenses when you prepare your tax return unless you record them when they occur.
Prepare your tax returns. You need good records to prepare your tax returns. These records must support the income, expenses, and credits you report. Generally, these are the same records you use to monitor your business and prepare your financial statements.
Support items reported on tax returns. You must keep your business records available at all times for inspection by the IRS. If the IRS examines any of your tax returns, you may be asked to explain the items reported. A complete set of records will speed up the examination.
Kinds of Records To Keep
Except in a few cases, the law does not require any specific kind of records. You can choose any recordkeeping system suited to your business that clearly shows your income and expenses.
The business you are in affects the type of records you need to keep for federal tax purposes. You should set up your recordkeeping system using an accounting method that clearly shows your income for your tax year. See Choosing an Accounting Method , earlier. If you are in more than one business, you should keep a complete and separate set of records for each business. A corporation should keep minutes of board of directors' meetings.
Your recordkeeping system should include a summary of your business transactions. This summary is ordinarily made in your books (for example, accounting journals and ledgers). Your books must show your gross income, as well as your deductions and credits. For most small businesses, the business checkbook (discussed later) is the main source for entries in the business books. In addition, you must keep supporting documents, explained later.
Electronic records. All requirements that apply to hard copy books and records also apply to electronic storage systems that maintain tax books and records. When you replace hard copy books and records, you must maintain the electronic storage systems for as long as they are material to the administration of tax law. An electronic storage system is any system for preparing or keeping your records either by electronic imaging or by transfer to an electronic storage media. The electronic storage system must index, store, preserve, retrieve, and reproduce the electronically stored books and records in legible format. All electronic storage systems must provide a complete and accurate record of your data that is accessible to the IRS. Electronic storage systems are also subject to the same controls and retention guidelines as those imposed on your original hard copy books and records.
The original hard copy books and records may be destroyed provided that the electronic storage system has been tested to establish that the hard copy books and records are being reproduced in compliance with IRS requirements for an electronic storage system and procedures are established to ensure continued compliance with all applicable rules and regulations. You still have the responsibility of retaining any other books and records that are required to be retained.
The IRS may test your electronic storage system, including the equipment used, indexing methodology, software and retrieval capabilities. This test is not considered an examination and the results must be shared with you. If your electronic storage system meets the requirements mentioned earlier, you will be in compliance. If not, you may be subject to penalties for non-compliance, unless you continue to maintain your original hard copy books and records in a manner that allows you and the IRS to determine your correct tax.
For details on electronic storage system requirements, see Revenue Procedure 97-22, available at www.irs.gov/Tax-Exempt-Bonds/Revenue-Procedures.
Purchases, sales, payroll, and other transactions you have in your business generate supporting documents. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. These documents contain information you need to record in your books.
It is important to keep these documents because they support the entries in your books and on your tax return. Keep them in an orderly fashion and in a safe place. For instance, organize them by year and type of income or expense.
Gross receipts. Gross receipts are the income you receive from your business. You should keep supporting documents that show the amounts and sources of your gross receipts. Documents that show gross receipts include the following.
- Cash register tapes.
- Bank deposit slips.
- Receipt books.
- Credit card charge slips.
- Forms 1099-MISC.
Inventory. Inventory is any item 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 manufacture into finished products. Your supporting documents should show the amount paid and that the amount was for inventory. Documents reporting the cost of inventory include the following.
- Canceled checks.
- Cash register tape receipts.
- Credit card sales slips.
These records will help you determine the value of your inventory at the end of the year. See Publication 538 for information on methods for valuing inventory.
Expenses. Expenses are the costs you incur (other than the cost of inventory) to carry on your business. Your supporting documents should show the amount paid and that the amount was for a business expense. Documents for expenses include the following.
- Canceled checks.
- Cash register tapes.
- Account statements.
- Credit card sales slips.
- Petty cash slips for small cash payments.
A petty cash fund allows you to make small payments without having to write checks for small amounts. Each time you make a payment from this fund, you should make out a petty cash slip and attach it to your receipt as proof of payment.
The De Minimis Rule: This is the perfect segway from the last 2 sentences above regarding a “petty cash fund”. There is a little known rule that allows business owners to simply document and expense and not have to save a receipt. Any expenditure under $75 falls under the De Minimis Rule. All you need to do is keep a record of what you purchased, how much was spent, the date and the payee. I use a petty cash system for recording these expenses. The De Minimis Rule can be satisfied simply by noting the expense in your daily planner or business journal and then recording those expenses in your bookkeeping system.
The Business Journal: So I’ve mentioned “business journal” several times now and that’s because it's a powerful business tool. Journaling is not only good for keeping track of what’s happening and when but it also serves as an important part of your books and records. You can document important business decisions, create corporate resolutions and even keep your petty cash records in a journal.
QuickBooks and Other Record Keeping Systems: News flash - QuickBooks is a tool used in creating your financial reports. It’s not a record keeping system and will not count as being part of your books and records. QuickBooks is a software program that people started using in place of their accounting systems. An accounting and/or bookkeeping system includes all of the processes needed in creating books and records, including filing documents and employing checks and balances ensuring the integrity of the accounting records. Tens of millions of businesses were negatively affected by this shift in business mentality. Intuit convinced small business owners that they could “Save money by doing your own books” without realizing they were trying to make auto repair shop owners and bakers into bookkeepers.
The first thing you need to assess is your bookkeeping requirements. If your only doing 15-20 transactions a month you may be fine with a simple spreadsheet. I’ve seen far to many new business owners dive into QuickBooks, waste a lot of time and produce meaningless financial reports. The size of the business and your own personal preferences will determine what the best record keeping system is for you.
|Joe DiChiara CPA offers Small Business Advisory Services to passionate entrepreneurs that want to Start, Build and Manage a small business successfully. He enjoys being an “Out of The Box Thinker” and has helped thousands of small business owners start, build and manage their own business. In 2009 Joe discovered a new approach to business through “The Science of Getting Rich” written by Wallace Wattles and the inspiration behind the movie "The Secret".
After successfully applying the SOGR principles as well as Napoleon Hill's "Think And Grow Rich" to his own business, Joe discovered that there is a large market segment that is being overtaxed, unprotected and unfairly targeted by IRS. Every year over 3,000,000 entrepreneurs start businesses unaware of the dangers of operating as a sole proprietor with over 25,000,000 in the process of going bankrupt. This discovery inspired Joe to develop programs, tools, and resources to help stem the tide of these avoidable small business failures.
Currently, Joe is building an online school for small business owners www.bedrockbusinessbuildersuniversity.com and www.taxauditsmackdown.com which will help entrepreneurs create the books and records needed to survive any tax audit.
Joe is a #1 Amazon Best-Selling Author and you can Check Out Joe’s Books on Amazon by clicking here!