When running a business, good recordkeeping is essential. As you probably already know, keeping detailed records helps you to more accurately track how well your business is doing. Records allow you to see what expenses could likely be cut, what expenditures are producing results and should be increased, which customers are your most profitable, and so on.
Recordkeeping is also essential for tax purposes. First, it makes the job much easier for the person preparing your taxes, whether you’re doing it yourself or getting professional help. You can save yourself a nightmare at tax time by keeping an organized list of your taxable receipts and deductible expenditures.
Equally important is the need to have sufficient records in case of an audit. If you’re audited and cannot produce evidence of an expense you claimed as a deduction, the deduction is almost certain to be disallowed. There are several recordkeeping software products (e.g., Quicken) on the market that are both affordable and fairly easy to use. The financial risk you incur by not keeping records far outweighs the cost of such software.
What Records to Keep
The first step, if you haven’t done so already, is to get a business checking account. Being able to separate your business expenses from your personal expenses will prove invaluable both for evaluating your success and for doing your taxes.
The most important record to keep is a ledger. This is a record of all of your business transactions. (Your personal ledger is the little booklet that accompanies your checks in your checkbook.) You can find paper versions of these at business supply stores, but it’s strongly recommended to find software to help you with this. However, if you do use a software package to help you, be sure to backup your file regularly. Losing this information due to something as simple as a computer failure would be quite unfortunate.
For tax purposes, you will also be required to maintain supporting documents for your ledger. For your income items, these will be things such as invoices, bank deposit slips, and so on. (If you run a business with lots of cash sales, an important record to keep is a daily log of the amount of cash received.) For expenses, your supporting documents will be receipts, credit card statements, bank statements, invoices, etc.
How Long to Keep Your Records
For tax purposes, the general rule is that you want to keep records until the applicable “statute of limitations” runs out. The statute of limitations is the period during which a) you can amend your return to claim a refund, or b) the IRS can assess an additional tax. For the most part, this is three years after the date the return was filed or the date the return was due, whichever is later.
There are two major exceptions to this three-year period. First, if you file a fraudulent return or do not file a return, the IRS has an unlimited amount of time to assess additional tax. Second, if you do not report income that you should have reported, and it is more than 25% of your gross income for the year, the applicable statute of limitations is six years.
So for the most part, three years is the length of time required to keep records for tax purposes. However, there are several reasons you may want to keep records (at least some of them) for far longer than that. Generally you will want to keep at least your ledger of revenues and expenses (although not the actual receipts) more or less indefinitely. This information will continue to be valuable for tracking your business’s progress. Also, your insurance company or creditors will quite possibly require you to maintain your records for longer than three years. Finally, your state law may require recordkeeping for longer than three years.
- The most important thing you can do to make preparing your taxes simpler is to get a separate checking account for your business.
- In case of an audit, you want to have both a canceled check (or credit card statement) and a receipt to prove each of your claimed deductions.
- Generally, you want to make sure to keep your records for three years for tax purposes, but you may be required to keep records for longer for your bank or insurance company.