This is another story from the war zone. This is not a new subject, it has been covered many times by myself and many other tax professionals; the importance of good record keeping. However, it seems not to be at the top of the priority list of business owners until the IRS comes knocking at their doors for an audit. Trying to recreate what happened two or three years ago it almost impossible, maybe that is part of the IRS audit tactics.
One case that comes to mind is Haron Veras v Commissioner. Veras operated a small trucking company and arrived in court with few records to prove his business expenses. The court laid some specific recordkeeping rules that are important for all business owners to keep in mind:
- The law requires a taxpayer to maintain records sufficient to establish the amount of his income and deductions.
- The court can make estimates, in select circumstances, when the taxpayer provides evidence sufficient to establish a rational basis for an estimate.
- The court may never make an estimate when the taxpayer fails to keep the records required for automobile, entertainment, meals, travel, and gifts.
What happened to Veras?
Here is a summary of what happened to Veras:
- Hired workers. While the court had no doubt that Veras hired and paid the workers, Veras presented no evidence of the hires and payments. Tax court was forced to disallow $16,000, since there was not sufficient basis for even an estimate.
- Business travel and meals. Veras did not write down the reasons for his business travel and provided no support for the business meals. Again, the court was left with no other option but to disallow $1,600 of travel expenses and $2,300 of meal expenses.
- Miscellaneous expenses. This is a line item on tax returns that should be avoided or kept to a minimum, it is a line item that screams, look at me! Veras could not substantiate the $7,200 of miscellaneous expenses and the court disallowed the full amount.
- Automobile expenses. Veras was able to sustain some of the fuel deductions, but he still lost $9,000 of truck expenses due to the failure to produce adequate records.
I chose to bring up the Veras case today, because it is the typical small business. Veras had approximately $83,000 in revenues and claimed total expenses of approximately $69,000. The tax court disallowed a total of approximately $36,000 of business expenses, on which Veras had to pay income tax, self-employment tax, penalties and interest.
The rules are clear; no records, no deductions. Don’t let this happen to you. Don’t wait and start now.
Tips on Recordkeeping
Here are some tips to help you figure out which records to keep and how long to keep them:
- Keep your tax records and supporting documentation until the statute of limitations runs for filing returns or filing for refund. For most taxpayers this is three years following the date of filing or the due date of your tax return, whichever is later. Here are a couple of notes on statute of limitations:
- If you file a fraudulent return or if you don’t file a return at all, the statute of limitations never actually runs. That means that there is no time limit on IRS action. In that event, you’ll want to hold onto your records forever.
- If you file an amended return, it does not extend the statute of limitations for your original return. The clock doesn’t restart: the original date determines the statute of limitations (some exceptions apply if you file within 60 days of the assessment window).
- Supporting documentations, you want to keep includes your W-2 and 1099 but also bills, credit card and other receipts, invoices, mileage logs, canceled, imaged or substitute checks, proofs of payment, and any other records to support deductions or credits you claim on your return.
- Keep records of minimum essential health insurance coverage or proof that you qualified for an exemption or premium tax credit (especially if you had to pay it back).
- Hold onto all IRA records – including Roth contributions – until you withdraw all of the money from the account.
- If you claim depreciation, amortization, or depletion deductions, you’ll want to keep related records for as long as you own the property. That includes deeds, titles and support for the purchase and major improvements.
- If you file a claim for a loss from worthless securities or bad debt deduction, you should keep those records for seven years.
- If you have employees, including household employees, keep your employment tax records (W-2 and W-4) for at least four years after the date that payroll taxes become due or is paid, whichever is later.
- If you own property that will result in a taxable event at sale or disposition such as stocks, bonds or your home, you’ll want to keep records until the disposition of the property plus three years.
- If you receive property as the result of a gift or inheritance, you’ll want to keep records that support your basis in that property. Don’t toss those old records just because you’re the new owner of the assets.
Keep your records organized, to save space and sanity, you can scan your records and store them electronically. If the IRS comes calling, you’ll want to be able to produce legible records in a pretty timely manner. You need to ensure that your scanned or electronic receipts are as accurate as your paper records and you must be able to index, store, preserve, retrieve, and reproduce the records. In other words, you need to have your records organized and be able to produce them in a hard copy form if needed.
One last piece of advice: when you’re ready to toss those old records, have a shredder handy. Remember that your records have personally identifying information, as well as details about your finances, that you want to keep private and away from potential identity thieves.