Record Keeping Retention Guidelines:
A Conservative and Basic Approach
Written by: Steven J. Fromm, J.D., LL.M. (Taxation)
Maintaining good financial records is an important part of running a successful business. Not only will good records help you identify strengths and weaknesses in your business' operations, but they will also help out tremendously if the IRS comes knocking on your door.
The IRS requires that business owners keep adequate books and records and that they be available when needed for any tax audit that may arise. Here are some basic business record retention guidelines:
Copies of Tax Returns
You must keep records that support each item of income or deduction on a business return until the statute of limitations for that return expires. In general, the statute of limitations is three years after the date on which the return was filed. Because the IRS may go back as far as six years to audit a tax return when a substantial understatement of income is suspected, it may be prudent to keep records for at least six years. In cases of suspected tax fraud or if a return is never filed, the statute of limitations never expires.
Chances are that if you have employees, you've accumulated a great deal of paperwork over the years. The IRS isn't looking to give you a break either: you are required to keep all employment tax records for at least 4 years after the date the tax becomes due or is paid, whichever is later. These records include payroll tax returns and employee time documentation.
Records relating to business assets should be kept until the statute of limitations expires for the year in which you dispose of the asset in a taxable disposition. Original acquisition documentation, (e.g. receipts, settlement sheets, escrow statements) should be kept to compute any depreciation, amortization, or depletion deduction, and to later determine your cost basis for computing gain or loss when you sell or otherwise dispose of the asset.
If your business has leased property that qualifies as a capital lease, you should retain the underlying lease agreement in case the IRS ever questions the nature of the lease.
For property received in a nontaxable exchange, additional documentation must be kept. With this type of transaction, your cost basis in the new property is the same as the cost basis of the property you disposed of, increased by money you paid. You must keep the records on the old property, as well as on the new property, until the statute of limitations expires for the year in which you dispose of the new property in a taxable disposition.
If your business maintains inventory, your record keeping requirements are even more arduous. The use of special inventory valuation methods (e.g. LIFO and UNICAP) may prolong the record retention period. For example, if you use the last-in, first-out (LIFO) method of accounting for inventory, you will need to maintain the records necessary to substantiate all costs since the first year you used LIFO.
Corporate Minute Book
This is an often overlooked compliance detail that needs to be addressed. The minute book should contain the Articles of Incorporation, Articles of Amendment, By-Laws, stock ledger, etc. Your attorney should be consulted to make sure minutes are being regularly kept, at least annually and sometimes more frequently depending upon the corporate event. The minute book should be kept indefinitely.
Conservative Policy For Record Retention
So what is the most conservative approach to take here to avoid problems. The following records should be kept indefinitely:
- Income tax an sales tax returns
- Payroll tax returns
- Inventory schedules
- Depreciation schedules
- General ledger, cash receipts and disbursements ledgers
- Financial statements
- Cancelled check for any tax payments
- Cancelled check for the acquisition of real estate
- Minute Book
Other cancelled checks should be kept 10 years.
The following need to be kept for seven years in most cases:
- Accounts payable ledgers
- Accounts receivable ledgers
- Bank statements and reconciliations
- Sale slips
- Purchase orders
- Vendors invoices
Specific Computerized Systems Requirements
If your company has modified, or is considering modifying its computer, record keeping and/or imaging systems, it is essential that you take the IRS's recently updated record keeping requirements into consideration.
If you use a computerized system, you must be able to produce sufficient legible records to support and verify amount shown on your business tax return and determine your correct tax liability. To meet this qualification, the machine-sensible records must reconcile with your books and business tax return. These records must provide enough detail to identify the underlying source documents. You must also keep all machine-sensible records and a complete description of the computerized portion of your record keeping system.
Some Final Advice
When your records are no longer needed for tax purposes, think twice before discarding them. They may still be needed for other non-tax purposes. Besides the wealth of information good records provide for business planning purposes, insurance companies and/or creditors may have different record retention requirements than the IRS. With the ability to scan documents onto the computer, from an ultra-conservative perspective it may be better and most prudent to simply scan these documents. This will provide additional protection if the paper documentation is lost or destroyed. In certain cases it may be wise to consult with tax or legal counsel as to the appropriate course of action.
Copyright © 2012 - Steven J. Fromm & Associates, P.C., 1420 Walnut Street, Suite 300, Philadelphia, PA 19102. All rights reserved.
If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.