Small Business Taxes & ManagementTM--Copyright 2019, A/N Group, Inc.
How long do I have to keep records? It's an oft-asked question and the usual answer is 3 years. But that's a very simplified answer. It can vary based on the type of record, the purpose of the record, for what agency or organization you're saving the record, etc. We can't deal with all the possibilities in this discussion, but we'll deal with most of them and alert you to special ones you should check on further. We've included some of the records you should keep as we're going through the discussion.
Tax returns. This one is relatively easy. For personal tax returns, keep them forever. Let your executor deal with them. If you're the executor, keep them for at least three years after the last return was filed. If the deceased reported business income or loss on the return, keep them at least six years from the date the last return was filed. Often more complex returns contain supporting schedules that are not required to be filed with the return by the IRS or state. For example, a detailed list of charitable contributions or a breakdown of repairs for a rental property. Your tax preparer may or may not provide this backup, if not ask for it. If you're preparing your own return, save these files. They can be very helpful.
Business tax returns for an S corporation, partnership, or other pass-through entity should be kept for at least six years from the date of filing of the last tax return. For example, if the S corporation is dissolved in 2019 and the return is filed March 15, 2020, keep the returns and back-up documentation until March 15, 2026.
General rule for records. If you don't have business income, you're generally safe in keeping the records for only three years after you file the return. For example, you file your 2019 return on June 15, 2020 (you've got an extension). Keep the records until June 15, 2023.
While this same rule extends to business records, you'll be on the safer side if you keep the records for six years from the date the return was filed. Why the difference? The IRS and most states can generally only audit up to three years after your file. However, if they can show that you omitted more than 25 percent of your income, they can go back six years. (If they can show fraud, they can go back indefinitely.) If your income is only from salary, investment transactions, pension income, etc. it's highly unlikely you have unreported income, especially today where most income is subject to reporting on a W-2 or 1099. Of course, if you haven't reported income from that side job where you're paid off the books, that's another issue.
If you haven't filed a return, the IRS or state tax authority can go back indefinitely. That's true for business and personal income taxes, sales tax, excise tax, etc. returns. Think they won't? We know of a number of situations where businesses haven't filed sales or income tax returns in a state other than the one they're incorporated in, even though required to do so. In one case the state went back 30 years, to when they first instituted a sales tax.
General records to keep. For business expenses you want an invoice and proof of payment for expenses. You may be able to support payment by bank or credit card statements or a canceled check. Bank statements are crucial documentation. You should be able to download them from your bank, but after a certain time period you may be charged. Check the rules with your bank. The best approach is to download them monthly. Don't rely on a third party. Invoices detailing the expenses are important so that the IRS can tell what the expense was for. If there could be a question of the relationship to the business or whether the expense was business or personal add notes to the invoice. For outgoing invoices, keep the invoices. Keep any Forms 1099 etc.
For individuals keep copies of brokerage statements, Forms 1099 and 1098, W-2s, and other information returns showing income or expenses. You should also keep copies of canceled checks, credit card or bank statements. You may be able to get a copy of your tax bill from the town online, but you'll still have to show you paid it. The town records may show it was paid, but the IRS could argue someone else paid it. For charitable contributions keep any receipts and payment documentation such as canceled checks, credit card documentation. If you're deducting or taking a credit for tuition, keep related documentation. There are other special situations such as charitable contributions of property where special documentation is required.
Special situations. The retention period for travel and meal records is the same as for other business records, but make sure you have the required information. The rules here are strict and the IRS will disallow a expenses if any one of the required items is missing. Car logs, diaries, etc. should also be retained. If nothing else they may be helpful in reconstructing your activities or to explain an expense. The car logs are essential to back up car and truck expenses. Diaries can support time spent working in the business for material participation purposes, to substantiate a salary, etc. You must also keep a diary for travel expenses. There's no rule that says you can't wrap them all in to one if you keep the details required for each. You might also need a diary to show time spent in or out of a state for residency purposes. In some cases that might be required for IRS purposes, but usually because if you spend 183 or more days in a state, that state will try and claim you should be taxed as a resident. In a worst case scenario if your other records are destroyed, keeping a good diary can help salvage at least some deductions in many cases. This is a complex area, but a good log could keep you out of trouble.
Basis in assets. You had a building constructed for $450,000 in 1999. Because the demographics changed you sold it in 2019 for $75,000. You took $231,000 in depreciation (your adjusted basis is now $219,000) and you're now claiming a loss on the sale of $144,000. If you're audited you could have to prove your original basis in the building to support your recent depreciation deductions. You'll need your old tax returns to support the depreciation you took over the years. That's one reason you need to save documentation showing your original cost basis in assets and retain such documentation until three (preferrably six) years after the sale of the property reported on your tax return. The same rules apply to other assets such as vehicles, office equipment, etc. Fortunately, these generally have a shorter life so you're unlikely to have to retain the documentation nearly as long. Intangible assets such as customer lists, copyrights, goodwill, are amortized over 15 years so you could be called on at any point to prove your basis for amortization purposes.
The same rule applies to personal assets such as stocks and other investments, collectibles, your home, etc. Can't prove your basis? The IRS can assign a basis of $0. That software company you bought in 1988 that's gone up 75 times in value would have a basis of zero if you can't show otherwise. It doesn't happen always, but the IRS can do it--and has. The courts have sided with the IRS. The good news is that the basis in stocks and other investments acquired through a broker must be tracked by the broker after 2011. That may not be true for investments in publicly traded partnerships, so keep all your documentation.
Like-kind exchanges. This one is a special subset of the discussion immediately above. The basis in the asset you have currently is computed from the basis in the asset you give up. That can happen multiple times. For example, in 1980 you bought a rental property in Connecticut. You exchanged the property in 1991 and, using a like-kind exchange (Sec. 1031) acquired a rental property in Massachusetts. You exchanged that property for a property in Vermont in 2001. In 2019 you sell the Vermont property without doing an exchange. Your basis in the property depends on what you paid for the original property, depreciation taken, the gain deferred over the years, as well as any improvements to the properties. While the computation of your basis is carried forward on Form 8824, you might have to prove all or a portion of that basis.
The same rule can apply to your home. Before 1996 you could roll over the gain on your principal residence. Many taxpayers did so. That means for some taxpayers the basis in their current home could depend on a residence purchased 40 years ago and rolled over several times. On the other hand, if you sold your principal residence after 1996 you would have reported the gain and started fresh.
Net operating losses and other carryforwards You can carry forward a net operating loss, capital loss, losses from rental real estate, certain credits, etc. The length of the carryforward period depends on the item, but the amount of the carryforward could be challenged by the IRS some years down the road. For example, in 2015 your business had a large loss that was passed through on your personal return. The net operating losses were reported on your 2016, 2017, 2018, and 2019 returns. When auditing your 2019 return the IRS could ask you to support the original 2015 loss. Keep in mind that capital losses and rental real estate losses can be carried forward indefinitely. There are a number of different carryfowards. Discuss this with your tax advisor.
Appraisals. If you got one on a property, business you purchased, etc., keep it until at least three years after the property is disposed of. The appraisal could be necessary to support your basis in the property and/or for depreciation or amortization purposes.
Employment records. There are both federal and state rules at work here. You should keep at least seven years after the individual has left your employ. That includes Form 941, 940, W-2s, W-4s, I-9, employment and salary agreements, etc. Don't forget related state forms. This is not a complete list. Don't forget updates or modifications to the original documents over the years. If employees has a pension through your business, check with your tax advisor.
Corporate records. Bylaws, incorporation papers, LLC or partnership documents, meeting minutes, S corporation election, etc. should be kept at least six years after the corporation, LLC, etc. is dissolved. Talk to your attorney and tax advisor on this one.
Other business records. There can be a number of other records your business might have to keep that depend on the industry. For example, medical records for a health care practitioner, records for food processors, etc. That's beyond the scope of this article, but some could be for considerably longer than 7 years.
Scanning. Using electronic methods to keep the records is almost universal now. If you're allowed, scanning them can save considerable space and make them easier to access, if you have a system. You can send out the documentation to be scanned, or do it in house. For a small business, a multifunction copier/printer/scanner should be fast enough. You can usually load 25 sheets at a time. The next step is a dedicated unit. Today, a decent one will not break the bank. Don't assume a CD or DVD will last forever. Technology continues to change. Consider a flash drive and a hard drive-either disk or SSD. Back up to both, or to one and the cloud. All these devices are cost effective today. Make sure you store drives in separate and safe places.
Copyright 2019 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject.--ISSN 1089-1536
--Last Update 06/10/19