Books and records, books and records [Tax]

You took the leap and decided you want to own and operate your own business. That's huge, congrats! Make money, spend money, repeat.

Now that you are operating though... What are you doing about your accounting books and records?

By choosing to do business in the United States, you agreed to comply with the tax laws of the United States. Sounds harsh, I know - but it's reality.

Title 26 of the United States Code (aka the Internal Revenue Code), Section 6001 says the following:

Every person liable for any tax imposed by this title, or for the collection thereof, shall keep such records, render such statements, make such returns, and comply with such rules and regulations as the Secretary may from time to time prescribe. Whenever in the judgment of the Secretary it is necessary, he may require any person, by notice served upon such person or by regulations, to make such returns, render such statements, or keep such records, as the Secretary deems sufficient to show whether or not such person is liable for tax under this title.

You are liable for tax - so yes, they are referring to you.

But "records," "statements," and "returns"... What do they actually mean? What is required? There is no singular required method for keeping records - records do however need to be sufficient to prove the numbers you file on your tax returns.

As the saying goes, the best offense is a good defense. Look at it from the perspective of the IRS conducting an audit - the IRS needs to know where all of the numbers on your tax return came from.

For example: The IRS wants to know how $25,000 of Office Expense reported on your return was calculated and supported.

• IRS: Where does the $25,000 come from?

  • You: My business Profit and Loss Statement

• IRS: Where are the details behind the Profit and Loss Statement, like a general ledger or transaction listing that shows this $25,000?

  • You: Here is my general ledger showing all of the transactions that total $25,000.

• IRS: Do you have receipts for these transactions?

From there, receipts will be reviewed, and further questioned if necessary (e.g. is the expense an ordinary, reasonable and necessary expense?). Everything should be documented to a degree.

Breaking down IRC § 6001

• Records can mean a combination of invoices from sales you made, receipts and invoices from expenses you paid and inventory you purchased, bank and credit card statements, canceled checks that you deposited as income and/or spent for expenses, loan documents detailing money borrowed, interest rates and terms, a diary of your business activities (see a future post about material participation), inventory records, contracts, etc.

• Create statements as necessary on your returns where additional information beyond the dollar amount reported is needed (e.g. elections for special tax treatments, breakdowns of expenses requiring more context, details of losses carried forward or backward, why you included a certain % of something as a deduction and omitted the rest)

• File tax returns using the numbers you derived from the above.

• Be served with an IRS summons requiring you to provide testimony or records if the IRS determines it is necessary.

You want to keep things orderly and supportable at the end of the day.

Common misunderstanding about expenses $75 or less

While many taxpayers retain records for at least seven years, the appropriate retention period depends on the nature of the records and whether they support carryforwards, basis calculations, or other tax attributes from prior years.

Despite what you may hear, there is no blanket rule that allows taxpayers to skip keeping receipts or invoices for all expenses under $75.

There is a limited $75 exception for certain travel expense documentation requirements, but it does not eliminate the need to maintain adequate books and records for most other expenditures. Don't fall into this trap!

Hash it out with a pro

Whether you're starting a new business or trying to improve an existing recordkeeping system, we can help develop practical processes that keep your books organized in the event of an examination. Not to mention there is also comfort in knowing that your books and records are backed up in the event of a disaster.

The information provided is for general informational purposes only. You should consult your own tax professional (or us) regarding your specific situation.