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When
a practitioner first gets a new business client, especially a client that
is beginning business ownership for the first time, one of the most
critical issues that must be addressed is the necessity to keep proper
business records both to aid in the preparation of the tax returns of the
business, and to document and substantiate all information that is entered
on the tax returns. Although
this has always been an important issue to address with clients, the rise
of electronic technology and its use in even the smallest of businesses
adds a new wrinkle to the traditional advice that practitioners have
traditionally provided clients on recordkeeping.
Why keep records?
In
Announcement 2001-8, 2001-3 IRB 357, the IRS announced the release of Pub
583, "Starting a Business and Keeping Records," which provides
the latest IRS spin on a business owner's need and responsibility to keep
records. In response to the
question of why keep records, the IRS lists the following reasons (both
tax and non-tax) for good business recordkeeping:
Monitoring the progress of the business.
Meticulous recordkeeping can let an
owner know which inventory items are selling and conversely, those items
that are not moving.
Preparing financial statements.
Detailed records on a business's
income and expenses facilitate the preparation of accurate financial
statements, which are particularly useful when dealing with banks,
suppliers and other creditors.
Identification of source of
receipts. In the
course of a client's day-to-day business operations, the business may
receive property or cash from a variety of sources.
Complete records can help a client track the origin of receipts,
and at times, can help separate business versus non-business receipts.
Keeping track of deductible expenses.
Accurate and timely records for business deductions helps keep a
client from overlooking expenses when the time comes to prepare an income
tax return.
Preparing tax returns.
Good business records are necessary to support income, expenses,
deductions, and credits reported on a return.
Support items reported on tax return.
The IRS requires business owners to keep business records that back
up tax return entries available for inspection.
Type of records required
Although
the IRS clearly requires the maintenance of complete and accurate business
records, neither the tax law nor the IRS requires that most records be
kept in any particular form. The
type of records that a client business keeps may be dependent upon the
type of business involved and the type of deduction involved.
However, clients should be advised that their recordkeeping system
should include at least a summary of all business transactions.
Ordinarily, your clients will keep this summary as part of the
company's accounting journal or business ledgers.
According to the IRS, business records should show both the gross
income of the business as well as deductions and credits.
g
Comment.
For most small businesses, the business checkbook, especially if it
is combined with an automatic ledger, should be sufficient.
Supporting documents
In the ordinary course
of running a business, purchases, sales, payroll, and other transactions
will generate supporting documents. Supporting
documents (also sometimes referred to as "substantiation") can
include items such as sales slips, paid bills, invoices, receipts, deposit
slips, and cancelled checks. Clients
should record the information from these items in their books and records.
In
Pub 583, the IRS provides examples of the type of supporting documents
that it deems appropriate to substantiate various types of receipts and
expenditures.
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Gross
receipts - cash register tapes, bank deposit slips, receipt books,
invoices, credit card charge slips, and Forms 1099-MISC.
˙
Purchases
(items bought and resold to customers) - cancelled checks, cash register
tape receipts, credit card sales slips, and invoices.
g
Comment.
These
records can also help establish the value of inventory at the end of the
year.
˙
Expenses
(costs the business incurs, other than purchases, to operate the business)
- cancelled checks, cash register tapes, account statements, credit card
sales slips, invoices, and petty cash slips.
Stricter
and more specialized requirements apply to travel, entertainment, and gift
expenses. A practitioner or
business owner may want to refer to IRS Publication 463 to make sure he or
she follows these rules. In
addition, see IRS Publication 15 (also referred to as Circular E) for
specific records that are required to back up payroll expenses.
Documentation of asset purchases
Assets are the property,
such as machinery and furniture, that a business owns and uses on a daily
or regular basis as part of operating the business.
Special records must be kept to verify certain information about
the business assets. Records
are needed to calculate annual depreciation, establish an asset's basis,
and the gain or loss realized when the asset is sold.
The records should clearly show the following information:
˙
When and
how the asset was acquired
˙
Purchase
price;
˙
The cost
of any improvements;
˙
Whether
the IRC §179 deduction was taken with respect to the acquisition of the
asset;
˙
Depreciation
taken
˙
Deductions
taken for casualty losses;
˙
How the
asset is used in the business;
˙
Disposition
of the asset;
˙
Selling
price;
˙
and
Expenses of sale.
Documents that show this
type of information include purchase and sales invoices, real estate
settlement statements, and cancelled checks.
Electronic
recordkeeping
Some small businesses
still start out with a traditional paper recordkeeping system, which
involves the business owner's use of either single entry or double entry
bookkeeping system. However,
it has almost become de rigueur today to have at least some of a
business's records on a computerized system.
As more and more business owners are using the computer as a matter
of course, it is important to review the IRS rules for how records must be
maintained on computer.
Store bought computer
software packages. Many
readily available software packages are relatively easy to use and require very little knowledge
of accounting and bookkeeping. A
business that uses a computerized system must be able to produce
sufficient legible records to verify entries on the business tax return
and determine the correct tax liability.
According to the IRS, in order to meet this qualification machine
sensible-records must reconcile with the company's books and with the tax
returns filed. Revenue
Procedure 98-25 should be consulted for the precise requirements.
Microfilm. The
IRS will accept microfilm and microfiche reproductions of general
books of account, such as cash books, journals, voucher registers, and
ledgers for recordkeeping purposes if they comply with the requirements of
Revenue Procedure 81-46.
Electronic storage system. According
to the IRS, this type of system is one that either images hardcopy (paper)
books and records or transfers computerized books and records to an
electronic storage media, such as an optical disk.
If you're ready to let the
FVBK Team go to work for you, contact us now.
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