Hans Kasper, MS-CPA, PS

Keeping and Retaining Records
Recordkeeping #1

The orderly filing of business documents and how long they should be retained is very important for every business for four reasons:

• an IRS or State audit,

• an insurance claim,

• a lawsuit, or

• the sale of your business.

The IRS has a policy that if you can not prove an expenditure through a

• cancelled check or credit card statement charge, AND

• a vendor receipt,

then the deduction will be disallowed during an audit.  

The IRS has an additional policy: all deposits to your bank account are income unless you can prove otherwise.  If you do not have a bank account, then what they figure as your cost of living is equal to your income.

As an ex-IRS agent, I once did that very thing, time-and-time again.  In 1975, additional tax collections from audits that I performed exceeded $3,000,000.

Your insurance company is in business to take your premiums and deny any claims that you can not prove.  This is how they make money.  They are not your best neighbor.  The best way to prove an insurance claim for all assets lost due to fire or theft is copies of vendor receipts, photographs or videos, and computer backups of your accounting files.

An asset register is essential.  No, this is not your depreciation schedule.  It is a list of your assets-down to every stapler and chair.

A lawsuit where copies of contracts and proof of job costs are important can mean a total loss to your business.

During the sale of a business, each owner presents financial statements of what the business has earned and what assets are owned by the company.  The owner guarantees these representations to be accurate.  If they are not, then the purchaser can, at a later date, sue for misrepresentation.  Without supporting documents to prove that the financial statements are correct, you will lose the lawsuit.

Top of Page

The IRS record retention policy is based on the IRS code statute of limitations which is generally three years.  Therefore, if you file an income tax return for 1998 on or before April 15, 1999 and the IRS does not audit you before April 15, 2002 (three years), then, unless they can prove that you didn't report all your income or the return was fraudulent, they can not assess you with any additional taxes for 1998.

Top of Page

The Washington Department of Revenue record retention policy is based on the Revised Code of Washington statute of limitations which is generally four years and recordkeeping for five years.

RCW 82.32.050 Limitations.
     (3) No assessment or correction of an assessment for additional taxes, penalties, or interest due may be made by the department more than four years after the close of the tax year, except (a) against a taxpayer who has not registered as required by this chapter, (b) upon a showing of fraud or of misrepresentation of a material fact by the taxpayer, or (c) where a taxpayer has executed a written waiver of such limitation.

RCW 82.32.070 Records to be preserved -- Examination -- Estoppel to question assessment -- Unified business identifier account number records.
(1) Every person liable for any fee or tax imposed by chapters 82.04 through 82.27 RCW shall keep and preserve, for a period of five years, suitable records as may be necessary to determine the amount of any tax for which he may be liable, which records shall include copies of all federal income tax and state tax returns and reports made by him. All his books, records, and invoices shall be open for examination at any time by the department of revenue. In the case of an out-of-state person or concern which does not keep the necessary books and records within this state, it shall be sufficient if it produces within the state such books and records as shall be required by the department of revenue, or permits the examination by an agent authorized or designated by the department of revenue at the place where such books and records are kept. Any person who fails to comply with the requirements of this section shall be forever barred from questioning, in any court action or proceedings, the correctness of any assessment of taxes made by the department of revenue based upon any period for which such books, records, and invoices have not been so kept and preserved.

     (2) A person liable for any fee or tax imposed by chapters 82.04 through 82.27 RCW who contracts with another person or entity for work subject to chapter 18.27 or 19.28 RCW shall obtain and preserve a record of the unified business identifier account number for the person or entity performing the work. Failure to obtain or maintain the record is subject to RCW 39.06.010 and to a penalty determined by the director, but not to exceed two hundred fifty dollars. The department shall notify the taxpayer and collect the penalty in the same manner as penalties under RCW 82.32.100.

Top of Page

Business documents are an important history of your business transactions with everyone you have worked with – including customers, vendors and employees.  These records need to be retained so that any questions can be resolved should they arise in the future. In addition, good records can monitor the progress of your business, and increase the likelihood of business success.

 Generally records should be retained for the periods indicated below, but there are some exceptions.  For example, if there is any potential or pending litigation the retention period may need to be extended.  In most cases, business records should be kept a minimum of 7 years.

Top of Page

Recordkeeping must be organized.  Below is a simple, structured method for a small-business filing system that will solve most of your recordkeeping issues.  It is recommended that file folders be used, that a two-hole punch be placed at the top, and that prongs be used with the two-hole punch to hold the papers in place.

Customer Invoices

• Place customer invoices into a numerical file at the time of invoicing.  As each file becomes full, start a new one.  Start new files at the beginning of each year.

• For those companies that are job orientated, a copy should also be placed in a job file.

• For those companies that have numerous repeat orders with the same customers, a copy should also be placed in a customer file.

Cash Registers

• Store the daily register tapes and reconciliations in a large envelope or small box for each week or month.

Unpaid Vendor Invoices

• Stamp as "Entered" at the time of entry into the accounting program

• Place in alphabetical files for unpaid vendor invoices (A-Z, with individual files for large vendors) and remove at the time of payment.

• Start new files at the beginning of each year.

Paid Vendor Invoices

• Stamp as "Paid" at the time of payment and attached the check stub to the paid invoice(s).

• Place in alphabetical files for paid vendor invoices (A-Z, with individual files for large vendors).

• Start new files at the beginning of each year.

• Each credit card statement should have its own separate file for each month with the individual charges slips attached.

Petty Cash Receipts

• Keep in separate envelopes for each month.

• Write the totals for each expense category on the outside of the envelope.

Employee Time Cards

• Create a separate time card file for each employee.

• File the time cards in those files in date order.

• Start new files at the beginning of each year.

Employee Records

• Create a separate Employee Record file for each employee.

• Store in each file: W-4, I-9, employee applications for benefits, employee's signature of receipt of personnel policy, employee reviews, employee notices, and approval of employee pay raises.

Payroll Tax Returns

• A separate file for each quarter which will include the Federal and State Form 941, Form 941 deposit or EFTPS receipts, Suta form , Futa deposit and calculation (all quarters), Form 940 (December only), payroll detail report for each employee.

• A file for the W-3 and W-2s for the year.

Form 1099s

• An alphabetical file for all W-9s completed by contractors who are not corporations.

• A file for Form 1099s for MISC (contractors and rent), INT (interest income), DIV (dividend income), and re-purchases of stock in your corporation from other owners (1099B).  Start new files at the beginning of each year.

Land, Buildings, Equipment, and Vehicles

• Create a separate file or notebook for each category.  These are perpetual files that will carry forward from year-to-year.

• As each asset is purchased, the purchase documents should be placed in each file.  Photos should be made of the assets as well for insurance purposes.

• One set of files should be kept for those items that are capitalized (placed on the depreciation schedule) and another set for those that are expensed (small office furniture).

• These files should be kept in duplicate--one on-site and one off-site in the event of a fire.  This is your proof for insurance purposes.

Bank Statements and Cancelled Checks

• Keep with the bank reconciliations in a separate box for each year.

Travel, Transportation, Entertainment, and Gift Expenses

• See travel at: Business travel

• See transportation at: Auto expense

• Meal and entertainment:

  • You must keep a receipt for each expense.

  • You must write on each receipt:

    • Who you met with.

    • What the business purpose was.

• Gift expenses:

  • You must keep a receipt for each expense.

  • Mark on the receipt who the gift was for and what the business purpose was.

  • Deductions for business gifts, whether made directly or indirectly, are limited to $25 per recipient per year. Items clearly of an advertising nature that cost $4 or less and signs, display racks, or other promotional materials given for use on business premises are not gifts.