Why Good Records Safeguard Business Owners and Taxpayers
File storage applications and services are a convenience to customers and a way to attract new prospects, but how long should you or your clients keep certain documents and why bother saving records anyway?
What Does the IRS Say?
In “How long should I keep records?” Small business owners and the self-employed are told in general the guideline is three years. Of course there are exceptions:
- 7 years if you file a claim for worthless securities or bad debt deduction.
- 6 years if you do not report income you should report and if it is more than 25% of the gross income shown on your return.
- Indefinitely if you don’t file a return.
- Indefinitely if you file a fraudulent return. (We’ll deal with you later.)
- Indefinitely or as long as you own the property (real estate), plus the period of limitations after the property has been sold.
- On nontaxable exchanges, you must retain records on the old property plus the new one until you sell the property and the period of limitations expires.
- 4 years for employment tax records counting from the due date or paid date, whichever is later.
What’s the Logic for Keeping Good Records and Holding onto Them?
A major reason small businesses incorporate is the corporate veil that provides a degree of protection from personal liability. The corporate veil may be pierced under certain circumstances.
- Not having formal, legal separation between the company and its owners.
- Not following corporate formalities like conducting an annual meeting and recording significant business decisions in corporate minutes of the meeting.
- Engaging in illegal activities or acting dishonestly.
Undercapitalization and complete control by a minority of individuals are also reasons, although that’s not relevant to the record keeping discussion.
Your business owning client should keep good records for many reasons:
1. Audits: Your client needs to be able to document everything they claim.
2. Lending money: At times business owners might determine the best way to cover a cash shortfall in the business is to loan the business money from their personal account. They are repaid when times are better. If the loan isn’t recorded in a letter expressing the terms and size of the loan along with another letter when the loan is repaid, it appears the business owner is running their personal and business finances from different pockets of the same pair of pants.
3. Selling the business: Unless the primary asset is the building and land, a potential buyer wants confirmation the business is a going concern. The value of the business will be largely determined by the revenue recorded and reported.
4. Two sets of books: If the appearance of revenue taken in doesn’t align with revenue reported it appears the owner is keeping two sets of books, one for the government and another for the silent partners and themselves. It happens all the time in movies about organized crime. You’ve seen the problems “cash businesses” can get into. Now the question of “Is this illegal activity?” becomes the rationale for piercing the corporate veil.
What about Ordinary Individuals?
Businesses need to keep good records to keep them legal and avoid the piercing of the corporate veil. Individuals need to keep good records for tax purposes and in case tragedy strikes.
Today, records don’t need to always be paper. They can be stored electronically but an individual’s records do need to be accessible. Why?
If it’s not in writing, it doesn’t apply
In days gone by business might have been done via “gentleman’s agreements,” implying honor made enforcement unnecessary. Today, everything must be in writing. If you take a job based on certain verbal assurances, yet they aren’t spelled out in the employment contract, you have little or no recourse.
You see evidence of this day to day in your non-professional life. When you accept the terms and conditions on websites or sign up for a cellphone or credit card, companies are saving the records you signed very carefully. You should treat your own records the same way.
Death of the individual
Many people have opted to go paperless with their bank and investment accounts. If something happen to you, would your survivors be able to find the money and assets unless you tell them where to look?
Paper that’s worth a lot of money
Think titles to real estate, survey documents showing the size of the property and titles to automobiles. Don’t forget marriage licenses and birth and baptismal certificates.
Loans to family members
You help out a relative and the loan never gets repaid. They claim it was a gift. How will you prove otherwise?
Good record keeping makes obvious sense for securities. Suppose you collect wine, art or jewelry and send the items to auction. The sale is reported to the government. They will assume it’s a windfall unless you can document your costs. The auction house will also want proof of ownership or a chain or provenance before they accept your item. How do they know it wasn’t stolen?
That great emerald you bought recently turns out to be a piece of green glass. You want to go after the store that sold it to you. Can you prove where you bought it and how much you paid?
You’ve been robbed and have reported the theft to the police. Do you know what was taken? Do you have photos? Do you have receipts showing what you paid? The insurance company will have their own point of view concerning your loss and it makes recovery much harder with minimal records.
Real estate improvements
One of the areas where accountants add value is clarifying for clients the difference between capital improvements and property maintenance expenses, especially if they own income producing real estate. When it becomes time to sell, you need receipts to document the improvements you made.
Bryce Sanders is president of Perceptive Business Solutions Inc. in New Hope, Pennsylvania. He provides high-net-worth client acquisition training for the financial services industry. His book, Captivating the Wealthy Investor, can be found on Amazon.com.