No Records, No Tax Savings
Recordkeeping is required to ensure a healthy business.
By Mark Battersby -- Gifts and Dec, 2/1/2009 12:00:00 AM
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Mark Battersby |
Records are not an option, not if a gift and decorative accessories operation is to survive and prosper. They are necessary to monitor the progress of the business, or more importantly, prepare an accurate income tax return, one that will stand up to scrutiny by the Internal Revenue Service.
When a taxpayer keeps either inadequate or no books or records, the Internal Revenue Service has authority to compute income, and the methods used by the IRS for reconstructing income vary depending on the facts and circumstances, but are rarely favorable to the errant taxpayer.
Why Keep Records?
A gift business owner needs good records to prepare accurate financial statements, which when properly prepared, also allow them to monitor whether the business is improving, when items or services are selling and whether changes are necessary. Profit-and-Loss statements and balance sheets frequently prove invaluable when dealing with the operation's bankers or investors.
Since most gift businesses receive money from a variety of sources, business records can identify the source of the receipts. This information is essential to separate business from non-business receipts and taxable from nontaxable income. Those records are also a reminder of expenses and credits that need to be reported, but sometimes get forgotten when it is time to prepare tax returns for the business. Generally, these are the same records used to monitor the state of the business and prepare financial statements. Without proper business records, it is impossible to understand what is going on financially in the business — and prove it to the IRS.
What Records?
The question of just what records a gift retail or wholesale operation needs to keep is extremely important — and a question without a blanket answer. Our Federal income tax laws require only that every business keep “complete and accurate records.” Unfortunately, they do not define what that means and list their requirements.
The area of sales tax recordkeeping provides an excellent illustration of why good records are so important. Frequently overlooked by many gift businesses is the amount of sales tax included in the reported total receipts. Without adequate detailed records, a business can wind up paying sales tax on the sales tax and income tax on the sales tax. Why? Because “gross receipts” means the total of all monies coming into the business, including sales tax collections. Careful recordkeeping is necessary to enable the business owner to “blackout” the sales tax from the gift operation's gross sales.
Business Transaction Records
Every good recordkeeping system includes a summary of the business' transactions. Transactions are normally summarized in books called journals and ledgers. A journal is where each business transaction shown in the operation's supporting documents is recorded. Many small business recordkeeping systems often include the following items:
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Business checkbook
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Daily summary of cash receipts
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Monthly cash receipts summary
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Check disbursements journal
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Depreciation worksheet
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Employee compensation records
Totals from all of the journals are usually summarized in a ledger, which is usually organized into different accounts.
Basic Recordkeeping Systems
Because, except in a few cases, the law does not require any gift retailer, manufacturer or supplier to keep a particular record or records, every business owner or manager can choose a recordkeeping method that is best suited to their business operation, so long as it clearly shows income. One notable exception occurred when the IRS issued guidelines for so-called “electronic records.” With more businesses turning to computers to track their financial matters, including tax records, the IRS expanded its electronic record retention rules.
Although the electronic recordkeeping requirements apply only to those businesses with assets of $10 million or more, those gift operations with assets of less than $10 million must also comply with the record retention rules if any of the following conditions exist:
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All or part of the information required by the tax law is not in the operation's hardcopy books and records, but is available in machine-sensible records
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Machine-sensible records were used for computations that can't be reasonably verified or recomputed without using a computer (e.g. LIFO inventories)
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The gift business has been notified by the IRS that machine-sensible records must be retained to meet their requirements.
With certain limited exceptions, no business is required to create any machine-sensible record other than those created in the ordinary course of its business or to establish return entries. For example, if in the ordinary course of business, a gift and decorative accessories retailer, manufacturer or supplier does not create the electronic equivalent of a traditional paper document (such as an invoice), it generally does not have to construct such a record.
The IRS guidelines go further by mandating that machine-sensible records must provide sufficient information to support and verify entries made on the operation's tax return and to determine the correct tax liability. To meet this requirement, machine-sensible records must reconcile with the taxpayer's books and tax return. Machine-sensible records must contain sufficient transaction-level detail so that the information and the source documents underlying them can be identified.
Those machine-sensible records must be retained so long as their contents may be material; in other words, at least until the statute of limitations expires for the tax year. Some records should be kept for a longer period of time, such as records that relate to fixed assets and LIFO inventories.
Finally, keeping electronic records does not relieve a gift retailer, manufacturer or supplier of their responsibility to retain hardcopy records that are created or received in the ordinary course of business. Hardcopy records may be retained in microfiche or microfilm format.
Keeping Records: For How Long?
The Internal Revenue Service requires records to be kept for a prescribed period of time, as stated in its Publication 543, Starting A Business And Keeping Records: “You must keep your records as long as they may be needed for the administration of any provision of the Internal Revenue Code” (basic tax law).
Generally, this means that a gift business must keep records that support an item of income or deduction on a return until the period of limitations runs out. The period of limitations is the period of time in which the gift business can amend a return, claim a credit or refund or the IRS can assess additional tax. That period of time is generally the later of: Three years after the date the return is due or filed, or two years after the tax is paid. (Returns that are filed before their due date are treated as having been filed on the due date.)
The IRS has three years from the date a return is filed to assess any additional tax. However, if a fraudulent return is filed, or no return files at all, the IRS has a longer period of time to assess additional tax. Here's a rundown on other records:
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Employment tax: If the gift business has employees, all employment tax records must be retained for at least four years after the date the tax becomes due or is paid, whichever is later.
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Assets: Records should be kept for property until the period of limitations expires for the year in which the property is disposed of or abandoned. These records must be maintained to determine depreciation, amortization or depletion deductions, as well as for computing gain or loss when the property is sold or otherwise disposed of.
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Tax returns: Keep indefinitely.
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Non-tax records: Should be retained until the owner or manager checks to see if they must be kept longer for other purposes. Insurance companies and creditors for example, may require some records to be kept longer than the IRS does.
Having good records and recordkeeping habits are not just about making the IRS happy, they play an important role in managing every gift and decorative accessories retail and wholesale business to profitability and success. And as with most things, it is far easier to do the job right, right from the start.
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