How to keep records
Why Keep Records?
Everyone in business must keep records. Good records will help you do the following.
Monitor the progress of your business
You need good records to monitor the progress of your business. Records can show whether your business is improving, which items are selling, or what changes you need to make. Good records can increase the likelihood of business success.
Prepare your financial statements
You need good records to prepare accurate financial statements. These include income (profit and loss) statements and balance sheets. These statements can help you in dealing with your bank or creditors and help you manage your business.
• An income statement shows the income and expenses of the business for a given period of time.
• A balance sheet shows the assets, liabilities, and your equity in the business on a given date. Identify source of receipts. You will receive money or property from many sources. Your records can identify the source of your receipts. You need this information to separate business from nonbusiness receipts and taxable from nontaxable income.
Keep track of deductible expenses
You may forget expenses when you prepare your tax return unless you record them when they occur.
Prepare your tax returns
You need good records to prepare your tax returns. These records must support the income, expenses, and credits you report. Generally, these are the same records you use to monitor your business and prepare your financial statements.
Support items reported on tax returns
You must keep your business records available at all times for inspection by the IRS. If the IRS examines any of your tax returns, you may be asked to explain the items reported. A complete set of records will speed up the examination.
Kinds of Records To Keep
Except in a few cases, the law does not require any specific kind of records. You can choose any recordkeeping system suited to your business that clearly shows your income and expenses.
The business you are in affects the type of records you need to keep for federal tax purposes. You should set up your recordkeeping system using an accounting method that clearly shows your income for your tax year. See our guide on Choosing an Accounting Method.
If you are in more than one business, you should keep a complete and separate set of records for each business. A corporation should keep minutes of board of directors' meetings. Your recordkeeping system should include a summary of your business transactions. This summary is ordinarily made in your books (for example, accounting journals and ledgers). Your books must show your gross income, as well as your deductions and credits. For most small businesses, the business checkbook (discussed later) is the main source for entries in the business books. In addition, you must keep supporting documents, explained later.
Electronic records
All requirements that apply to hard copy books and records also apply to electronic storage systems that maintain tax books and records. When you replace hard copy books and records, you must maintain the electronic storage systems for as long as they are material to the administration of tax law.
An electronic storage system is any system for preparing or keeping your records either by electronic imaging or by transfer to an electronic storage media. The electronic storage system must index, store, preserve, retrieve, and reproduce the electronically stored books and records in legible format. All electronic storage systems must provide a complete and accurate record of your data that is accessible to the IRS.
Electronic storage systems are also subject to the same controls and retention guidelines as those imposed on your original hard copy books and records. The original hard copy books and records may be destroyed provided that the electronic storage system has been tested to establish that the hard copy books and records are being reproduced in compliance with IRS requirements for an electronic storage system and procedures are established to ensure continued compliance with all applicable rules and regulations. You still have the responsibility of retaining any other books and records that are required to be retained.
The IRS may test your electronic storage system, including the equipment used, indexing methodology, software and retrieval capabilities. This test is not considered an examination and the results must be shared with you. If your electronic storage system meets the requirements mentioned earlier, you will be in compliance. If not, you may be subject to penalties for non-compliance, unless you continue to maintain your original hard copy books and records in a manner that allows you and the IRS to determine your correct tax.
For details on electronic storage system requirements,
see Revenue Procedure 97-22.
Supporting Documents
Purchases, sales, payroll, and other transactions you have in your business generate supporting documents. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. These documents contain information you need to record in your books.
It is important to keep these documents because they support the entries in your books and on your tax return. Keep them in an orderly fashion and in a safe place. For instance, organize them by year and type of income or expense.
Gross receipts
Gross receipts are the income you receive from your business. You should keep supporting documents that show the amounts and sources of your gross receipts. Documents that show gross receipts include the following:
• Cash register tapes
• Bank deposit slips
• Receipt books
• Invoices
• Credit card charge slips
• Forms 1099-MISC
• Forms 1099-NEC
Inventory
Inventory is any item you buy and resell to customers. If you are a manufacturer or producer, this includes the cost of all raw materials or parts purchased for manufacture into finished products. Your supporting documents should show the amount paid and that the amount was for inventory. Documents reporting the cost of inventory include the following:
• Canceled checks
• Cash register tape receipts
• Credit card sales slips
• Invoices
These records will help you determine the value of your inventory at the end of the year. See Pub. 538 for information on methods for valuing inventory.
Expenses
Expenses are the costs you incur (other than the cost of inventory) to carry on your business. Your supporting documents should show the amount paid and that the amount was for a business expense. Documents for expenses include the following:
- Canceled checks
- Cash register tapes.
- Account statements.
- Credit card sales slips.
- Invoices.
- Petty cash slips for small cash payments.
Tip: a petty cash fund allows you to make small payments without having to write checks for small amounts. Each time you make a payment from this fund, you should make out a petty cash slip and attach it to your receipt as proof of payment.
Travel, transportation, and gift expenses
Specific recordkeeping rules apply to these expenses. For more information, see Pub. 463.
Employment taxes
There are specific employment tax records you must keep. For a list, see Pub. 15.
Assets
Assets are the property, such as machinery and furniture you own and use in your business. You must keep records to verify certain information about your business assets. You need records to figure the annual depreciation and the gain or loss when you sell the assets.
Your records should show the following information:
• When and how you acquired the asset
• Purchase price
• Cost of any improvements
• Section 179 deduction taken
• Deductions taken for depreciation
• Deductions taken for casualty losses, such as losses
resulting from fires or storms
• How you used the asset
• When and how you disposed of the asset
• Selling price
• Expenses of sale
The following documents may show the information above:
• Purchase and sales invoices
• Real estate closing statements
• Canceled checks
What if I don't have a canceled check?
If you do not have a canceled check, you may be able to prove payment with certain financial account statements prepared by financial institutions. These include account statements prepared for the financial institution by a third party. These account statements must be highly legible. The following table lists acceptable account statements:
| IF payment is by... | THEN the statement must show the... |
| Check | • Check number • Amount • Payee's name • Date the check amount was posted to the account by the financial institution |
| Electronic funds transfer | • Amount transferred • Payee's name • Date the transfer was posted to the account by the financial institution |
| Credit card | • Amount charged • Payee's name • Transaction date |
Please note: proof of payment of an amount, by itself, does not establish you are entitled to a tax deduction. You should also keep other documents, such as credit card sales slips and invoices, to show that you also incurred the cost.
Recording Business Transactions
A good recordkeeping system includes a summary of your business transactions. (Your business transactions are shown on the supporting documents just discussed.) Business transactions are ordinarily summarized in books called journals and ledgers. You can buy them over the Internet and at your local stationery or office supply store.
A journal is a book where you record each business transaction shown on your supporting documents. You may have to keep separate journals for transactions that occur frequently.
A ledger is a book that contains the totals from all of your journals. It is organized into different accounts.
Whether you keep journals and ledgers and how you keep them depends on the type of business you are in. A recordkeeping system for a small business might include the following items:
• Business checkbook
• Daily summary of cash receipts
• Monthly summary of cash receipts
• Check disbursements journal
• Depreciation worksheet
• Employee compensation record
The system you use to record business transactions will be more effective if you follow good recordkeeping practices. For example, record expenses when they occur, and identify the source of recorded receipts. Generally, it is best to record transactions on a daily basis.
Business checkbook
One of the first things you should do when you start a business is open a business checking account. You should keep your business account separate from your personal checking account. The business checkbook is your basic source of information for recording your business expenses. You should deposit all daily receipts in your business checking account. You should check your account for errors by reconciling it. Reconciling is discussed next.
Consider using a checkbook that allows enough space to identify the source of deposits as business income, personal funds, or loans. You should also note on the deposit slip the source of the deposit and keep copies of all slips.
You should make all payments by check to document business expenses. Write checks payable to yourself only when making withdrawals from your business for personal use. Avoid writing checks payable to cash. If you must write a check for cash to pay a business expense, include the receipt for the cash payment in your records. If you cannot get a receipt for a cash payment, you should make an adequate explanation in your records at the time of payment.
Use the business account for business purposes only. Indicate the source of deposits and the type of expense in the checkbook.
Reconciling the checking account
When you receive your bank statement, make sure the statement, your checkbook, and your books agree. The statement balance may not agree with the balance in your checkbook and books if the statement:
• Includes bank charges you did not enter in your books
and subtract from your checkbook balance, or
• Does not include deposits made after the statement
date or checks that did not clear your account before
the statement date.
By reconciling your checking account, you will:
• Verify how much money you have in the account,
• Make sure that your checkbook and books reflect all
bank charges and the correct balance in the checking
account, and
• Correct any errors in your bank statement, checkbook,
and books.
You should reconcile your checking account each month.
Before you reconcile your monthly bank statement, check your own figures. Begin with the balance shown in your checkbook at the end of the previous month. To this balance, add the total cash deposited during the month and subtract the total cash disbursements.
After checking your figures, the result should agree with your checkbook balance at the end of the month. If the result does not agree, you may have made an error in recording a check or deposit. You can find the error by doing the following:
1. Adding the amounts on your check stubs and comparing that total with the total in the “amount of check” column in your check disbursements journal. If the totals do not agree, check the individual amounts to see if an error was made in your check stub record or in the related entry in your check disbursements journal.
2. Adding the deposit amounts in your checkbook. Compare that total with the monthly total in your cash receipt book, if you have one. If the totals do not agree,
check the individual amounts to find any errors.
If your checkbook and journal entries still disagree, then refigure the running balance in your checkbook to make sure additions and subtractions are correct. When your checkbook balance agrees with the balance figured from the journal entries, you may begin reconciling your checkbook with the bank statement. Many banks print a reconciliation worksheet on the back of the statement.
To reconcile your account, follow these steps:
1. Compare the deposits listed on the bank statement with the deposits shown in your checkbook. Note all differences in the dollar amounts.
2. Compare each canceled check, including both check number and dollar amount, with the entry in your checkbook. Note all differences in the dollar amounts. Mark the check number in the checkbook as having cleared the bank. After accounting for all checks returned by the bank, those not marked in your checkbook are your outstanding checks.
3. Prepare a bank reconciliation.
4. Update your checkbook and journals for items shown on the reconciliation as not recorded (such as service charges) or recorded incorrectly.
At this point, the adjusted bank statement balance should equal your adjusted checkbook balance. If you still have differences, check the previous steps to find the errors.
Bookkeeping system
You must decide whether to use a single-entry or a double-entry bookkeeping system. Although the single-entry system of bookkeeping is the simplest to maintain, it may not be suitable for everyone. We recommend the double-entry system, because it has built-in checks and balances to assure accuracy and control.
Single-entry
A single-entry system is based on the income statement (profit or loss statement). It can be a simple and practical system if you are starting a small business. The system records the flow of income and expenses through the use of:
1. A daily summary of cash receipts, and
2. Monthly summaries of cash receipts and disbursements.
Double-entry
A double-entry bookkeeping system uses journals and ledgers. Transactions are first entered in a journal and then posted to ledger accounts. These accounts show income, expenses, assets (property a business owns), liabilities (debts of a business), and net worth (excess of assets over liabilities).
You close income and expense accounts at the end of each tax year. You keep
asset, liability, and net worth accounts open on a permanent basis.
In the double-entry system, each account has a left side for debits and a right side for credits. It is self-balancing because you record every transaction as a debit entry in one account and as a credit entry in another.
Under this system, the total debits must equal the total credits after you post the journal entries to the ledger accounts. If the amounts do not balance, you have made an error and you must find and correct it.
Here is an example of a journal entry exhibiting a payment of
rent in October:
| Date | Description of entry | Debit | Credit |
| Oct. 5 | Rent expense | 780 | |
| Cash | 780 |
Computerized System
There are computer software packages you can use for recordkeeping. They can be purchased over the Internet and in many retail stores. These packages are very helpful and relatively easy to use; they require very little knowledge of bookkeeping and accounting.
If you use a computerized system, you must be able to produce sufficient legible records to support and verify entries made on your return and determine your correct tax liability. To meet this qualification, the machine-sensible records must reconcile with your books and return. These records must provide enough detail to identify the underlying source documents.
You must also keep all machine-sensible records and a complete description of the computerized portion of your recordkeeping system. This documentation must be sufficiently detailed to show all of the following items:
• Functions being performed as the data flows through the system.
• Controls used to ensure accurate and reliable processing.
• Controls used to prevent the unauthorized addition, alteration, or deletion of retained records.
• Charts of accounts and detailed account descriptions.
For more information, see Revenue Procedure 98-25 in
Cumulative Bulletin 1998-1.
How Long To Keep Records
You must keep your records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Generally, this means you must keep records that support an item of income or deduction on a return until the period of limitations for that return runs out.
The period of limitations is the period of time in which you can amend your return to claim a credit or refund, or the IRS can assess additional tax. The Period of Limitations Table, at the bottom of the page, contains the periods of limitations that apply to income tax returns. Unless otherwise stated, the years refer to the period after the return was filed. Returns filed before the due date are treated as filed on the due date.
Make sure to keep copies of your filed tax returns. They help in preparing future tax returns and making computations if you file an amended return.
Employment taxes
If you have employees, you must keep all employment tax records for at least 4 years after the date the tax becomes due or is paid, whichever is later. For more information about recordkeeping for employment taxes, see Pub. 15.
Assets
Keep records relating to property until the period of limitations expires for the year in which you dispose of the property in a taxable disposition. You must keep these
records to figure any depreciation, amortization, or depletion deduction, and to figure your basis for computing gain or loss when you sell or otherwise dispose of the property.
Generally, if you received property in a nontaxable exchange, your basis in that property is the same as the basis of the property you gave up, increased by any money you paid. You must keep the records on the old property, as well as on the new property, until the period of limitations expires for the year in which you dispose of the new property in a taxable disposition.
Records for non-tax purposes
When your records are no longer needed for tax purposes, do not discard them
until you check to see if you have to keep them longer for other purposes. For example, your insurance company or creditors may require you to keep them longer than the IRS does.
Period of Limitations
| IF you... | THEN the period is... |
| 1. Owe additional tax and situations (2), (3), and (4), below, do not apply to you | 3 years |
| 2. Do not report income that you should report and it is more than 25% of the gross income shown on the return |
6 years |
| 3. File a fraudulent return | Not limited |
| 4. Do not file a return | Not limited |
| 5. File a claim for credit or refund after you filed your return | Later of: 3 years or 2 years after tax was paid |
| 6. File a claim for a loss from worthless securities or a bad debt deduction | 7 years |