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By Mark E. Battersby / Published November 2017
The IRS recently reminded every pressure cleaning business about the importance of records, especially the importance of safeguarding tax records against natural disasters. Good records can, however, also help a pressure washing business owner monitor the progress of his or her business and prepare financial statements when selling the business, attracting partners or investors, securing financing, or facing any government audit.
Although our federal income tax laws require only that every pressure cleaning business keep “complete and accurate records,” just what records a pressure washer needs to keep and for how long is usually unclear.
It makes a great deal of sense to keep a copy of the pressure cleaning business’s tax returns permanently to help prepare future or amended returns. The IRS suggests that tax-related records be retained until the “period of limitations” expires for that year’s return.
According to the IRS, the period of limitations is the time period from the filing date until the date which a return can be amended or the IRS can legitimately pursue the pressure cleaning business for additional taxes. Typically, the IRS can come after a business for failing to report income for up to six years after filing if the amount is greater than 25 percent of the operation’s gross income. If a deduction was claimed for a bad debt or worthless security, the IRS recommends retaining supporting tax records for seven years.
A business with employees should retain all employment tax records for a minimum of four years according to the IRS. Employment tax records include such things as employer identification number and amounts and dates of wage payments and tax deposits as well as the names, addresses, social security numbers, dates of employment, and occupations of employees.
If business property is involved, the IRS suggests retaining records until the period of limitations ends for the tax year when the property was disposed of. These records will aid in calculating depreciation, amortization, or depletion deductions, and for determining any gain or loss on that property. If the business property involves real estate or a vehicle, the deed or vehicle title should be kept in a safe, secure spot until sold or otherwise disposed of.
When it comes to taxes, the most frequent reason given by an IRS auditor for denying a tax deduction claimed by a pressure cleaning business, or its owner/operator, is not because it is not allowed, but because the amount of the deduction cannot be substantiated. Although the government is reportedly reducing the need to keep records of income, adequate documentation substantiating deductions is still extremely important.
To document expenditures, ideally every pressure washing business should have a canceled check and an invoice marked “paid” for any item purchased. A canceled check without an invoice or other document showing the item purchased could be a problem. Fortunately, with few checks being returned by banks, the IRS will accept check images.
While an invoice is usually required to show what was purchased, statements from a supplier may be substituted but only if they show the item. The best advice is to save all invoices and don’t assume the IRS will accept a check written without an accompanying invoice.
What about payments to independent contractors? Even for small jobs, the pressure washing business should have an invoice. What’s more, the independent contractor should receive a Form 1099-MISC, Miscellaneous Income. Without a Form 1099, the deduction could be lost and the business fined.
While there is no requirement to keep receipts for any expense of less than $75, it is necessary to record all information about the expense; how much, to whom payment was made, what type of expense it was, the date paid, etc. Another good strategy: Keep a record of every deposit made to all bank accounts. Record all money coming in, whether taxable or not. At a minimum, note in the check register the source of each deposit.
Although it is common and convenient to use a business check or credit card to purchase personal items, it should be kept in mind that one misclassified expense deduction may increase scrutiny of all business expenses. Above all, avoid checks made out to cash. The larger the amount, the more they should be avoided. If unavoidable, always indicate on the check what the purchase was for. This is one time when an invoice can be critical.
As more and more pressure cleaning businesses are turning to their computers to keep track of financial matters, the IRS continues to expand programs for electronic filing of tax returns. Taxpayers with assets of $10 million or more at the end of their tax year are required to comply with the retention requirements for “machine sensible records.” A machine sensible record is data in an electronic format intended for use by a computer.
Fortunately, a pressure cleaning business with assets of less than $10 million must comply with the record retention requirements for machine sensible records in only a few rare situations. Although document retention is easier to manage electronically, it is still subject to the same retention rules. Of course, records should only be kept for as long as they are relevant which, as mentioned, for tax returns may mean six years.
Not too surprisingly, there are exceptions to this rule of thumb, such as returns that generate net operating or other types of losses, credits that may be carried forward for many years, tax audit records, and property basis records. These may need to be kept for longer periods.
The operation’s financial statements generally have a shorter period of relevancy than tax returns, and there are few hard and fast rules for these. Retention should be dictated by the pressure cleaning business’s situation with records involving employee benefit plans and brokerage statements, and actuarial reports should be maintained permanently.
One rule of thumb maintains that canceled checks and other documents should be held for three years. Technically, it is three years from the date the tax return was filed. If the IRS suspects that income was underreported, they can go back six years. If it believes fraud is present, there is no time limit.
For assets such as autos, equipment, etc., documentation should be retained for at least three years after the asset is disposed of. Longer retention periods can apply to employment records. Ideally, using a seven-year holding period for most records should be considered.
Obviously, no record should be disposed of simply because it is no longer needed for tax purposes. Those records should be retained until the contractor, business 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.
As previously mentioned, the IRS continues to warn everyone to safeguard themselves against natural disasters by keeping a set of backup records in a safe place. Naturally, the backup should be stored away from the original set of records.
Keeping a backup set of records, including bank statements, tax returns, insurance policies, etc., is far easier today with many financial institutions providing statements and documents electronically and much financial information being readily available on the internet. Even if records exist only on paper, they can be scanned into an electronic format.
With documents in electronic form, the business can download them to a backup storage device, such as an external hard drive, or burn them to a CD or DVD. In fact, the IRS encourages saving scanned records to the cloud or to other storage devices.
Reconstructing records after a disaster, any disaster, may be essential for tax purposes or for obtaining federal assistance or insurance reimbursement. After a disaster, a contractor, business owner, or manager might need certain records to prove a loss. The more accurately the loss is estimated, the more loan and grant money may be available.
Fortunately, the IRS allows its examiners to make some exceptions to the recordkeeping rules. Among other things, they are authorized to waive the recordkeeping requirements and accept “reasonable reconstruction” when, according to the IRS administrative guidelines, records were lost “due to circumstances beyond the taxpayer’s control, such as destruction by fire, flood, earthquake, or other casualty.” Naturally, whether an event was beyond a contractor, business owner, or manager’s control depends on the particular circumstances. The courts may also allow deductions without records.
Everyone knows the IRS has the authority to compute the income of any pressure washing business with inadequate or no books or records. The methods used by the IRS for reconstructing income vary depending on the facts and circumstances but are rarely favorable to the errant taxpayer.
Records and recordkeeping can take a variety of forms and shapes. Remember, however, records are not only about making the IRS happy. They also play an important role in managing the business.
Consulting with an attorney or tax professional can help guide a pressure cleaning business to a legal and tax-compliant recordkeeping policy. In order to avoid identity theft and to protect sensitive business information, all business records should be disposed of properly or shredded.
Making Up For Lost Records
Should disaster strike, the IRS has specialists trained to handle disaster-related issues (Phone: (866) 562-5227). Back copies of previously filed tax returns can be requested by filing Form 4506, Request for Copy of Tax Return. While the IRS and the courts do occasionally accept unsubstantiated estimates of expenses, tax deductions, insurance claims, and disaster reimbursements, these are far easier with documentation.
For a pressure cleaning business that has lost some or all of their records during a disaster, there are several steps that may help:
- Create a list of lost inventories; copies of invoices can be obtained from suppliers.
- Check mobile phones or other cameras for pictures and videos taken of buildings, equipment, and inventory.
- For information about income, obtain copies of bank statements. The deposits should closely reflect sales for any given time period.
- Provide copies of last year’s federal, state, and local tax returns, including sales tax reports, payroll tax returns, and business licenses obtained from the city or county, which will reflect gross sales for a given time period.
- If the pressure cleaning business was pre-existing, the broker should have a copy of the purchase agreement.
- Suppliers and equipment dealers can provide copies of invoices.
The bottom line, however, is nothing beats the actual records and documentation for reconstructing, proving, and reminding the business’s owners or managers of deductions, credits, and income that might otherwise be overlooked.