By Mark E. Battersby / Published June 2021
Records are important, not only to back up tax deductions but also to qualify for those recent government funding programs or traditional loans. And, of course, records are an invaluable tool when preparing the financial statements so necessary in managing the pressure washing operation.
Obviously, there’s a lot more to recordkeeping then meets the eye. The so-called “Cohan Rule” allows taxpayers to deduct business expenses even if they do not have the receipts to document them. But both the IRS and the Tax Court can legally reconstruct the expenses and income of any business without records, and it is up to the taxpayer to prove them wrong.
A canceled check and an invoice marked paid, along with the serial number of the item purchased or a description of the work performed, is standard recordkeeping 101. However, while this recordkeeping strategy might be viable for big-ticket items, realistically, that’s not often the case for most of a pressure cleaning operation’s expenses as the IRS well knows. There are many other acceptable ways to account for expenses.
Every pressure washing contractor and business owner should be able to show that a payment was made (e.g., a canceled check, credit card receipt) and the nature of the item purchased (an invoice with a description of the item or service). But the business must also show a bona fide business purpose for an expenditure, and there must be a proximate relationship between the expenditure and the business.
Unfortunately, neither the IRS nor the Tax Court will allow the use of the Cohan rule when it comes to travel and entertainment expenses—the area where it is usually needed the most.
Another recordkeeping burden involves keeping the pressure washing operation’s records safe. Failure to take steps to prevent a breach could prove costly. It could be a loss of customers; lawsuits by customers, suppliers, or employees; and, in many cases, substantial fines. At least one state has passed legislation imposing fines for a breach of a customer’s information.
Exactly what steps should be taken to safeguard the operation’s data depends on a number of factors. Ensure the computers have antivirus and antimalware in place. Use strong passwords and change them frequently. And, make sure there is a firewall.
There are also some commonsense steps that can be taken immediately. Employees should be warned not to leave a company laptop in a car or public place unattended. Upon purchasing new computers or systems, consider those with fingerprint or eye scanners. And, limit access to information to those employees who really need it. Once they no longer need it or leave the business, access should be denied.
Any operation with nonexistent or inadequate books and records is opening the door to having the IRS reconstruct the operation’s income. In one recent court case, the IRS’s reconstruction of income based on bank deposits was challenged by the taxpayer.
Although the Tax Court did not “see bad faith in the way the IRS conducted this bank-deposits income reconstruction,” if it turned out to have been inaccurate, the fault was with the taxpayer’s failures at recordkeeping. After all, as the court pointed out, the burden of proof was on the taxpayer to show the IRS was wrong, which he couldn’t do without records.
One of the biggest problems for anyone is reconstructing lost or destroyed records. While every pressure cleaning business should have a backup of all records and supporting documentation, reconstructing absent records is possible, if difficult.
Every business owner is expected to take steps to reconstruct lost records. That can involve a little effort. Most financial institutions, for instance, keep records for a number of years. Usually, the first 18 months, and sometimes more, is free online.
In addition to requesting bank and credit card statements, invoices from vendors, etc., information and copies of previously filed returns can be obtained from the IRS.
It should be possible to alternatively document 80 percent of the operation’s expenses easily (though time consuming). The other 20 percent could be extremely difficult, although the IRS and courts will often accept less documentation than they would under other circumstances and may allow a significant portion of the 20 percent.
One thing needed by every business is accurate recordkeeping. As mentioned, records are a key to many aspects of the operation’s success—from assessing profit margins to ensuring it is in compliance with the tax rules.
Since the IRS does not require a business to keep records in any one manner, as long as the records produce an accurate accounting of income and expenses, any recordkeeping system that works best for the pressure cleaning operation will do the trick. Today, there are two ways to keep those records—manual recordkeeping and computerized (or automated).
Many businesses, particularly smaller ones, continue to opt for a manual recordkeeping system. While the so-called “pencil and paper” method is adequate, some businesses grow out of it as others, such as independent contractors and freelancers, find it continues to work for them.
Manually kept records satisfy the tax law as long as they are accurate and can be understood or explained if questioned. That usually means business records are kept in one of two ways:
With both, each expense must be recorded, along with a brief description, the date incurred, the amount,
and to whom it was paid. On the profit side, similar records should show any income received by the business.
On the plus side, manual recordkeeping is inexpensive and easy to use. On the other hand, it is usually “single entry” with each transaction entered only once. In other words, there is no automatic check and balance system, and it is time consuming to tally expenses and income by category or by month.
Keeping the operation’s records on a computer uses the same principals as manual systems, except it is faster and more accurate. A simple-to-use software program eliminates the need for a handwritten set of books, with each expense or income item automatically categorized.
By utilizing a software program, math errors are eliminated, and profit and loss statements along with other financial statements can be produced with the click of a button. And, yes, software programs for business recordkeeping are more expensive than manual recordkeeping, but purchasing an online software program means the pressure cleaning operation’s accounting information can be accessed anywhere by the owner, manager, or its accountant.
Regardless of how the operation’s records are kept, the so-called “source” documents must be retained. These are the receipts, bank statements, purchase invoices, and other records that back up the number entered into the recordkeeping system. 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.
That’s right, keeping electronic records doesn’t relieve a business of its responsibility to retain hardcopy records that are created or received in the ordinary course of business. Hardcopy records may, of course, be retained in microfiche or microfilm format. The IRS has also approved scanning to relieve the need to keep original documents.
The common belief that canceled checks and other documents should be held for three years is wrong. It’s more complicated than that. With taxes, technically, it’s three years from the date the tax return is filed. But, if the IRS suspects income is underreported, they can go back six years. If they believe fraud is present, there is no limit.
For assets such as autos, equipment and other business property, all documentation should be kept for at least three years after the asset is disposed of. Even longer retention periods can apply to employment records. A good general rule of thumb might be to use a seven-year holding period.
Some of the most important records to keep are the operation’s financial records. Many contractors and business owners concentrate on the required tax records but neglect the financial records because of a lack of time or knowledge of how to do it properly. Many, in fact, attempt to do it themselves, figuring they will save money without an expensive professional. Unfortunately, problems can develop down the road as potential lenders as well as many government agencies often impose legal record requirements mandating the business maintain accurate and timely records.
Bottom line, more claimed deductions are disallowed by the IRS and more loans denied by lenders for lack of substantiation than for being nondeductible or unqualified. Obviously, records are not only about making the IRS happy but also about strategically operating and managing the pressure washing business.
How, after all, can any owner or manager monitor the progress of his or her pressure cleaning business and guide it to increased profits and success without records?