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Special Records for Special Tax Savings

Financial

Special Records for Special Tax Savings

By Mark E. Battersby / Published December 2021

Photo by iStockphoto.com/SamuelBrownNG

Records are important, not only for backing up tax deductions but also to qualify for traditional loans or many of the government’s recent funding programs. Records are, of course, invaluable when preparing the financial statements so necessary if the pressure cleaning operation is ever sued or audited.

     The IRS requires a business’s financial records be retained, but for how long? What records should be held? The answer can be as simple as keeping tax returns forever and backup documentation for three years. Quite a few other items, however, have extremely different requirements.

Today’s Recordkeeping Basics

     The IRS can audit tax returns three years from the date it was filed or when the return was due, whichever is later. However, if a substantial under-statement of income of more than 25 percent is discovered, the period is extended to six years. With fraud or failure to file a return, there is no limit.

     Naturally, there is more to recordkeeping than the basics. Consider the special recordkeeping necessary for write-offs, tax credits, and transactions such as the following:

  • Net operating losses are often used up relatively fast, but not always. Many businesses suffered huge losses last year, and those losses can be used to offset future profits. Since those losses may be used in future tax years, all documentation needed to prove that loss, not merely the loss year’s tax return, must be properly kept. Documentation—including accounting records, invoices, and checks and bank statements—proving the loss may be required.
  • Business credits offset taxes, but if there is little or no income, there may be little or no tax bill to offset. If the credit can’t be used currently, it might qualify to be carried forward. The rule here is similar to that of the net operating losses, although only data related to the amount of the credit and how much was utilized is necessary.
  • Most property-related records should be kept until the IRS can no longer audit that year’s tax return. The purchase of equipment or other assets means saving the purchase documentation along with records of improvements made to it for three years after its disposal. If the asset is sold, some or all of that depreciation may have to be recaptured or paid back. Also, don’t forget those records will also be needed to calculate gain or loss when the property is eventually disposed of.
  • Installment sales are those transactions where payments—and the portion of the gain attached to each payment—may be reported on a return for 5, 10, 20 years, or longer. Not only will the property’s original basis be needed, but records documenting improvements made, depreciation taken, and a copy of the sale document are also necessary.
  • Owners, partners, or S corporation shareholders’ basis or book value of the property held by the pressure washing operation is used to determine whether a sale or gift of that property will be subject to a tax bill. If a gift, as one example, is more than $15,000 (in 2021), a gift tax return will have to be filed. Those in a partnership, LLC, or S corporation have a basis equal to the original investment plus any loans and profits but less any distributions or losses.
  • The majority of businesses are careful to put acquired assets on the books and take depreciation. All too often, however, when assets are sold, scrapped, converted to personal use, destroyed, etc., they are not always retired. If the asset is sold for more than its adjusted basis (generally cost less depreciation taken), it will result in either an ordinary or a capital gain. If it’s disposed of for less, an ordinary loss could result.
  • And, speaking of basis, business start-up expenses before opening must be capitalized (with the exception of $5,000 that can be immediately written off) and amortized over 180 months. The IRS could request supporting documents of how those expenses were calculated and amortized. Goodwill, often associated with the purchase of a business or part of the business, can’t be deducted. It too must be amortized over 180 months, although the documentation requirements here are often less complex.
  • Don’t forget, the Taxpayer Certainty and Disaster Relief Act, enacted in December 2020, in-creased to 25 percent (up from the former 10 percent) of a business’s taxable income that could be deducted for charitable gifts, at least until the end of 2021. Special recordkeeping rules apply to any business claiming a charitable contribution deduction. Usually, this involves obtaining an acknowledgement letter from the charity and retaining a canceled check or credit card receipt for contributions of cash. For donations of property, additional recordkeeping rules apply and may include filing Form 8283, Noncash Charitable Contributions, and obtaining a qualified appraisal.

Never All or Nothing

     Receipts, especially those for small amounts, often get lost. That’s why the IRS has special rules that generally make receipts for expenditures under $75 unnecessary. Of course, all business deductions are fair game and can be questioned by auditors. 

     In the event of an IRS audit, for the IRS to uphold a deduction under $75 without a receipt, a record of the amount, where and when it was made, and the purpose of the expense are required. With meal and entertainment expenses, a list of those present and a record of what was discussed must be included. 

Recapping The Basics

     It can’t be mentioned enough: when it comes to income tax returns, copies of those filed returns should be kept indefinitely. Past returns can help in preparing future tax returns.

     Supporting documents means different things to different people. Supporting documents generally include any records related to business expenses, asset purchases, sales, payroll, investments, and more—all subject to a number of basic rules, including the following:

  • Always keep receipts, bank statements, invoices, payroll records, and any other documentary evidence supporting an item of income, deduction, or credit shown on the pressure cleaning operation’s tax return.
  • Most supporting documents need to be kept for at least three years.
  • Employment records must be kept for at least four years.
  • If income was omitted from the return, keep records for six years.
  • If the operation deducted a bad debt or worthless security, records should be kept for seven years.
  • Go paperless, store everything electronically, and make a backup.
  • Even if a document is not needed to prepare the pressure washer’s taxes, it might be needed for something else. When in doubt, keep it.

Safe and Accessible

     In addition to keeping records, there is the problem of keeping them safe and accessible. Failure to take steps to prevent a breach could prove costly. It could be lost 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.

     This brings up another tried-and-true strategy: if a business record is truly not needed any longer, shred it. This is essential to protect the pressure cleaning business, its employees, and customers from identity theft. After all, failure to take steps to prevent a breach can prove costly for every size of business.

     Ensuring the pressure cleaning operation has antivirus and anti-malware in place, using strong pass-words and changing them frequently (substantial changes, not merely changing a letter or two), and making sure there is a firewall are obvious protections. Above all, don’t forget non-computer information thefts.

Backing Up The Backup

     Many pressure washing business owners routinely make PDFs of important papers and records or store backups in a safe place. But what happens if the original papers are exposed, scattered, or lost in a hurricane, tornado, or similar catastrophe? If records are stored someplace that is vulnerable, at least put some roadblocks, such as a safe, in place to deter crooks or combat natural disasters.

     As mentioned, records such as receipts, canceled checks, and other documents that support an item of income, a deduction, or a credit appearing on the return must be kept as long as they may become material to the administration of our voluminous tax laws. 

     Manually-kept records satisfy the tax law as long as they are accurate and can be understood or explained if questioned. However, most businesses will go paperless and store everything electronically.

     According to the IRS, electronic records are just as official as the paper originals. By utilizing a software program, math errors are eliminated, and profit and loss statements, along with the operation’s other financial statements, can be produced with the click of a button. 

The End Game

     Well-organized records make it easier to prepare the annual tax returns and help provide answers should the return be selected for scrutiny by the IRS. Without records, how can any owner or manager monitor the progress of his or her pressure cleaning business and guide it to increased profits and success? 

     The SBA and several other watchdog agencies are auditing beneficiaries. Every pressure cleaning contractor, business owner, or manager should consult a professional about today’s increasingly more complex recordkeeping requirements.

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