Thoughts on audit-proofing your records…

You can improve your business’s tax health by routinely performing a check-up on your record keeping habits.  It may sound painful to make changes today but the payoff, in the event of an audit by a tax agency, will prove beneficial.

Checking Accounts – It is critical to keep separate checking accounts for each business activity.  NEVER mix personal activity, income or expenses, with business activity.  True, sometimes deposits and disbursements are comprised of business and personal activity–in these situations, you need to carefully document the splits between business and personal activity.  However, it is critical that you avoid such comingling of personal and business activity whenever possible.  Also, the portion of deposits and expenses relating to personal activity should be posted to equity accounts, not income or expense accounts!

By consistently segregating business and personal activity, you develop trust and confidence among those persons reviewing your financial information.  Such confidence and trust translates into fewer inquiries by your tax preparer and any auditor(s) you may encounter, thus saving time, money, and your sanity.

So the question is, how many checking accounts should you have?  Ideally, you will have individual checking accounts for each spouse as well as each activity reported on your Schedules C (business), E (rentals), or F (farms).  If you have a Schedule E, it may be best to have separate checking accounts for each type of rental.

Promise yourself that you will maintain separate checking accounts for each individual business activity!

Regarding deposits, do not convert income earned in your personal name to company activity.  On the flip side, if your company receives checks from customers using your personal name as the payee, kindly request that the customer reissue the check using your full company name in the payee field.  Always provide a completed W9 to your customers so they have all necessary information for properly and legally paying your company. Mixing personal and business tax identification numbers when all should be business will create confusion and may result in increased tax preparation fees, as well as potentially increase your audit risk.

Remember: If an agent of a revenue agency (IRS, state Department of Revenue) is confused, they may just resort to disallowing your deductions.  This generally translates into increased taxes and professional defense fees.  Do your part by keeping your records clean, proper, and organized.

Record Deductible Expenses DAILY – In order to deduct expenses, you need proof they actually exist.  It is irrelevant to which legal form your company is organized–you need proof!

Your records (proof) should eliminate all doubt as to what was a) paid for and b) the business purpose.  Many invoices are self-evident but others are not and require additional documentation.  You will need enough detail to document WHEN, WHY, and WITH WHOM, especially for expenses relating to travel and entertainment. Daily diaries go a long way in providing evidence of expenses for vehicle use, means, and travel and entertainment.

Keep logs.  Travel and entertainment deductions are arguably the highest risk deductions taken by most entrepreneurs and small corporations.  To deduct your travel and entertainment expenses, you need to have a log that is completed daily.  If not daily, NO LATER than one week after the date of the actual activity whose expense(s) you wish to deduct.  E-mail us if you would like to receive an Excel form that may just work for recording your expenses.

If you own rental properties and claim “material” participation or “real estate professional status,” you should track at minimum three consecutive months worth of time spent managing your properties.

Statute of Limitations – Ah yes, the statute of limitations.  Following are some common record retention requirements:

• All supporting documents must be kept for three years following the date of timely tax filing IF you did not understate your income by 25% or more AND IF you did not fraudulently file your tax return(s).  Generally, you figure out the percentage level of your mistake long after having made the initial error(s).
• Six years following timely tax filing IF you did understate your income by more than 25%.
• Forever IF you filed a fraudulent tax return, or are accused of having filed a fraudulent return.  After all, how can you defend against such an accusation without records?
• Forever IF you failed to file a tax return.
• Three years after filing or two years after the tax liability was paid, IF you filed an amended return or made other changes to your original tax return(s).  Amending a tax return restarts the record retention period.
• Seven years IF you filed a claim for a loss from worthless securities or a bad-debt deduction.  Will you remember which tax return had which of these deductions without adequate records?
• Forever IF you need records to establish a tax basis on a future sale.  Tax basis can evolve over decades.  For any asset with a life exceeding twelve months, create a permanent file and retain it forever.
• Employment tax records, both payments and associated returns, must be kept for four years after the tax became due or was paid, whichever was later.

Wednesday, December 22nd, 2010, by admin.