Preparing Your Business For Tax Season

Uncategorized Nov 03, 2021

Tax time is just around the corner. One of the most common non-tax questions clients ask is “how long should I keep these?” We are talking bank records, copies of tax returns, and virtually any other piece of business information. This is a reasonably comprehensive overview on keeping business records for tax compliance, specifically, what to keep and how long to keep it in case a taxing authority ever decides to examine (audit) your returns. 


Obviously, keeping good books and records is just good business. But why? The answer to that isn’t as simple as “in case you are audited.” The answer is often evident when a business owner needs to substantiate profits to borrow money. Keeping good business records allows a business owner to obtain a snapshot of their company’s cash flow, profits, assets, and liabilities. It can make the difference between a client who is proactively managing their tax planning and compliance obligations and a client who, at the annual reckoning, looks at their tax return and says, “How can I owe that much in taxes? I don’t feel like I made any money.”


Good record-keeping for tax compliance is, like most things tax-related, an active process. It is not a process of scrambling everything together at the end of the year, or worse, when a problem occurs (e.g., an audit letter). However, this will be different for each business, depending on the size and type of the business. For example, busy realtors should keep their mileage logs daily. Even trying to reconstruct them at the end of the week may prove too cumbersome. And for a full month? Fuggedaboudit. For small business owners in less mileage-intensive industries a weekly or monthly recap of business trips may be perfectly fine.

Good record-keeping is also comprehensive enough to allow a business owner to reconstruct not simply income and expenses, but ownership percentages and other agreements necessary to determine pro rata shares of profit and loss or to facilitate the addition or loss of shareholders or partners. It is, in the best of circumstances, well planned and implemented on a regular schedule.


The consequences for improper (or absent) business record-keeping are extreme. Fixing a problem is almost always more expensive than simply avoiding it in the first place. As soon as a business owner recognizes that business growth is creating a record-keeping issue, that working on the business is becoming more work than working in the business, record-keeping needs to be made a priority. Maybe not as big a priority as actually working and making money, but close.

Business owners who are struggling to keep up with their record-keeping requirements should consider automating some of their more mundane tasks, hiring administrative help, or both. The time and money spent on getting and staying organized is usually going to be much less than what it will cost to organize months’ (or even years’) worth of records in the event of an emergency (e.g., an audit).


Understanding the different types of business records necessary for tax compliance is important. In general, these records have four categories:

  • Documents that substantiate income;
  • Documents that substantiate deductions;
  • Documents related to assets and liabilities;
  • Documents that substantiate ownership interests.

Documents that Substantiate Income – In general, all income is taxable unless it isn’t. In other words, unless there exists a specific exception in the code that excludes it, all items of income are taxable. Some items that aren’t income that accountants commonly see included in client books and records as income are borrowed money, money gifted to the taxpayer to help them start the business that does not represent an actual investment in the business, and the owner’s own cash contributions to the business.

Unless the client wants to pay income tax on money that isn’t income, it’s important to both book the items properly (i.e., as something other than income) and to exclude these items from income reported on the tax return. But it’s equally important, if those items show up in the client’s bank deposits, to substantiate why the amounts deposited do not represent income (clear accession to wealth) to the taxpayer.

Keep the following documents for three years after the return is filed:

  • Bank and broker Forms 1099 to support interest and dividend income;
  • Invoices and sales receipts to support gross sales revenue;
  • Loan paperwork, signed receipts, check copies, and other documents to support cash deposits that are not income, but might look like income when looking exclusively at bank deposits.

Documents that Substantiate Deductions – Clients often, and wrongly, think that simply paying an expense from a business account magically converts it to a business expense. Deductions are allowable for “ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” Nevertheless, cases that remind taxpayers that deductions are a matter of legislative grace litter the Tax Court landscape. Clients should be reminded that even when considered ordinary and necessary, certain business deductions (e.g, travel expenses, meals, and mileage) are subject to heightened substantiation rules.

Obviously, and often to our clients’ dismay, physical or virtual shoeboxes full of unorganized receipts are not enough to substantiate an expense as a business deduction. Neither are credit card statements. ( I just had this exact conversation with a client today) Proper substantiation of a deduction proves not only the fact of the expense but also how it is tied to the taxpayer’s trade or business (i.e., its business nexus). In other words, it shows the following:

  • The amount of the deduction;
  • The date of the deduction;
  • The business purpose of the deduction.

It’s on that last item that clients fail most often and why just keeping receipts is not sufficient to properly substantiate a deduction. Showing business nexus is one of the main reasons that using separate accounts, credit cards, and records for business and personal expenditures is a best practice. But having separate business and personal accounts is only the first step; clients must use them properly as well. When maintained and used properly, business-only accounts simplify record-keeping, tax reporting, and information retrieval in the event of an audit.

Keep the following documents for three years after filing the return:

  • Lender Forms 1098 to substantiate interest paid on mortgaged real property;
  • Credit card statements showing end-of-year interest paid on business-use-only credit cards;
  • Loan or other statements showing business interest paid on loans for tangible personal property or lines of credit from creditors or vendors;
  • Receipts showing the payment amount, the payment date, and the payment’s business purpose for all business expenses;
  • Mileage logs showing the date of the trip, the mileage, and the business purpose of the trip for each vehicle used in the business. Mileage logs should include business use trips as well as other personal use to determine the business use percentage for the vehicle.

Documents Related to Assets and Liabilities – As mentioned above, booking and reporting loan proceeds as income is a common mistake for clients (and sometimes inexperienced tax practitioners). Clients should keep loan documents to help substantiate deposits from loan proceeds. As a best practice, don’t deposit loan proceeds on the same deposit ticket as sales revenue. Also, keep loan documents, amortization schedules, and end-of-year payment statements for three years to substantiate the amount of business interest paid for a given tax year, unless the loan relates to the purchase of a specific asset, in which case, keep reading.

Keep documents (including loan documents) that substantiate basis in an asset for at least three years after selling the asset or otherwise disposing of it. Remember, overstating the basis of an asset has the same effect as under-reporting gross income. Substantial understatement of income (by 25 percent or more) extends the statute of limitations for potential examination from three to six years.

Documents That Substantiate Ownership Interests – Keep these documents for at least three years after terminating a given shareholder or partner’s interest. The documents should clearly show what was given in exchange for the partnership interest or shares (money, property, etc.) and the shareholder or partner’s basis as well as the fair market value of the property contributed. The documents should also clearly state what was received in terms of shares or percentage interest in exchange for the contribution.

Because partnership distributions do not have to be strictly pro rata (as is the case with distributions from S corporations), partnership documents should include an operating agreement or some other document that spells out the partner’s distributive percentage if it is different from their ownership percentage.

Partnership ownership documents should also include records that substantiate whether the partner is a limited (usually investment only) partner or a general partner (i.e., a working partner subject to self-employment tax on distributions). It is also important to keep any documents that report changes to distributive share, ownership percentage, etc. in addition to the original documents. Keep these documents for three years after the filing date of the returns to which they apply.

It is often the case that the partner or shareholder’s basis is different from the business’ basis in certain assets. For example, the partner’s basis of a piece of heavy equipment contributed in return for a partnership interest is the partner’s adjusted basis in the vehicle. The partnership’s basis in that equipment is the equipment’s fair market value (FMV).

Given the importance of not overstating basis in an asset, it is prudent for the partnership to retain documentation of both the partner’s adjusted basis in the property as well as substantiation of how FMV was determined in the event the equipment is sold or the amount of depreciation taken must be substantiated.

Other Applications

While these are principles of record-keeping for income tax compliance, the general principles apply to other tax and administrative compliance as well. Additional tax records could include sales or gross receipts tax, excise taxes, and payroll taxes. Administrative compliance requirements could include payroll documents such as Forms W4 and I9, corporate minutes and annual report filings, safety compliance documents, etc.


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