Special Records, Special Tax Savings

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

The IRS requires a business’s financial records be retained but for how long? And 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 different requirements.

TODAY’S RECORDKEEPING BASICS

The IRS can audit tax returns three years from the date they were filed or when the return was due, whichever is later. However, if a substantial understatement of income of more than 25% 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:

Net operating losses are often used up relatively fast, but not always. Many snow removal contractors 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, means keeping proper records. Documentation, including accounting records, invoices, 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 the data related to the credit and how much was utilized is usually 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 depreciation amounts may have to be recaptured or paid back. And don’t forget how useful those records are for calculating gain or loss when the property is eventually disposed of.

Installment sales, those transactions where payments – and the portion of the gain attached to each payment – may be reported on a return 5, 10, 20 years later. 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 shareholder’s basis or book value of the property held by the snow removal operation is used to determines whether a sale or gift of that property will be subject to a tax bill. If a gift is more than $15,000 (in 2021), for example, a gift tax return must be filed. Those in partnership, LLC or S corporation have a basis equal to the original investment plus any loans and profits but less any distributions or losses.

All-too-often, when the depreciable assets of the business 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 basics, start-up expenses before the business begins operating must be capitalized (with the exception of $5,000 that can be immediately written-off) and amortized over 180 months. The IRS could request documents supporting the expense calculations and amortization claims. 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.

Special rules apply to a 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 donations of property, additional recordkeeping rules apply and may include filing Form 8283, Noncash Charitable Contributions, and obtaining a qualified appraisal.

On a down note, although 2020’s Taxpayer Certainty and Disaster Relief Act increased to 25% (up from the former 10%) of a business’s taxable income that could be deducted for charitable gifts, that ceiling has yet to be raised for the 2022 tax year.

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 is required. With meal and entertainment expenses, a list of those present, and a record of what was discussed.

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.

Regardless of how they are defined, 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 always keep receipts, bank statements, invoices, payroll records and any other documentary evidence supporting an item of income, deduction or credit shown on the operation’s tax return.

Most supporting documents need to be kept for at least three years, and employment records must be kept for at least four years. If income was omitted from the return, keep records for six years. And if the business deducted a bad debt or worthless security, records should be kept for seven years.

Go paperless, store everything electronically and make a backup. And even if a document is not needed to prepare the operation’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 mean 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.

Which 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 snow removal business, its employees and customers from identity theft. After all, failure to take steps to prevent a breach can prove costly for every-sized business.

Ensuring the snow and ice management operation has antivirus and antimalware in place, using strong passwords 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.

THE END GAME

Well-organized records make it easier to prepare the annual tax returns and help provide answers should the return come under IRS scrutiny. After all, without records how can anyone monitor the business's progress and guide it to increased profits and success?

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