Financial Recordkeeping for Small Businesses

A business of any size needs to keep well-organized and up-to-date financial records. Recordkeeping for small businesses can be done through either hard copy or electronic filing. Not only does this organizational practice help when preparing financial statements and tax returns, but it's also an effective way to track your company's personal growth while maximizing your return.

As you operate your business, you may need guidance on which documents to include in your financial recordkeeping. Read on for a high-level overview of financial recordkeeping best practices for small businesses, including:

• Why small businesses need to keep financial records
• Which records small businesses should keep track of, and how long to hold onto them
• Systems that can help you effectively keep financial records for your small business

Why Should a Small Business Keep Financial Records?

Keeping books and records may not be the most exciting part of running a business. Still, it's a crucial aspect of your operations, and there are multiple reasons why a business should keep financial records. The Internal Revenue service (IRS) notes a few, highlighting that solid recordkeeping practices are designed to help you monitor the progress of your business, prepare financial statements, identify sources of income, keep track of deductible expenses, keep track of your basis in property, prepare tax returns, and support items reported on your tax returns.

Now is a great time to review your recordkeeping practices so that you can maintain the information you need for your business and tax purposes.

Which Records To Keep for Your Small Business

The IRS requires business owners to keep certain records for specific periods, as this documentation will substantiate the income, deductions, and credits you report on your tax returns. Adequately keeping tax records involves documenting the following information.

Documenting Your Income

Income that flows into your business will generate a receipt or invoice. Once that information has been entered into your accounting system, keep a copy as confirmation. Small-business owners should keep gross receipts for 3 years from the date of filing taxes. Besides receipts and invoices, income documentation you need to file includes bank deposits, credit card slips, and cash register tapes.

Filing Your Purchases and Expenses

All costs, whether purchases (materials) or expenses (rent and utilities), must be filed for tax purposes. Financial recordkeeping for purchases includes saving:

• Cash register slips
• Invoices
• Canceled checks
• Credit card slips
• Any other documentation of items and supplies purchased

Like purchases, expenses require you to keep the same files plus petty cash vouchers for the more nominal expenses. Businesses claiming travel, gift, and entertainment tax deductions should keep original expense documentation.

Retain purchase and expense documents for at least 3 years from the date you file your tax return. If, however, the business claims a bad debt loss, keep the records for 7 years.

Keeping Tabs on Your Assets

Keeping track of the purchase, sale, and depreciation of assets is an integral part of financial recordkeeping for small businesses. A portion of the value of your assets may be deducted against taxable income through depreciation. If your company sells an asset, there may be a financial gain or loss, which will either increase or reduce your taxes.

Make sure to keep all real estate documents, canceled checks, purchase and sale invoices, bills of sale, and receipts for the period of limitation for the particular asset. An asset's period of limitation is determined by the time of its "taxable disposition." This refers to transferring ownership from one party to another in a taxable transaction. In other words, hold onto this documentation until your business gets rid of the asset through direct sale or another method.

Organizing Employment Tax Records

If you are a small business owner, your employment records should include details on all employees and payments (including pensions) made to them. Additionally, make sure to document the following employee information:

• Names
• Addresses
• Social Security Numbers
• Dates of employment, plus absences
• All income tax withholding allowance certificates
• Tips or fringe benefits received, if applicable

The IRS stipulates that employment tax records should be kept for at least 4 years.

Choosing Between Hard and Electronic Copies for Financial Recordkeeping

While you have the choice of how you maintain business records, the IRS auditing process has become far more efficient for businesses that use an online accounting system versus a manual method with spreadsheets. Electronic filing allows the IRS to examine all proper documentation without printouts; documentation can be more easily shared if your business has filed everything electronically. All required is a backup file, which the IRS can request during an audit.

How To Establish a Simple Recordkeeping Process for a Small Business

Knowing how to keep financial records for a small business is all about diligence and consistency. Once you have established systems and continue to meet recordkeeping obligations, the process becomes second nature for you and your employees. At a high level, keeping records for a small business involves the following steps.

Create an Accounting System

Businesses are required under tax law to keep books and records and to make them available to the IRS in certain situations. Whether you use a desktop or cloud accounting solution, be sure to have business practices in place to maintain these records. This includes:

• Determining how frequently to input information and which employees can access this sensitive business information.
• Working with your CPA or other financial advisor to review your books so you can improve profitability and optimize for tax-saving opportunities throughout the year.

Maintain a System for Important Paperwork

Tracking income and expenses in your accounting system is one of many parts of recordkeeping. You must also retain receipts, invoices, and other proof of income and expenses. At the start of the year, consider:

• Setting up a filing system for storing your paperwork: This will facilitate tax preparation and be available as proof if the IRS questions your return.
• Scanning paperwork: Instead of keeping receipts and other papers, you may prefer to scan and retain them for storage purposes. Ensure you have a retrieval system to find what you've scanned quickly.
• Using a recordkeeping provider: You can use a third party to organize and store your paperwork offsite.

Institute a Company Policy for Employee Recordkeeping

Take time each year to educate employees about company policy on recordkeeping or include this information when onboarding new hires. For example, if you maintain an accountable plan to reimburse employees for company-related business travel and entertainment expenses, they must provide you with certain substantiation for these costs. This means:

• Maintaining an expense account or other log, noting required information (see Table 5-1 in IRS Publication 463): There are apps that you can request employees use for this purpose in place of self-created expense account statements.
• Keeping receipts or other evidence of expenses: Having employees use business credit cards is helpful for this purpose.
• Providing you with the account and receipts promptly: You can set any reasonable deadline. The IRS considers 60 days a reasonable period, but you may want a shorter deadline.

Oversee Company Vehicle Records

If you want to deduct the cost of using your car, pickup truck, or van for business, you must track your mileage and record other aspects of each trip (e.g., the trip's date, destination, and business purpose). Here are some tips to ease your recordkeeping burden for a vehicle:

• Take note of the vehicle's odometer at the start and end of the year: This information is required for tax reporting.
• Use an app for vehicle recordkeeping: There are numerous apps for this purpose. They use GPS to record each trip's mileage, date, and destination, but you still need to record other elements, such as the business purpose.
• Consider sampling: This is a recordkeeping method in which you make adequate records for part of the year and then extrapolate the amount for the entire year, demonstrating with sufficient records that the part of the year represents driving for the whole year. The IRS gives this example: You drive your vehicle to see customers daily and keep adequate records for the first week of each month that shows 65 percent of car use is for business. Invoices and bills show that this driving is at the same rate for the rest of the month. Here, extrapolation is permissible.

Get Help Managing Financial Records With Paychex

When it comes to recordkeeping for small businesses, it takes a lot of work to play catch-up. Memory can be unreliable, and you may lose track of necessary paperwork. And if you find yourself in a situation where your business is audited, a lack of recordkeeping could come at a cost. Now is a great time to get back on track with recordkeeping, evaluate or update any systems you have in place, and educate or remind your staff about their obligations. Find more information about recordkeeping in IRS Publication 583. Learn more about how Paychex can help you manage your business finances with our small business solutions.