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, 2 September, 2020

7 Tips to Record Retention and Avoid Paying Tax Adjustments

Do you ever get to tax time and think, where is all my stuff? Taxes are stressful enough without having to sift through mail and records and consolidate everything you need for your CPA. Keeping track of tax records can be burdensome, especially if you are a sole proprietor. I have spoken with many clients over the years who have told me to, “use last year’s information nothing really changed”. Rather than reviewing their records and tracking income and expenses throughout the year, they think using similar information will keep them safe from the IRS.

Audit Example

Here is an example of when that line of thinking backfired. I have a client that was a sole proprietor. They had the same business for many years, doing small residential construction work. Each year they would bring in a hand-written document showing income and a breakout of expenses (which is perfectly fine by the way). Occasionally, for certain expenses – rather than specifying an amount, they would say “use last year”, which we did. It seemed reasonable and the client would indicate that nothing changed in that expense.

The IRS selected a tax year to audit and requested information to validate the deductions they claimed on the return. I worked with the client to gather everything together – bank records, tax forms, etc. Two problems arose: 1) They did not actually have verification of some of the expenditures that they claimed, and 2) the bank records proved fewer expenses than were reported on the return. Oops!!

These two problems serve to point out an important consideration to make: record keeping! The IRS has some general guidelines for record-keeping:

Keep Records
  1. In general, keep records for 3 years.
  2. Keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later if you file a claim for credit or refund after you file your return.
  3. Keep records for 7 years if you file a claim for a loss from worthless securities or bad debt deduction.
  4. Keep records for 6 years if you do not report income that you should report, and it is more than 25% of the gross income shown on your return (Or better yet, report all your income).
  5. Keep records indefinitely if you do not file a return (But just plan on filing).
  6. Keep records indefinitely if you file a fraudulent return (Filing a fraudulent return is also not recommended).
  7. Keep employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.

In the case of my client, their records could not validate everything claimed on the return. The IRS made some adjustments and assessed additional taxes, penalties, and interest. That is not fun! Nobody wants to pay more tax to the government, especially when the time elapsed since filing is significant.  

It is important to make time to keep and review records prior to filing taxes. Taking time throughout the year to reconcile your accounts can help accomplish many things, including maximizing profits, increasing deductions, finding opportunities to grow your business, and keeping things organized.

Written by Cole Hunter of DrillDown Solution

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Note: The material and contents provided in this article are informative in nature only. It is not intended to be advice and you should not act specifically on the basis of this information alone. If expert assistance is required, professional advice should be obtained.

Ed Gabriel, CPA is President of DrillDown Solution and a graduate of Brigham Young University. His clients benefit from over 40 years of experience in maximizing profits, minimizing taxes and putting them in the best financial position possible.