This part of the course explains why you must keep records, what kinds of records you must keep, and how to keep them. It also explains how long you must keep your records for federal tax purposes.
Why Keep Records?
Everyone in business must keep records. Good records will help you do the following.
Monitor the progress of your business. You need good records to monitor the progress of your business. Records can show whether your business is improving, which items are selling, or what changes you need to make. Good records can increase the likelihood of business success.
Prepare your financial statements. You need good records to prepare accurate financial statements. These include income (profit and loss) statements and balance sheets. These statements can help you in dealing with your bank or creditors and help you manage your business.
- An income statement shows the income and expenses of the business for a given period of time.
- A balance sheet shows the assets, liabilities, and your equity in the business on a given date.
Identify source of receipts. You will receive money or property from many sources. Your records can identify the source of your receipts. You need this information to separate business from non-business receipts and taxable from nontaxable income.
Keep track of deductible expenses. You may forget expenses when you prepare your tax return unless you record them when they occur.
Prepare your tax returns. You need good records to prepare your tax returns. These records must support the income, expenses, and credits you report. Generally, these are the same records you use to monitor your business and prepare your financial statements.
Support items reported on tax returns. You must keep your business records available at all times for inspection by the IRS. IF the IRS examines any of your tax returns, you may be asked to explain the items reported. A complete set of records will speed up the examination.
Kinds of Records to Keep
Except in a few cases, the law does not require any specific kind of records. You can choose any recordkeeping system suited to your business that clearly shows your income and expenses. The business you are in affects the type of records you need to keep. You should set up your recordkeeping system using an accounting method that clearly shows your income for your tax year. If you are in more than one business, you should keep a complete and separate set of records for each business. A corporation should keep minutes of board of directors' meetings.
Your recordkeeping system should include a summary of your business transactions. This summary is ordinarily made in your books (for example, accounting journals and ledgers). Your books must show your gross income, as well as your deductions and credits. For most small businesses, the business checkbook is a main source for entries in the business books. In addition, you must keep supporting documents.