The art of recordkeeping

Knowing which documentation
 to save, and for how long, 
can make recordkeeping
 less of a hassle.

The “tax season” may be long over but the need for good recordkeeping is not. Records are not only essential for tax deductions but, as many aggregate producers are all-too-well aware, a similar need for books and records is also important when selling the business, attracting partners or investors, getting a loan or being audited by any government agency.

Although U.S. federal income tax laws require only that every sand, gravel or crushed stone business keep “complete and accurate records,” just what records an aggregates business needs to keep, what records it should retain and for how long, usually requires a good strategy.

Taxing tax records

It makes a great deal of sense to keep a copy of the aggregate business’s tax returns permanently to help prepare future or amended returns. The IRS suggests that tax-related records be retained until the “period of limitations” expires for that year’s return.

According to the Internal Revenue Service (IRS), the period of limitation is the time period from the filing date until the date that a return can be amended or the IRS can legitimately pursue the aggregates business for additional taxes. Typically, the IRS can come after a business for failing to report income for up to six years after filing if the amount is greater than 25 percent of the operation’s gross income. If a deduction was claimed for a bad debt or worthless security, the IRS recommends retaining supporting tax records for seven years.

A business with employees should retain all employment tax records for a minimum of four years according to the IRS. Employment tax records include such things as employer identification number, amounts and dates of wage payments and tax deposits, as well as the names, addresses, social security numbers, dates of employment and occupations of employees.

If business property is involved, the IRS suggests retaining records until the period of limitations ends for the tax year when the property was disposed of. These records will aid in calculating depreciation, amortization or depletion deductions and for determining any gain or loss on that property. If the business property involves real estate or a vehicle, the deed or vehicle title should be kept in a safe, secure spot until sold or otherwise disposed of.

When the IRS wants to know

When it comes to taxes, the most frequent reason given by an IRS auditor for denying a tax deduction claimed by an aggregates business – or its owner/operator – is not because it is not allowed, but because the amount of the deduction cannot be substantiated. Although the government is reducing the need to keep records of income thanks to a mandate that credit card companies must now report all transactions to merchants – and the IRS – adequate documentation substantiating deductions is still extremely important.

To document expenditures, ideally every aggregates business should have a canceled check and an invoice marked “paid” for any item purchased. A canceled check without an invoice or other document showing the item purchased could be a problem. Fortunately, with few checks being returned by banks, the IRS will accept check images.

While an invoice is usually required to show what was purchased, statements from a supplier may be substituted – but only if they show the item. Best advice: save all invoices and don’t assume the IRS will accept a check written without an accompanying invoice.

What about payments to independent contractors? Even for small jobs, the aggregates business should have an invoice. What’s more, the independent contractor should receive a Form 1099-MISC, Miscellaneous Income. Without a Form 1099, the deduction could be lost and the business fined.

While there is no requirement to keep receipts for any expense of less than $75, it is necessary to record all information about the expense; how much, to whom payment was made and what type of expense it was, the date paid, etc. Another good strategy: Keep a record of every deposit made to all bank accounts. Record all money coming in, whether taxable or not. At a minimum, note in the check register the source of each deposit.

The personal side of records

Although it is common and convenient to use a business check or credit card to purchase personal items, it should be kept in mind that one misclassified expense deduction may increase scrutiny of all business expenses. Above all, avoid checks made out to cash. The larger the amount, the more they should be avoided. If unavoidable, always indicate on the check what the purchase was for. This is one time when an invoice can be critical.

It is not unusual for an employee to purchase office supplies, small equipment, shop supplies, etc. Records are especially critical when it comes to an employee/shareholder paying company expenses out of their own pocket.

If these situations cannot be avoided, the correct procedure is to have the employee file an expense report and attach the documentation. The sand, gravel or crushed stone business should then cut the employee a check for the amount documented.
Without the expense report, the aggregates business can’t take the deduction because it didn’t pay for the item; the employee/owner can’t take the deduction because it is not a valid deduction.

Today if there is no receipt or proof of payment the courts – not the IRS –may allow the deduction based on an estimate. But there must be some basis on which the court can make an estimate.

Recordkeeping in our 
electronic age

As more and more aggregate producers are turning to their computers to keep track of financial matters, the IRS continues to expand programs for electronic filing of tax returns. Taxpayers with assets of $10 million or more at the end of their tax year are required to comply with the retention requirements for “machine sensible records.” A machine sensible record is data in an electronic format intended for use by a computer.

Fortunately, an aggregates business with assets of less than $10 million must comply with the record retention requirements for machine sensible records in only a few rare situations. Unfortunately, keeping electronic records doesn’t relieve taxpayers of their responsibility to retain hardcopy records that are created or received in the ordinary course of business. Hardcopy records may of course, be retained in microfiche or microfilm format. The IRS has also approved scanning to relieve the need to keep original documents.

Holding on to records

In general, the rule of thumb is that canceled checks and other documents should be held for three years. Technically, it is three years from the date the tax return was filed. If the IRS suspects that income was underreported, they can go back six years. If it believes fraud is present, there is no time limit.

For assets such as trucks, autos, equipment, machinery, etc., documentation should be retained for at least three years after the asset is disposed of. Longer retention periods can apply to employment records. Ideally, using a seven-year holding period for most records should be considered.

Obviously, no record should be disposed of simply because it is no longer needed for tax purposes. Those records should be retained until the aggregates producer checks to see if they must be kept longer for other purposes. Insurance companies and creditors for example, may require some records be kept longer than the IRS does.

Consulting with an attorney or tax professional can help guide any aggregates business to a legal and tax compliant recordkeeping policy. In order to avoid identity theft and to protect sensitive business information, all business records should be disposed of properly or shredded.

Recordkeeping disasters

It is not only the IRS that warns everyone to safeguard themselves against natural disasters by keeping a set of backup records in a safe place. Naturally, the backup should be stored away from the original set of records.

Keeping a backup set of records – including bank statements, tax returns, insurance policies, etc. – is far easier today with many financial institutions providing statements and documents electronically and much financial information being readily available on the Internet. Even if records exist only on paper, they can be scanned into an electronic format. With documents in electronic form, the aggregates producer can download them to a backup storage device, such as an external hard drive, or burn them to a CD or DVD.

A beneficial headache

Everyone knows the IRS has the authority to compute the income of any sand, gravel or crushed stone operation with inadequate books, or no books or records. The methods used by the IRS for reconstructing income vary depending on the facts and circumstances, but are rarely favorable to the errant taxpayer.

Records and recordkeeping can take a variety of forms. Remember, however, records are not only about making the IRS happy. They also play an important role in managing the business.

Take note

Save all invoices and don’t assume the IRS will accept a check written without an accompanying invoice.

Mark E. Battersby is a freelance writer who has specialized in taxes and finance for the last 25 years.