How Long Should You Keep Your Business Tax Records?

Good record-keeping does more than keep your business organized. It helps you accurately report and substantiate the income, expenses, and deductions on your tax returns; but, how long are you supposed to keep those records for?

For many business owners, the answer depends on the type of record involved.

The Three-Year Rule

For most taxpayers, the IRS generally has three years after a return is filed to assess additional taxes.

So, if you're talking about ordinary records supporting income and deductions, three years will often get you through the normal statute of limitations.

But, as is so often the case with taxes, there are exceptions.

The Four-Year Rule

If you have employees, you generally need to keep your employment tax records, such as records showing wages paid and taxes withheld, for at least four years.

The Six-Year Rule

The IRS can generally go back six years if you omitted income that should have been reported and the amount omitted is more than 25 percent of the gross income shown on your return.

The Seven-Year Rule

If you claim a tax deduction for a bad debt, because someone owed you money that you couldn’t collect, or for an investment that became completely worthless, you should keep the records supporting that deduction for seven years.

Some Records Need to Be Kept Even Longer

Not every business record fits neatly into a three-, four-, six-, or seven-year rule.

For example, records connected to business assets may need to be kept for as long as you own the asset, and for a period afterward, because you may need them to establish things like your basis, depreciation, and any gain or loss.

For a micro-business owner who wants a simple record-keeping system, a good rule of thumb is to keep your ordinary tax records for seven years.

That way, you don’t have to try to decide each year:

Three years? Four years? Six years? Seven?

No, thanks.

File it away.

Keep it for seven years.

And move on with your life.

What Happens If You Don't Have the Records?

This is where record-keeping stops being boring admin work and starts affecting your wallet.

Suppose you claimed several thousand dollars of business expenses on your tax return.

Maybe advertising.

Software.

Office supplies.

Professional fees.

Equipment.

Then your return is randomly selected for examination.

Yes, friends, you could do everything right and still be randomly selected for an audit.

Now the IRS asks you to prove the expenses you claimed.

That could mean producing an invoice, a receipt, a bank or credit card statement showing payment, or some combination the aforementioned to prove what you purchased, how much you paid, when you paid it, and how the expense was connected to your business.

Now imagine that you don't have those records.

The deduction you claimed can suddenly be in jeopardy.

If the IRS determines that you don’t have adequate substantiation, it may disallow the deduction.

And when deductions disappear, your taxable income goes up and, by extension, so can the amount of tax you owe.

Something as insignificant as not keeping a receipt can become quite expensive several years later. In certain cases, additional tax assessed during an audit can also lead to accuracy-related penalties.

Your Records Are Your Evidence

Record-keeping is not simply about staying organized.

Your records are the evidence you may need if your return is audited.

And the worst time to start reconstructing three-year-old business expenses is when an IRS examiner is asking you about them.

Fortunately, keeping records today does not have to mean maintaining boxes of paper receipts. You can scan receipts, photograph them, save invoices electronically, download bank and credit card statements, create folders by tax year, and back up your files.

Then keep your ordinary tax records for seven years unless there is a reason a particular record should be kept longer.

It’s simple.

And if your return is ever audited, you’ll be in a much better position to support what you reported.

Because claiming a deduction is one thing.

Being able to prove it is another.