RECORD RETENTION



Record Retention 724
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Record retention refers to the practice of retaining copies of business or personal records over time. It is important for small business owners not only to keep good records, but also to know which ones to retain and for how long. Some aspects of record retention are determined by Internal Revenue Service (IRS) guidelines. Certain records that substantiate a small business's income, expenses, and withholding and payment of taxes must be retained for at least three years, or until the statute of limitations on an IRS audit expires. But good record retention is also in the best interest of companies. A poor system can not only prevent managers from retrieving the information they need to make sound business decisions, but can also pose a security risk.

The means chosen for record retention are also important for the simple reason that small businesses often suffer from a shortage of space. An article in Purchasing noted that paper records in an average business multiply at a rate of 7 percent per year, while electronic data stored on computer networks increases at a rate of 60 percent per year. Although some small businesses may find it adequate to keep their records in file folders, many find it helpful to use an electronic storage medium. The IRS issued new guidelines regarding electronic storage of business records in early 1997.

Businesses generate three main kinds of records: income, expenses, and capital expenditures. Income includes the revenue from sales of products or services, including both cash receipts and the collection of receivables. Expenses include cash disbursements and accounts payable that cover all operating expenses. These records should be maintained continuously. In the case of expenses, the records must not only prove that an expense was incurred, but also show how it was related to business. This is particularly important in the case of meals and entertainment expenses, for which the records must indicate the date, place, amount, and purpose of the expenses, as well as the type of business relationship with the person entertained.

It is also important for small business owners to keep records for major capital purchases to determine depreciation for tax purposes. These records must include the date and place of purchase, a complete description of the item, the amount paid, how it was purchased, and the date when it was put into service for the business. Keeping these basic business records enables business owners to track their progress, identify problems, and take advantage of all possible tax deductions.

Small businesses that employ people other than the owner or partners are required by the IRS to keep detailed payroll records. In fact, there are a total of 20 different types of records that must be kept for income tax withholding, FICA (Social Security) tax withholding, and FUTA (federal unemployment) taxes. These records—which include employees' names, addresses, and Social Security numbers, the amount and date of wages paid and withheld, and the amount of each type of tax paid, among other things—must be retained for at least four years from the time the relevant taxes were due or were paid, whichever was later. Experts also recommend that small businesses keep careful records regarding any automobile, life, fire, health, and other insurance coverage they hold. These records should list policy numbers and carriers, amounts of premiums and dates paid, and information on claims.

RECORD-RETENTION POLICIES

In addition to meeting legal and tax requirements, good record retention policies can help small businesses improve the efficiency and productivity of day-to-day operations and reduce their costs. "With a carefully considered, written record-retention policy in place," Kelly Hackett wrote in Association Management, a small business "accrues a number of business and legal benefits. Important records are on hand, while unimportant records are not allowed to consume precious storage space. Storage and maintenance costs are reduced. With important files well-organized, staff easily find files. Moreover, a thorough record-retention policy helps ensure compliance with applicable regulations."

In developing a record-retention policy, Hackett recommends that small businesses begin by surveying their activities to see which records are most important to retain. The next step is to make sure that the policy meets all applicable legal and tax requirements. The record-retention policy should separate the business's records into categories, then specify the types of records retained for each category and the minimum retention periods. Finally, Hackett suggests that small businesses help employees understand the policy and know where to access records, and that management review the policy periodically to make sure it continues to meet business needs and legal requirements.

HOW LONG TO RETAIN VARIOUS TYPES OF RECORDS

There are a number of different types of records that small business owners should retain indefinitely—for the life of the business. These include copies of federal income tax returns, annual financial statements, general ledgers, fixed asset records, and corporate documents (charter, bylaws, stock records, patent and trademark applications, labor contracts, pension records, etc.). Regular business documents that support financial statements and tax payments—such as canceled checks, payroll checks, bank statements, invoices, purchase orders, and personnel records—should be retained for at least six years. These time periods allow for a margin of safety in meeting the IRS rules, which also address the means that may be used in retaining records.

Most of the IRS guidelines for record retention are included in Section 6001 of the Internal Revenue Code. "Virtually all taxpayers are required to keep records sufficient to establish the amount of gross income, deductions, credits, or any other relevant matters concerning their tax liability," Noelle Allen explained in an article for The Tax Advisor. These records can take the form of paper files or computerized data. Further IRS guidelines for record retention were issued in 1997 through Procedure 97-22, which allows taxpayers to transfer their paper files or computerized records to an adequate electronic storage media. "The general requirements are that an electronic storage system must ensure an accurate and complete transfer of the hard copy or computerized books and records to an electronic storage media, and the system must also index, store, preserve, retrieve, and reproduce the electronically stored books and records," Allen wrote. The procedure allows the IRS to test the storage system periodically without actually conducting an audit, and if it does not comply with the guidelines then the taxpayer may be subject to penalties.

More information about record retention is available in the IRS publications Recordkeeping for Individuals and Guide to Record Retention Requirements .

FURTHER READING:

Allen, Noelle. "New Revenue Procedure Outlines Electronic Record Retention Rules and Allows for Destruction of Originals." The Tax Advisor. July 1997.

Dailey, Frederick W. Tax Savvy for Small Business: Year-Round Tax Advice for Small Businesses. Berkeley, CA: Nolo Press, 1997.

"Don't Underestimate the Need for Recordkeeping." Purchasing. November 9, 1995.

Jacobs, Jerald A., and Kelly P. Hackett. "Record-Retention Policies." Association Management. September 1998.

Krumwiede, Tim, Raymond A. Zimmermann, and Patricia Eason. "Record Retention Needed to Avoid Tax Redeterminations." Taxation for Accountants. December 1995.

Serchuk, David, and Jonathan Senft. "Q & A: Record Retention." Compliance Reporter. December 18, 2000.

SEE ALSO: Internal Revenue Service Audits



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