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Keeping Records

What kind of records should I keep?

In the operation of your business, you will come across many types of records related to your income and expense transactions. While it is impossible to list all the records for every possible transaction, following are some examples of records to maintain:

  • For gains and losses reported on Schedule D such as sale of real estate or securities, you will need documents to verify the sales price, the cost of the asset you sold plus improvements if any, e.g. sales and purchase agreements, escrow papers, copies of checks, brokerage statements, etc.
  • For general expenses, you must be able to document the type of expense, the date and amount of payment, copies of cancelled checks, and that it was incurred in the operation of your trade or business.
  • For revenue/income items, you should keep copies of 1099's, sales invoices, sales agreements or contracts, etc.

There are two methods of filing tax returns: paper and electronic. Both require similar recordkeeping.

  • Summary of your business transactions.
  • Books and records that support your income, deductions, and credits. This might include journals and ledgers, as well as cash register records, sales records, bank statements, W-2's, 1099's, invoices, cancelled checks, sales agreements, etc.
  • For more information regarding e-file, please see Individual e-file Frequently Asked Questions and Business e-file for Tax Professionals.

How long should I keep records?

The Franchise Tax Board (FTB) may request information regarding your California income tax return within the California statute of limitations period, which is usually the later of four years from the due date of the return or the date the return is filed. (Exception: an extended statute of limitations period may apply for California or federal tax returns that are related to or subject to a federal audit.)

Keep a copy of your return and the records that verify the income, deductions, adjustments, or credits reported on your return. Some records should be kept longer. For example, keep property records as long as they are needed to figure the basis of the property. In transactions relating to Abusive Tax Avoidance Transactions:

  • For notices issued prior to August 1, 2011: FTB has 8 years after a taxpayer files a return to mail a proposed deficiency assessment. Therefore, tax documentation should be kept for at least 8 years.
  • For notices issued beginning August 1, 2011: FTB has 12 years after a taxpayer files a return to mail a proposed deficiency assessment. Therefore, tax documentation should be kept for at least 12 years.

Why should I keep records?

Good records will help you do the following:

  • Determine whether you are making or losing money and why.
  • Prepare your financial statements.
  • Identify and categorize sources of revenue.
  • Keep track of deductible expenses.
  • Prepare your tax returns.
  • Document your expenses and transactions in case of an audit.

What is the "Burden of Proof" if I ever need to provide proof of income and deductions claimed on my tax return?

The responsibility to prove entries, deductions, and statements made on your tax returns is known as the burden of proof. You must be able to prove (substantiate) certain elements of expenses to deduct them. Generally, taxpayers meet their burden of proof by having the information and receipts (where needed) for the expenses. You should keep adequate records to prove your expenses or have sufficient evidence that will support your own statement. You generally must have documentary evidence, such as receipts, cancelled checks, or bills, to support your expenses. Additional evidence is required for travel, entertainment, gifts, and auto expenses.

How should I record my business transactions?

Business transactions are ordinarily summarized in journals and ledgers; many of them are in computer software format.

A journal is where you record each business transaction. You may have to keep separate journals for transactions that occur frequently, such as a sales journal, a payroll journal or a check disbursement journal.

A ledger is where you record the totals from all of your journals. It is organized into different accounts.

Whether you keep journals and ledgers depends on the type of business. For example, a recordkeeping system for a small business might include the following items:

  • Business checkbook
  • Daily summary of cash receipts
  • Monthly summary of cash receipts
  • Cash & Check disbursements journal
  • Depreciation worksheet
  • Employee compensation records

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