You’ve launched your business, organized your startup's finances, and are excited to hit the ground running. However, once you’re open for business, you’ll notice that financial information documents start to pile up. As a business owner, you know it’s important to keep records, but at some point, those records become obsolete. But when does that happen?
If you’re like many first-time business owners, you may have no idea how long to keep business records. Moreover, as a business owner, your time is limited. You don’t want to have to file and store paperwork or keep track of digital documents any longer than you have to. Implementing proper record retention practices will protect your business in the long run.
The Importance of Record Keeping
Before we discuss the retention requirements for business records like employee and financial documents, it’s important to understand why you should practice good recordkeeping. Keeping accurate business records protects you, your employees, and your customers. Here’s how:
- Your protection: When you maintain proper business records, you’ll be prepared for audits. But the IRS isn’t the only reason to keep proper records. These records could also protect you in the event of employee, client, and legal disputes.
- Your employees: Your records could also provide protection for your employees. After all, you’ll keep records of hours worked, agreements made, and accomplishments. All of these could come in handy when you evaluate performance or if your employees need copies of their records for legal or tax purposes.
- Your customers: Solid recordkeeping will also help protect your relationship with your customers. For example, say you're a roofer, and your customer notes they ordered a specific type of nail, but you don’t remember that detail. When you look in your records, you find they were right. This helps you resolve issues quickly so that you keep your customers happy.
Types of Business Records
There are three different types of business records that you should maintain. It’s important to understand the different types of records, as each has its own retention period and other recordkeeping requirements. Those three types of business records include:
Financial records include anything that would be considered a financial statement. For example, credit card statements, bank statements, accounting records, any records of cash payments, and even ownership records all fall under the financial records category.
Financial records are important for several reasons. Some of the most important include:
- Analysis: Savvy business owners analyze their financial records regularly to look for opportunities for their company to save or make more money.
- Audits: When you have accurate and comprehensive financial records, you’ll be ready if the IRS or investors request an audit.
- Disputes: Your records could be a source of protection for you in the event of financial or legal disputes.
Employee records include legal documents like Social Security and identification cards, employee agreements, drug test results, employee payment records, and more. As is the case with financial records, there are several reasons you should keep accurate employee records. Some of the most important include:
- Compensation disputes: Your employees may dispute their compensation from time to time. If you have records, you can prove they have been compensated for all the work they did.
- Taxes: It’s important that you pay all the tax money you owe on time. Accurately recording what you’ve paid your employees and what you've earned makes it easier to determine how much you owe in taxes.
- Legal: You may need to prove that your employees are able to legally work in the United States. Your records should help you do so if the need arises.
Finally, it’s imperative that you keep track of your business tax records. This includes the receipts or invoices you need to prove any tax deductions, copies of your business tax returns, and copies of documents having anything to do with taxable events.
Your tax records are also important for multiple reasons. Some of the most important include:
- Annual tax returns: Your accountant or accounting team may need tax returns from previous years to file the most accurate tax returns for future years.
- Audits: You want to make sure you have access to receipts and invoices for write-offs as well as other tax records in the event that you’re audited.
- Grants and more: Your business may qualify for grants and other assistance from time to time. However, you typically need to provide your tax documents to prove the size of your business and other aspects if you want to qualify for these cash injections.
Record Retention Requirements and Periods
Whether you’re talking about financial records, employee records, or tax records, it’s important to maintain records for the right amount of time. That way, you can easily access your records when you need them.
However, some records are important to hold onto for longer. After all, your need for a legal document establishing a partnership will likely outlast your need for a tax document. So, how long should you retain your records? Here’s what you need to know:
General Business Documents
General business records like annual reports and insurance documents should be retained for at least three years. After the three-year period, you’ll likely have little to no need for these documents. However, these aren’t the only records that qualify as general business documents.
Other documents, like legal documents, are far more sensitive. As such, you should retain any contracts you or anyone else affiliated with your business signs for a period of at least seven years. In some cases, you’ll want to keep the original document even longer.
For example, say you sign a 15-year royalty agreement. It wouldn’t make sense to get rid of the agreement after seven years. After all, it’s still active. A general rule of thumb is to retain agreements for at least seven years or at least three years after the agreement has expired if that agreement covers a term longer than seven years.
Employee Payroll and Tax Records
Employee payroll records and tax documentation have different retention periods depending on the state where you operate your business. In most states, you’ll need to maintain payroll and employment tax records for at least three years.
However, in some states, that retention period can last much longer. For example, employers in Hawaii are required to maintain employee payroll records for a minimum of seven years — that’s more than double the three-year average.
So, make sure you look into your local regulations to determine how long you need to retain your employee records.
Most tax professionals suggest that you retain business tax records, like your previous tax returns and documents to prove write-offs, for at least three years. There’s a good reason for this retention period.
In most cases, when the IRS audits a business or other entity, they look for three years of financial records. So, as long as you have three years of records handy, you should be able to appease the IRS.
But keeping tax records on hand for at least three years is good practice for other reasons, too. Your investors may want access to your tax information. Moreover, your accountant or accounting department may need access to your tax information for future returns.
Consequences of Inadequate Record Keeping
Whether it comes to tax filings, employee records, or other financial records, it’s critical that you maintain records properly. After all, the consequences of inadequate recordkeeping could be significant. For example:
- Fees: You could face fees and additional taxes from the IRS if you are unable to meet documentation requirements as part of an audit.
- Legal ramifications: If you can’t prove that you’ve paid your employees as agreed, you could face legal ramifications as part of compensation disputes.
- Lost opportunities: Good recordkeeping makes it easier to find opportunities to optimize your business finances and processes. If you don’t maintain strong records, you’ll likely miss these opportunities.
Best Practices for Record Management
There are a few steps all business owners should take when collecting and maintaining records:
- Act immediately: You should file your records as soon as you get them. That way, there’s no possibility that you’ll lose them before you have the chance to file.
- Audit your records: Perform regular records audits to make sure you’re not missing any important records.
- Use technology: You don’t have to work through the old-school pen-and-paper recordkeeping process. Take advantage of the latest technologies to improve your record management.
Ensure Smooth Business Operations Through Effective Record Keeping
The bottom line is that your time is valuable and best spent building your business. Maintaining proper records solves both of these problems. If there’s ever a dispute between your company and an employee or a client, clear records will help resolve the dispute faster.
Accurate and comprehensive records can also help you during an IRS audit and give you the data you need to improve your operations. So, make sure you implement recordkeeping best practices to keep your business running smoothly.
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