Traders need to be aware of their responsibilities under the law to
maintain adequate books and records and document their activities.
IRS and the courts generally consider documentation that was
contemporaneously prepared to be better than compiling support for
deductions afterwards. For example: it can be better to use a
business credit card at the time of purchasing business items rather
than using a personal credit card and then, long after paying it off,
making the allocations of what items pertained to the business.
"But I have a friend who says (or my accountant says) that this is "too
conservative" and there's no reason for keeping all these records, it's
a waste of time!" What these people are invoking, whether they are
aware of it or not, is the "Cohan rule" [Cohan v. Comr., 39 F.2d
540 (2d Cir. 1930)] . The Cohan rule allows a taxpayer to
approximate the amount at issue despite inadequate records, if it is
clear that an expenditure was incurred.
An example of this might be - you have solid documentation that 50% of
your car mileage is valid business mileage, but you lost all of your
gasoline purchase receipts in a fire. The gasoline purchased can
be approximated based on the documented miles, the average MPG of your
vehicle and the average cost of gasoline at the pump.
As such, the Cohan rule lowers the requirements for substantiation of
valid business expenses if the IRS finds the taxpayer to be credible.
If, after considering the taxpayer's other records and everything
else, the IRS does not feel comfortable with the credibility of the
taxpayer - then the deductions are disallowed. Why take the
chance? Laziness on the part of a taxpayer?
The danger here is that when it comes to an Individual's Trader
Status and Trader Status Entities, the lack of credible
substantiation can lead to a revocation of Trader Status in its entirety
and thus reverting the taxpayer to Investor Status [Higgins v. Comr.,
312 U.S. 212 (1941)]. When doing this, the Cohan rule is not
helpful. True, without substantiation the deductions may still be
allowed under the Cohan rule, but only as an Investor's expenses.
QuickBooks - warning of confiscation by the IRS:
- treat your trading business
professionally and apart from your personal activities.
- avoid commingling business
and non-business assets and activities.
- save all invoices for
expenses and equipment for several years.
- also save all canceled
checks, bank statements,
credit card statements and loan paperwork
to support payment of invoices. (also see
electronic records below)
- save all 12 monthly
brokerage statements. If saving in electronic format, maintain
multiple backup copies.
- save all confirmations and
other evidence to show the amount of time and effort spend pursuing
your trading activities.
- reconcile your broker's
1099-B sales to your records.
- reconcile your annual net
gain or loss to your 12 monthly brokerage statements.
- verify that your downloaded
trading records are correctly based on transaction date as required
for IRS, and not by settlement date as per the SEC rules (usually
just the activity between December 25 and January 7 needs to be
- keep copy of any form 2848
power of attorney and show it to IRS if the need arises.
- never speak with the IRS
about your tax return or your trading activity, refer them to your
- avoid using any busch league
"net change in broker account value" as your primary method of computing
net gains or losses for the year. we've seen as many errors with traders
erroneously overpaying their taxes as illegally underpaying their taxes using this
foolhardy, unprofessional approach.
- preferably format your
activity like a schedule D: description, date acquired, date
of sale, amount of sale, tax basis or cost, net gain or loss.
Many brokers do this for you, others provide a download file to
import into Excel or other
All M2M Traders:
- keep copy of your
mark-to-market election and proof of timely filing.
- keep copy of your form 3115
for a change to mark-to-market accounting and proof of timely
- keep records clearly
documenting your year-end mark-to-market computations and your
following year adjustments to tax basis.
- verify that any year-end
unsettled transactions are properly accounted for (usually just the
activity between December 25 and January 7 needs to be reviewed).
Corporations and Multi Member LLCs:
- keep copy of form SS-4 and
the IRS acknowledgement of your federal identification number.
- keep copy of form 2553 and
the IRS acknowledgement of your s-corp election.
- issue stock certificates or
member certificates to shareholders/members and assure that they are
"fully paid for," preferably with a separate payment made by check
from the shareholder/member to the entity.
- maintain a minute book to
document what happened at annual meetings and special meetings.
- maintain an LLC
- maintain an owners' buy-sell
agreement funded with disability insurance or life insurance, as
- establish your retirement
plan before December 31st.
- fund your retirement plan
before the initial due date of your tax return or...
- if you will absolutely be
filing timely, fund your retirement plan before the extended due
date of your return.
A Recommended Chart of Accounts:
Earned Income is required for Retirement
Plans and Medical Insurance Plans:
or "self-employed" Independent Contractor
Why Retain Documents and Records?
Your business records and your personal financial records must be
retained for as long as they may be relevant for any tax purpose.
Generally, you will need to keep all records that support items on your
tax return for at least four years, since the IRS may challenge your
return for three years after its due date. (Even longer in certain
Records for long-term assets,
such as real estate, business equipment, and investments, should be
maintained as long as you own the assets plus several years
afterwards, since you will need them in order to determine your
taxable gain or loss upon sale of disposition of the asset, and you
may need them to support depreciation or casualty loss deductions
along the way. If you rolled over a gain in the asset, as was
permitted under the old rollover replacement rule for personal
residences, or because you traded some business or investment property
in a tax-free exchange, you must keep records of the original asset
until you dispose of the asset that took its place.
Be sure to keep copies of your
income tax return itself. If you have ever made any nondeductible IRA
contributions, you must retain the Forms 8606 from each year you made a
contribution or received a distribution from any IRAs. But more
generally, if your return is ever challenged for something serious such
as fraud or not filing a tax return, the IRS can go back in time to
examine your returns for as many years as it thinks necessary. The
problem is that the IRS computer system might not have accessible copies
of your returns from, say, 10 or 15 years ago. Therefore it is very
important that you keep copies of your own tax records indefinitely, and
What Tax Records to Keep and For How Long:
The general rule under federal
income tax regulations requires you to keep your records so long as they
may be material to administration of the income tax law.
- Income Tax Returns: Keep all federal and state income tax returns
permanently along with copy of and forms W-2 and 1099-MISC for
- Income Tax Return Related
Items: Keep all federal and state income tax return supporting documents (i.e., those items confirming your income
and/or deductions) for a minimum of three years after the return's
filing date. The more prudent route is to keep these returns and
documents for six years. Why? The IRS can assess additional taxes
within three years of its filing date, but has up to six years in
which to make a tax assessment if the IRS determines that a
substantial amount of income has been omitted from the return.
In certain cases, including when fraud is suspected, the IRS can go
back even further.
- Property Taxes: The
Statute Of Limitations on personal property taxes are fifteen (15)
years of more after the due date of the tax. The sale of
long-ago forgotten tax liens on personal property you no longer own,
or real property you still own can come back to haunt you a decade
later unless you have canceled checks and stamp receipted tax bills
to prove that you already paid.
- Mailing Receipts:
Keep with your file copy of each tax return the U.S. Postal Service
receipt -- i.e., the registered mail receipt --showing the date the
return was mailed. If your return is filed electronically, keep a
copy of the electronic filing confirmation with a printed copy of
the return. In the event the return is misplaced or lost, this
documentation will save you from penalties.
- Residential Property
Records: Keep settlement records from all of your home purchases
and sales in a safe place. This will help you determine basis for
any future sale and gain determination. In addition, keep records of
the amounts that you spend for home improvements with this file.
These records will provide documentation of your basis in the house
if and when it comes time to compute your taxable gain.
- Stock and Bond Records:
Keep records of your investment and trading purchases (e.g., stocks,
options, futures, mutual funds, and bonds). Besides providing
you with a date for determining the type of gain -- long term versus
short term -- these records establish your basis in the investment
and help to compute the gain/loss when you sell. In addition, keep
records that show a return of capital on your investments.
- Depreciation Records:
For any rental real estate or depreciable business property that you
own, keep records of the property's cost, the purchase date, the
method used to calculate depreciation, and a schedule of all
depreciation claimed on the property in previous years. Maintain
these records until you sell or dispose of the property. Once you
sell the property, keep these records with the tax return on which
you report the sale.
- Personal Records:
Keep a permanent file of personal records -- such as divorce
agreements, copies of estate and gift tax returns under which you
received property, etc. - - since they can provide a basis for
determining your tax liability when you dispose of the property.
- Other Records: There
are other situations in which you will benefit from keeping records.
For example, if you have made nondeductible contributions to an IRA
or Roth IRA, maintaining records of these contributions will
facilitate proving your tax liability when funds are withdrawn from
Guidelines for Paper Records:
- Auto mileage logs (three years
or life of vehicle)
- Bank deposit slips
- Cancelled checks
- Daily sales records
- Entertainment records
- Expense reports
- Paid vendor invoices
- Written acknowledgment from
charity for contributions of $250 or more
*From date of filing return or
due date of return, whichever is later
- Bank statements
- Contracts (after expiration)
- Annual financial statements
- Corporate stock records
- General ledger & journals
- Real estate records
- Tax returns
- Copy of Form W-2
- LIFO inventory record
- Parking tickets and Motor Vehicle
Violation tickets along with proof of payment
- Depreciation schedules (life
of asset, plus three years)
- Meeting minutes (life of
- IRA contribution and
distribution records (three years after final distribution)
Here's another records retention list:
IRS typically has three years to audit tax returns. But it is six
years if it suspects that the return understates income by more than
25%. There is no statute of limitations if tax fraud is involved
or if the tax return was not filed.
Copies of tax returns including corrections and amended tax filings -
Tax / Legal correspondence - Keep Forever
Audit Reports - Keep Forever
Contracts and leases - Keep Forever
Real Estate Records - Keep Forever
Mortgages and Notes - Keep Forever
Corporate Minutes and Stock records - Keep Forever
General Ledger and Journals - Keep Forever
Bank Statements - Six Years
Sales Records and supporting journals - Six Years
Personal Investment Records - Six Years after final taxable sales to a
IRA Records - Six Years after final taxable withdrawals
Canceled Checks - Three Years
Paid Vendor invoices - Three Years
Employee Payroll Records - Three Years
Employee Expense Records - Three Years
Depreciation Schedules - Life of asset plus Three Years
updated 1/31/2011 Recently a client had a
former employee sue for for back pay. The court wanted to see
twelve (12) years of payroll records. The client actually was able
to provide all twelve years and was able to use them to prove to the
court that there was no unpaid back pay.
your financial records
PDF file from MFS Investment
California's listing of record keeping requirements
(remember that the CA
Statute of Limitations is 4 years, not only 3 years as is the case for
After recent audits of personal income
tax returns, we recognize that taxpayers and preparers may not be aware
of the rules and regulations pertaining to the requirements of record
keeping for expenses and deductions.
Taxpayers need to be prepared to provide documentation
that proves why they claimed what they did on the return. The burden of
proof is on the taxpayer. Taxpayers must be able to prove (substantiate)
certain elements of expenses to deduct them. Deductions are only allowed
if they are ordinary and necessary as determined by IRC Section 162(a)
and conforming CR&TC Section 17201.
Why keep good records?
Good records help to prepare and support taxpayer tax
return information. Whether it is business or personal, good records
help when applying for a loan or for supporting an insurance claim.
Poor or no records result in missed deductions and
higher taxes. If audited, poor records can result in underreported
income and unsupported deductions, which will result in higher taxes and
What are good records?
Good records support the deduction(s) taken on the tax
return. Taxpayers have the right to take every deduction the law allows
them. However, we have the right to say "Show me."
What records need to be kept?
Lack of good records show that taxpayers are not
following the rules and regulations established by the law (Federal Tax
Regulation 1.274-5T). Examples of records needed to support expenses and
- Payment records
– Provide either a canceled check or credit card payment to show that
payment was made.
- Invoices -
Along with the proof of payment, provide the invoice cross referencing
the business expense.
- Receipts –
Provide receipts that itemize the purchases and/or method of payment.
- Mileage logs
– Keep and provide mileage records during an examination. Federal Tax
Regulation 1.274-5T outlines specific requirements for mileage
- Charitable cash or non-cash contributions –
Keep records of your donations. IRC
Section 170 allows deductible contributions given to qualified exempt
- Meals and entertainment
– Check Federal Tax Regulation 1.274-5T for guidance on what the
taxpayer must provide. For example; there is a meeting with a client
to discuss sales opportunities at a local restaurant, generally, the
receipt must show the meeting time, the reason for the meeting, and
who attended the meeting.
Basic records enable the taxpayer to determine the
basis or adjusted basis of their home. If claiming a carryover loss,
then the records need to be kept for as long as there is a carryover
How long should I keep records?
Generally, California's minimum statute of limitations
is four years.
The length of time you should keep a document depends
on the action, expense, or event. You must keep your records as long as
they may be needed to prove the income or deductions on a tax return
until the statute of limitations runs out for that return.
Are there requirements on how to keep the records?
No. In general, taxpayers may choose any record
keeping system that suits their personal or business needs and that
clearly shows their income and expenses. However, if the taxpayer
chooses the "shoebox" method, then the taxpayer will be responsible for
assembling and reconciling the records to the tax return.
For small businesses, the business checkbook is the
main source of entries. We cannot over emphasize the importance of
keeping business accounts separate from personal accounts, so business
and personal transactions are not commingled. Computerized software
packages are available that require little or no experience in
bookkeeping and accounting.
FTB's mission is to collect the proper amount of tax.
No more, but no less than your fair share.
References – Internal Revenue Service Publications
Publication 552 – Recordkeeping for
Publication 583 –
Starting a Business and Keeping Records.
Publication 463 –
Travel, Entertainment, Gifts and Car Expenses.
FAQ: Do I need
to retain original business expense receipts if I scan them into my
Many taxpayers maintain books and
records by using an electronic storage system that either images their
hardcopy books and records to an electronic stage media, such as an
optical disk. Records maintained in an electronic storage system that
complies with certain requirements will constitute records under Code
Code Sec. 6001
provides that every person liable for any tax imposed by the Code, or
for the collection, must retain records. Any person subject to income
tax, or a person required to file an information return, must maintain
books and records, including inventories sufficient to establish the
amount of gross income, deductions, credits, or other matters required
to be shown.
A taxpayer’s electronic storage
system that meets certain requirements will be treated as being in
compliance with the recordkeeping requirements of Code Sec. 6001.
The definition of books and records goes beyond the typical hard
copy items when you maintain all or part of your accounting records on a
computer. In general, record-retention periods are the same for
“machine-sensible” records as they are for their hard-copy counterparts.
Machine-sensible records include magnetic tapes, punched cards and
Where machine-sensible records are concerned, however, retrievability is
important. Not only must certain records be maintained, but the IRS must
have access to those records. This becomes especially burdensome when
computer systems are upgraded.
If you or your business have
more than $10 million in assets*, and you maintain all or a portion
of your accounting records on a computer, the IRS requires that your
machine-sensible records be in a retrievable format and provide the
information necessary to determine the correct tax liability. This
requirement applies even if your accounting system is maintained by an
outside service bureau. To comply with this requirement, you must retain
the following specific documentation for all data files:
- Record formats (including the
meaning of all the codes used to represent information)
- System and program flowcharts
- Label descriptions
- Source program listings of
programs that created the files retained
- Detailed charts of accounts
- Evidence that periodic tests
are performed on the retained records to ensure they can produce the
data stored in the records
- Evidence that the retained
records reconcile to the taxpayer’s books and the tax return
If you or your business have
less than $10 million in assets, but you nevertheless maintain all
or a portion of your accounting records on a computer, the IRS requires
you to conform to the above standards if (1) your books and records are
only available in machine-sensible format, (2) machine-sensible records
were used for complex computations (such as LIFO) or (3) you are
notified by the IRS that your machine-sensible records must be
* Members of a controlled group of corporations are combined for this
The IRS permits the
destruction of the original hardcopy books and records and the deletion
of the original computerized records once the taxpayer has:
- Completed its own testing of
the electronic storage systems that establishes that hardcopy or
computerized books and records are being reproduced in compliance with
certain requirements; and
- Instituted procedures that
ensured its continued compliance with these requirements.
here for more information on
here for more information on
planned record purging and destruction.
Relevant IRS Procedures and Rulings Pertaining to Records: