Audits are no fun for anyone. Whether it’s an individual or a business who gets that dreaded letter in the mail from the Internal Revenue Service (IRS), audits have a way of sucking the life right out of you. If you own a business and want to ensure that you successfully get through an audit should one arise, you need to have a solid grasp on the document retention rules and regulations surrounding employee expense reports as well as invoices.
In the first of a two-part blog series in collaboration with our accounting firm partner Brown Smith Wallace (BSW), we examine the information reviewed by the IRS on invoices and employee expense reports, the rules surrounding how long documents should be retained, and how these rules apply to purchase cards (P-cards).
When it comes to documentation, employee expense reports tend to have greater requirements than invoices, and the IRS is looking for specific key information.
“The IRS states in Publication 463, adequate ‘documentary evidence’ to support the business purpose and nature of the expense should be retained,” says Ann Janoski, Tax Manager at BSW. “Receipts are required by the IRS for expenses of $75 or more. Electronic or scanned documentation is sufficient as long as it has enough information to show name of service provider, location for a hotel or restaurant, dates of service, amounts, and separate amounts for lodging, meals, telephone calls, etc. Restaurant receipts should include the number of people served. The business purpose of the expense must also be noted unless evident by the nature of the expense. A credit card statement or cancelled check by itself will support payment of an expense but not provide sufficient information for the business purpose of an expense.”
The IRS requires that you keep contemporaneous records, a practice that is recommended, especially on expense reports, because it’s easier than trying to reconstruct what took place three years prior.
For tax return purposes, all documents that you need to support your income, deductions and positions should be kept for the period of limitation that applies to the return. For example, you should:
- Keep records for at least three years (after the extended filing due date), but note that there are instances that may require longer retention periods for records not related to expense reports (five to seven years of retention is recommended).
- Keep records for six years if you do not report income that you should report and the amount is more than 25% of your adjusted gross income.
- Keep employment tax records for at least four years after the date the tax becomes due or is paid, whichever is later.
In addition, if you have taken a tax position on your return which at a later date the IRS could consider to be fraudulent, those records should be retained permanently.
You should also keep in mind if your company does business outside the United States, you will have to adhere to the document retention guidelines in whatever country you are operating in. “For example, each European jurisdiction has specific requirements related to document retention periods,” explains Lisa Schmaltz, Principal at BSW. “In general, taxpayers are required to maintain all information that may be relevant to their tax position, including all books and records, for a period of time ranging anywhere from five to 10 years.”
As more and more companies begin using P-cards to handle employee purchasing, the question becomes, is the purchasing statement enough, or are original receipts from employees required?
“Some of the P-card vendors can provide the necessary support as part of your statement documentation,” Janoski says. “The IRS will accept electronic documentation in lieu of original paper receipts if the statement or report provided contains adequate evidence of the transaction. This would include the payee, amount, date, place and essential character of the expense. In many cases, this could be sufficient. However, the IRS has specific rules for travel and entertainment documentation that might require more information.”
Sometimes potential clients ask us if the IRS will accept images of invoices or receipts as opposed to physical documents for the purposes of their audits.
“The IRS, as well as many states, will generally accept images or electronic documentation as long as the information is readable and provides the necessary substantiation to support the transaction,” Janoski explains. “Once scanned and secured, keeping the original documents would not be necessary.”
As for how long companies should keep physical copies of their invoices or expense receipts, Janoski advises that if electronic or scanned versions are maintained, the physical copies generally do not need to be kept. In fact, if you keep the physical copies, they remain the legal “document of record,” not the electronic versions, so it’s best to discard them. That being said, notarized documents and documents with corporate seals should be maintained in paper form because when scanned the IRS can’t be certain it is the original since it loses the 3D or dimensional effect.
For a general guideline from BSW that you can use in determining which records you need to keep and for how long, click here.
In Part 2 of our series, we will look at document retention requirements at the state level.