how long should you keep business tax records

How Long Should You Keep Business Tax Records?

An important part of any business is record keeping. You should keep records about payrolls, invoices, and taxes. Not only will these records keep you in compliance with the law, but will also help you understand your business’ financial health.

A large amount of paperwork is accumulated each year, and it can be difficult to determine how long you should keep this information. When determining how long you should keep records, you first should consider the type of information you’re looking at. The IRS has given businesses specific guidelines for particular pieces of information, such as how long you should keep business tax records. You want to make sure the relevant information is available if your business is audited.

For laws that apply to your specific business, you need to consultant an accountant, but here are some general guidelines:

Tax returns

Businesses file quarterly taxes with the federal and state government. You also file a tax return each year. The IRS recommends that you keep tax records for three years from the date you file. If you file a claim for credit or refund after you file your return, you should keep the returns for two years from the date you paid the tax. Always file for your tax return. If you never file, or if you commit an act of deliberate fraud, there is no statute of limitations.

State Rules

Each state has specific rules about keeping tax returns. In Virginia, for example, the law says you need to keep tax returns for at least three years from the date of the return or the date the return was filed. The same law applies in Maryland. It’s best to check with your accountant on the rules that apply in your state.

Employment Tax Records

If you have employees, you have to keep track of records pertaining to them. These records include things like:

  • Employer identification number
  • Wages, annuities, and pension payments
  • Amounts of tips reported
  • Names, addresses, and social security numbers
  • Copies of Form W-2 that were returned to you as undeliverable
  • Copies of employees’ and recipients’ income tax withholding allowance certificates
  • Copies of returns filed

The IRS recommends keeping employment tax records for at least four years after the date that the tax becomes due or is paid. However, the IRS can go after payroll taxes indefinitely. In Beeler v. Commissioner, the IRS was able to receive payment for outstanding payroll taxes after 24 years.

Personnel Files

Along with tax information, you must also keep an I-9 and other personnel records. The I-9 form verifies that a person is legally allowed to work in the United States. Records must be kept for a year after an employee leaves or three years from the start of employment, whichever is greater. Many attorneys and human resource professionals recommend keeping personnel files for seven years.

Supporting Evidence

While the three-year rule generally applies, the IRS can seek to recover unpaid taxes for up to six years if you failed to pay an amount greater than 25% of your business’s gross income. It’s wise to keep receipts, bank statements, invoices, and other supporting documents for seven years.

Healthcare Information

The Affordable Care Act brought new tax implications to many businesses. Businesses with more than 100 employees are required to show proof of insurance with their tax returns or pay a penalty. The IRS recommends keeping these records for three years from the time of filing.

Records Connected to Property

The IRS guidelines for property states “keep records relating to property until the period of limitations expires for the year in which you dispose of the property.” You need property records for depreciation, amortization or depletion deduction. You will also need to calculate gains or loss when you sell the property.

Insurance Records

Businesses can have various types of insurance — property, workman’s comp, product liability and others. It’s best to keep these records for four years. If you manufacture a product, it’s best to hang on to these records indefinitely, as you never know when a lawsuit will be filed. Four years is a good guideline for other insurance records.

Capital Assets

If you have capital assets – stocks and bonds, real estate, etc. – and you sell them some day, you should retain proof of how much you paid for it to establish your cost basis.

When it comes to record keeping, the philosophy is definitely “better safe than sorry.” If you’re not sure how long to keep a business tax record, it’s better to file it away in a secure place than destroy it, only to find out that you need it later.

For more on record keeping or if you have any questions, feel free to contact us.

KDuncan & Company is dedicated to providing knowledge and support for small government contractors about concerns regarding government contracting. For questions on areas such as as cost proposals, accounting systems, DCAA compliance, and incurred cost audits, reach out to KDuncan & Company. 

DCAA Audit Process: When Can You Expect A DCAA Audit

In our last blog post, we provided the background for what to expect from a DCAA audit. In this post, I’ll give share my experience concerning the “when” as part of the DCAA audit process.

As mentioned before, it is the Contracting Officer’s responsibility to request an audit.

A DCAA audit is an evaluation of a condition within your company against particular government standards and/or regulations. The various audits are:

  • Preaward Pricing Proposal Review
  • Preaward Accounting System Review
  • Financial Capability Review
  • Floorcheck Review
  • Incurred Cost Audit
  • Postaward Defective Pricing Audit

When to expect an audit is greatly determined by the type of audit, which is greatly determined by the type (s) of contracts. The basic types of contracts are:

  • Cost Plus
  • Time & Material (T&M)
  • Firm Fixed Price (FFP)

Cost Plus

Your probability of having DCAA audits is increased exponentially with cost plus contracts.

  • Preaward Accounting System Review: 90%

First, per FAR 9.104-1(e), to be determined responsible, the contractor must have the necessary accounting and operational controls in place. This usually is interpreted as in order for a contractor to be awarded a cost plus contract, they must have an adequate accounting system. Thus, there must be a review/audit of a contractor’s accounting system to determine adequacy. Thus, if awarded a cost plus contract, the probability of audit is 90% in my experience.

  • Incurred Cost Audits: DOD, USAID, NASA: 75%, CMS: 40% Other Civilian Agencies: 15%

When awarded a cost plus contract, the contractor is required to submit an annual incurred cost submission to its cognizant agency or DCAA. Typically, there is an initial review of the submission by an auditor to determine the adequacy of the submission. Later, the government will determine whether they will audit the submission for the year or years. The determination is based on risk. I don’t know the formula, so I can’t share that with you. However, sometimes, I cannot make sense of the decision. Recently, a client was required to do an incurred cost submission for an $8,500. Luckily, DCAA decided not to audit and accept the indirect rates proposed. We have had clients go through incurred cost audits even though the submission shows that they are grossly under-billed and the government will have no recovery.

  • Floorcheck: 10%

Mostly happens to larger contractors.

  • Preaward Pricing: 25%

Occurs more for DOE and NASA procurements in my experience. There was a directive from DCMA a few years ago saying that DCAA would not review cost plus proposals for amounts less than $100 million.

For more information and for help preparing for your audit or in the DCAA audit process, contact us.

KDuncan & Company is dedicated to providing knowledge and support for small government contractors about concerns regarding government contracting. For questions on areas such as as cost proposals, accounting systems, DCAA compliance, and incurred cost audits, reach out to KDuncan & Company.

What is a DCAA Audit?

As a government contractor, audits, sometimes DCAA, are a regular part of the business. It is the Contracting Officer’s responsibility to request an audit. Here are six important questions that arise:

  1. What is a DCAA audit?
  2. How important is it to my business?
  3. When can I expect it?
  4. How do I prepare for it?
  5. How do I survive it?
  6. What does it buy my company?

This blog post will address the first two questions. A DCAA audit is an evaluation of a condition within your company against particular government standards and/or regulations. I will list the various audits in order of the life cycle of a typical contractor.

1. Pre-award Pricing Proposal Review

You have submitted a cost proposal on a FAR 15, Negotiated Contract, procurement. The auditor’s job is to determine if the pricing proposed is fair and reasonable. In government contracting, pricing is considered fair and reasonable if there is adequate competition or if pricing is based on projected costs incurred, then the reasonableness, allocability, and allowability of the projected direct and indirect costs. Ultimately, the auditor will produce information for the government to project the real price of your cost proposal. This could determine win versus loss of this procurement.

2. Pre-award Accounting System Review

The auditor’s job is to evaluate the design of Accounting System to determine if it is acceptable for prospective contract. Per FAR 9.104-1(e), to be determined responsible, the contractor must have the necessary accounting and operational controls in place. The auditor uses the SF1408 from FAR 53 as a guideline. The form is a checklist of criteria. The auditor must check “Yes” to all applicable criteria or you and your system fail the review. When you pass, you will move forward to the next step of the procurement process.

3. Financial Capability Review

The auditor’s job is to determine if the potential contractor can stay in business long enough to complete existing and potential contract work.  The auditor will request financial statements to conduct a financial analysis on them. The auditor will focus on 8 key financial ratios. Unless a review of the certified statements uncovers something obviously erroneous and of a material nature, the analyst can only assume that the statements are accurate.  The contractor’s or its CPA’s certification is required. This could determine win versus loss of this procurement.

4. Floorcheck Review

The auditor’s job is to evaluate the accuracy of contractor employees (salaried and/or hourly) labor hour charges to contracts, indirect accounts, or other cost objectives. When properly tailored and approved by the supervisory auditor, this program can be used to perform labor floor checks and interviews to help satisfy the mandatory annual audit requirement relating to labor floor checks and/or interviews. Typically, this review is done without prior notification. This could determine the level of scrutiny the government uses in reviewing you billings or whether the government choosing to continue your current costs reimbursable contracts.

5. Incurred Cost Audit

You have been operating and billing a cost reimbursable contract, cost plus or T&M. You have provided an incurred cost submission to the government. The auditor’s job is to evaluate the accuracy of the incurred cost submission; ultimately determining whether you have under-billed or over-billed the government. The auditor will conduct transaction testing of your general ledger and the support documents available to support the transactions to determine the total costs per contract with indirect costs applied. An important aspect is the determination of allowability, allocability, and reasonableness of costs. Note: retaining source documents is of vital importance in these engagements. This will determine whether you owe money to the government or the government owes you.

6. Postaward Defective Pricing Audit

The government thinks that you have violated the Truth In Negotiations Act. You have inflated the costs projections used as the basis of your costs proposal in order to raise the price of an Fixed Priced or T&M contract. The auditor’s job is to determine if a negotiated contract price was increased by a significant amount because the contractor did not submit or disclose accurate, complete, and current cost or pricing data.

In our next blog post, we’ll address what you can expect in a DCAA audit. Have questions? Contact us.

KDuncan & Company is dedicated to providing knowledge and support for small government contractors about concerns regarding government contracting. For questions on areas such as as cost proposals, accounting systems, DCAA compliance, and incurred cost audits, reach out to KDuncan & Company.