Recordkeeping is a task that few people enjoy, whether you are doing it for yourself or for your business. Yet maintaining documentation of financial transactions is critical not just for the health of your company, but to protect yourself in the event of an audit.
Source documents create a paper trail that documents a financial transaction. These source documents are important for a number of reasons, including drafting financial statements, balancing your budget, and defending yourself in tax litigation. They can be maintained in paper or electronic form and must be kept for at least 3 to 4 years after the transaction has been completed.
At Pridgeon & Zoss, we advocate for both individuals and businesses in their dealings with the Internal Revenue Service (IRS) and the Minnesota Department of Revenue (MDR). We often rely on source documents to prove our clients’ case to the tax authorities. If you are facing an audit or are embroiled in a tax dispute, reach out to our law office today.
What Are Source Documents?
“Source document” is a term used in the accounting world to mean the original document that contains the details of a business or financial transaction. It typically has information about the names of the parties involved, the amount paid (if any), the purpose of the transaction, and the date. Source documents often have a unique number assigned to them, so that they can be easily identified within an accounting or software system.
Examples of source documents may include:
- Credit memos
- Canceled checks
- Expense reports
- Deposit slips
- Purchase orders
- Material requisition forms
- Time cards
In the modern era, many businesses and individuals choose to store source documents in electronic form. This can be as simple as scanning a receipt or invoice or even taking a picture of a purchase order for your records. Most businesses and government agencies follow the IRS standard that photocopies or an electronic version of source documents are acceptable as long as they are legible, contain all of the information present in the original document, and present the information in a format that is identical to the original document.
Why Are Source Documents Important?
Source documents are vital when it comes to bookkeeping and accounting because it proves that a particular financial transaction has occurred. For example, a company that sells widgets would want to keep track of all widget sales. Source documents – such as invoices and purchase orders – can be used to document each sale.
These documents can be used to monitor your business’ progress, prepare financial statements, identify the source of receipts, track deductible expenses, prepare tax returns, and support items reported on your tax returns. If you are audited, these source documents will be vital to support your position and to defend yourself in a tax dispute.
Depending on the type of business you run, you may need to maintain source documents related to:
- Gross receipts, which may be proven through cash register tapes, bank deposit slips, receipt books, invoices, credit card charge slips, and/or Forms 1099-MISC and 1099-NEC.
- Inventory, which may be shown through invoices, credit card sales slips, canceled checks, and cash register tape receipts.
- Expenses may be proven through invoices, petty cash slips, account statements, cash register tapes, and canceled checks.
- Travel, transportation, and gift expenses
- Employment taxes
- Assets, including purchase and sales invoices, real estate closing statements, and canceled checks.
These documents should be maintained by businesses just as an individual would keep receipts for tax-deductible items. During an internal or external audit, the source documents will prove that the financial transaction in question occurred.
The Internal Revenue Service (IRS) requires both individuals and businesses to keep certain source documents for a period of time. Generally, these documents should be maintained until the period of limitations for assessment of tax or for refund claims has expired. Individuals and businesses should maintain these source documents for:
- 3 years from the date that a tax return was filed;
- 6 years if you don’t report income that you should have reported and it is more than 25% of the gross income shown on the return, or it’s more than $5,000 and attributable to foreign financial assets; or
- Indefinitely if you fail to file a return or file a fraudulent tax return.
If you plan to make a refund claim, you should keep the relevant records for a period of 2 to 7 years, depending on your specific financial situation. All documents related to employment taxes must be maintained for a period of 4 years.
Facing Tax Issues? Give Our Law Firm a Call Today
If you are being audited by the IRS or the MDR, source documents will be vital to defending yourself and achieving the best possible outcome for your case. A skilled tax attorney can work with you to analyze your source documents and put together a strong defense.
Pridgeon & Zoss was founded by two former IRS attorneys. We have the knowledge and experience necessary to help our clients handle all types of tax issues, from audits to tax disputes to tax appeals. To learn more or to schedule a consultation with a Minnesota tax lawyer or fill out our online contact form.