Banking and Financial Services Sections

Regarding Records Retention

Often, ‘What’ May Be More Important Than ‘for How Long?’

By KRISTINA DRZAL-HOUGHTON, CPA MST

Kristina Drzal-Houghton

Kristina Drzal-Houghton

With the start of a new tax year, taxes become the focus of many businesses. As administrators gather their financial information to provide to their accountants, questions regarding records retention begin to fly. More often than not, administrators ask, “how long do I keep these?” or “when should we destroy our records?”

However, one area of concern that can often be overlooked is determining what records to keep in order to substantiate expenses. In this case, the ‘what’ may be more important than the ‘how long,’ should an IRS audit occur.

Every item of expense taken as a business deduction must be supported by documentary evidence. Documentary evidence consists of receipts, paid bills, or similar evidence sufficient to support an expenditure.  Ordinarily, documentary evidence will be considered adequate to support an expenditure if it includes sufficient information to establish the amount, date, place, and essential character of the expenditure. These documents can be retained electronically and need not be the original bills.

Documentary evidence includes electronic charge expense receipts provided by a credit-card company. In many cases, a credit-card statement or charge record is sufficient documentary evidence of an expense. For example, the nature of an expense paid to a car-rental company is ordinarily clear on its face.

If the nature of the expense isn’t clear on the face of the receipt, a credit-card receipt isn’t sufficient unless it contains an itemized breakdown. The requirement of a detailed breakdown would be required for payments to online or retail stores. The IRS will also detail examine phone and other utility bills to confirm the service location.  Auditors will often request the backup policy information for insurance payments so they can confirm the business purpose. Additionally, payments to service vendors should indicate where the services were rendered.

Reimbursing employees’ business expenses can often be an area where there are documentation challenges, especially where the employee is also a shareholder. It is important to obtain the proper documentations from all employees. I have seen practices assessed taxes when former shareholders are no longer with the practice and will not supply backup documents. When substantiating expenses, the initial documentation obtained is key.

For any payment to be deductible, there must be a business connection. An arrangement meets the business-connection requirement if it provides reimbursements only for business expenses that are allowable as deductions and that are paid or incurred by the employee in connection with the performance of services as an employee. The reimbursement to the employee may include amounts charged directly or indirectly to the practice through credit-card systems or another direct method.  

The documentation requirement is met if the arrangement requires each business expense to be substantiated to the practice within a reasonable period of time. An arrangement that reimburses travel, entertainment, or other deductible business expenses meets this requirement if information sufficient to satisfy the requirement is submitted to the practice.

The IRS will disallow any expense for travel away from home, including meals, lodging, and entertainment, unless the taxpayer substantiates by adequate records for each expenditure.

For example, when substantiating expenses for travel away from home, the IRS requires, in addition to documentary substantiation for each expense, that the time, place. and business purpose of the travel be proven. Furthermore, when substantiating entertainment expenses, you must prove the time, place, and business purpose of the entertainment, and the business relationship of the persons entertained.

Documentary evidence of lodging must show separate amounts for charges such as lodging, meals, and telephone calls. Thus, a hotel receipt will support an expenditure for business travel if it shows the name, location, date, and separate amounts charged for lodging, meals, telephone.

An electronic credit-card receipt meets this documentary evidence requirement if the receipt has an aggregate charge itemizing each expense, such as a final bill from a hotel listing separately the costs for meals, lodging, and telephone calls. But neither an electronic credit-card receipt nor a regular credit-card statement or charge record alone is acceptable evidence of a lodging expense if the statement doesn’t segregate lodging from other expenses that may not be deducted, such as non-deductible meal and entertainment expenses or personal expenses (e.g., spa charges or gift purchases).

Unreimbursed business expenses paid by a shareholder-employee on behalf of a corporation are employee business expenses subject to the 2%-of-AGI floor. However, when a shareholder-employee is a controlling stockholder, the IRS often asserts that the shareholder cannot deduct the expenses at all because they relate to corporate business rather than to duties as an employee. Therefore, practices should consider having a policy requiring the reimbursement of corporate expenses paid by shareholders. The corporation can then deduct the expense when paid, while the shareholder can treat the reimbursement as a repayment of the advanced funds.

Now may be the perfect time to draft or update your accounting policies and procedures document. Many associations can provide model documents, but you should still consult your accountant or tax advisor before finalizing your document.


Kristina Drzal-Houghton, CPA MST is the partner in charge of Taxation at Holyoke-based Meyers Brothers Kalicka, P.C.; (413) 536-8510.

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