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All taxpayers are required to keep accurate, permanent books and records so as to be able to determine the various types of income, gains, losses, costs, expenses, and other amounts that affect their income tax liability for the year. These 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 up to three years after its due date.
Deduction rules. In order to claim any deduction, a business owner, like any taxpayer, should be able to prove two things:
So, for every expense, you need a receipt or invoice showing the description and cost of the item, plus a canceled check or credit card charge slip.
In many cases, if you don't have records of a particular business expense but it's obvious that you must have incurred it, in an audit situation the IRS will estimate the amount of your expenses and allow you to deduct them. An example would be a retailer who has incomplete records of inventory purchases. The IRS will come up with a reasonable estimate of what the purchases should have been.
Certain expenses, which lend themselves to cheating, are subject to special documentation rules. The following expenses generally must be proven by adequate records or other evidence. For these expenses, if you have no records, the deduction will be completely disallowed:
For these types of expenses, you must keep receipts for any expense over $75, and for all lodging expenses whatever the amount. You must also substantiate each individual expense as to: (1) amount, (2) time and place, and (3) business purpose.
For entertainment and gift expenses, you must also note the business relationship of the person(s) being entertained or receiving a gift. These things can be noted on the back of the receipt, or recorded in a formal expense log. For vehicle expenses, you'll also have to keep a mileage log.