A sole proprietorship is a common business structure because it is relatively straight forward to set up and has fewer filing and tax requirements than other business entities. However, like any business, sole proprietors must maintain business records. A sole proprietorship is formed by a single owner who may do business in his own name and remains personally liable for the debts of the business.
All businesses must maintain records, not only for tax purposes but also to monitor the progress of the business. The IRS requires that all businesses track and report business income. It also allows businesses to reduce income for tax purposes by certain expenses necessary to doing business. However, these expenses must be substantiated by receipts.
Sole Proprietorship Taxes
A sole proprietorship is not considered a separate legal entity, meaning that the business is simply an extension of the owner. The sole proprietorship is not taxed separately. Instead, the owner reports income from a sole proprietorship on his personal income taxes. Sole proprietor income and expenses are reported on Schedule C and included with form 1040. Sole proprietors must pay self-employment taxes to the IRS in addition to personal income tax.
Read More: Tax Differences Between an LLC & a Sole Proprietorship
The IRS recommends that both individuals and businesses hold onto their returns through the period of limitations for collecting unpaid taxes. Generally, the IRS may collect taxes for three years after you filed your personal return. However, if you had unreported income that was more than 25 percent of your income shown on your return, the IRS has six years to bring a claim against you. If you filed a fraudulent return, there is no deadline for the IRS to pursue a claim against you. In addition to maintaining the returns themselves, you must also hold onto all supporting documents, such as receipts for expenses you reported on your tax return. If your business has employees, the IRS recommends that you hold onto your records for at least four years after employment tax is paid.
After the period for tax collection has expired, there may be other reasons to continue to hold onto your tax returns and records. Your insurance company or creditors may require you to hold onto records for a longer period of time, for example. If you have employees, you must maintain personnel records for a year after an employee leaves, and payroll records must be held onto for three years. Essentially, you should hold onto business records for as long as there may be any legal claim that would require you to access old records.
Elizabeth Rayne earned her J.D. from Penn State University and has been practicing law since 2009, advising clients on issues ranging from employment law to nonprofit management. For two years, she served as a contributing editor for the "Vermont Environmental Monitor."