Documenting Your Deposits
When a small business is subject to an IRS audit, one important focus may be the company’s reported income. This scrutiny typically involves a review of the business and personal bank accounts and accounting records, requiring the taxpayer to document and explain all income and non-income deposits made into these accounts.
While the IRS traditionally emphasizes larger deposits, I have encountered situations where clients were required to account for every single deposit in their bank accounts. Clearly distinct business and personal accounts can simplify matters, although explanations for personal deposits in a personal account may still be necessary.
We advise our clients to meticulously document each deposit entering their bank accounts. Some choose to note explanations in writing on their bank statements directly, retaining these statements in their permanent records. Others opt to record explanations in the ‘notes’ or ‘memo’ sections of their accounting software or spreadsheets. The key is to ensure that, when confronted by the IRS, adequate explanations can be provided for any non-income based deposits, even if it is as straightforward as withdrawing and redepositing funds.
It is crucial not to delay in making these notes, as the details can easily be forgotten. Additionally, it is important to bear in mind that the IRS may conduct audits several years later; maintain records for a minimum of 3 years.
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