Category Archives: Corporation Taxation (1120 / 1120S)

IRS extends upcoming deadlines, provides tax relief for victims of Hurricane Florence

Hurricane Florence victims in parts of North Carolina and elsewhere have until Jan. 31, 2019, to file certain individual and business tax returns and make certain tax payments, the Internal Revenue Service announced today.

The IRS is offering this relief to any area designated by the Federal Emergency Management Agency (FEMA), as qualifying for individual assistance. Currently, this only includes parts of North Carolina, but taxpayers in localities added later to the disaster area, including those in other states, will automatically receive the same filing and payment relief. The current list of eligible localities is always available on the disaster relief page on IRS.gov.

The tax relief postpones various tax filing and payment deadlines that occurred starting on Sept. 7, 2018 in North Carolina. As a result, affected individuals and businesses will have until Jan. 31, 2019, to file returns and pay any taxes that were originally due during this period.

This includes quarterly estimated income tax payments due on Sept. 17, 2018, and the quarterly payroll and excise tax returns normally due on Oct. 31, 2018. Businesses with extensions also have the additional time including, among others, calendar-year partnerships whose 2017 extensions run out on Sept. 17, 2018. Taxpayers who had a valid extension to file their 2017 return due to run out on Oct. 15, 2018 will also have more time to file.

In addition, penalties on payroll and excise tax deposits due on or after Sept. 7, 2018, and before Sept. 24, 2018, will be abated as long as the deposits are made by Sept. 24, 2018.

The IRS disaster relief page has details on other returns, payments and tax-related actions qualifying for the additional time.

The IRS automatically provides filing and penalty relief to any taxpayer with an IRS address of record located in the disaster area. Thus, taxpayers need not contact the IRS to get this relief. However, if an affected taxpayer receives a late filing or late payment penalty notice from the IRS that has an original or extended filing, payment or deposit due date falling within the postponement period, the taxpayer should call the number on the notice to have the penalty abated.

In addition, the IRS will work with any taxpayer who lives outside the disaster area but whose records necessary to meet a deadline occurring during the postponement period are located in the affected area. Taxpayers qualifying for relief who live outside the disaster area need to contact the IRS at 866-562-5227. This also includes workers assisting the relief activities who are affiliated with a recognized government or philanthropic organization.

Individuals and businesses in a federally declared disaster area who suffered uninsured or unreimbursed disaster-related losses can choose to claim them on either the return for the year the loss occurred (in this instance, the 2018 return normally filed next year), or the return for the prior year (2017). See Publication 547 for details.

The tax relief is part of a coordinated federal response to the damage caused by severe storms and flooding and is based on local damage assessments by FEMA. For information on disaster recovery, visit disasterassistance.gov.

See also the Hurricane Florence Information Center.

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Drought-Stricken Texas Farmers and Ranchers Have More Time to Replace Livestock

Texas farmers and ranchers who previously were forced to sell livestock due to drought, like the drought currently affecting much of the nation, have an extended period of time in which to replace the livestock and defer tax on any gains from the forced sales, the Internal Revenue Service announced today.

Farmers and ranchers who, due to drought, sell more livestock than they normally would may defer tax on the extra gains from those sales. To qualify, the livestock generally must be replaced within a four-year period. The IRS is authorized to extend this period if the drought continues.

The one-year extension of the replacement period announced today generally applies to capital gains realized by eligible farmers and ranchers on sales of livestock held for draft, dairy or breeding purposes due to drought. Sales of other livestock, such as those raised for slaughter or held for sporting purposes, and poultry are not eligible.

The IRS is providing this relief to any farm located in a county, parish, city, borough, census area or district, listed as suffering exceptional, extreme or severe drought conditions by the National Drought Mitigation Center (NDMC), during any weekly period between Sept. 1, 2013, and Aug. 31, 2014. All or part of 30 states are listed. Any county contiguous to a county listed by the NDMC also qualifies for this relief.

As a result, farmers and ranchers in these areas whose drought sale replacement period was scheduled to expire at the end of this tax year, Dec. 31, 2014, in most cases, will now have until the end of their next tax year. Because the normal drought sale replacement period is four years, this extension immediately impacts drought sales that occurred during 2010. But because of previous drought-related extensions affecting some of these localities, the replacement periods for some drought sales before 2010 are also affected. Additional extensions will be granted if severe drought conditions persist.

Steve Eubanks, EA
Strategic Tax Group
www.strategictaxgroup.com

Late S Corporation Elections

A new revenue procedure was issued that provides requirements to be met for relief for taxpayers that make late S corporation elections, electing small business trust (ESBT) elections, qualified subchapter S trust (QSST) elections, qualified subchapter S subsidiary (QSub) elections, and late corporate classification elections that the taxpayer intended to take effect on the same date that the taxpayer intended that an S corporation election for the entity should take effect (Rev. Proc. 2013-30 ).

We are here to assist you with your tax issues.

Steve Eubanks, EA
Strategic Tax Group
Dallas, Texas
www.strategictaxgroup.com

Tax Strategies for Small Businesses – Part 6

Under Utilized Deductions

In this free tax strategy update, I limited how much free advice I would provide. Instead of just throwing a bunch of bullet points together, I decided to get into some specifics around two areas that are likely to save you real money – Business Travel and Healthcare. In future editions, I will discuss other areas based on feedback from my clients.

Business Travel Deductions

If travel occurs purely for business purposes, the travel expenses (including transportation, lodging, meals and reasonable entertainment) are either fully or partially deductible. Business meals and entertainment expenses are only 50% deductible, but almost every other travel related expense is fully deductible. Even if the travel includes both personal and business components, as long as the trip is primarily for business, the full cost of the trip is likely deductible.

The phrase, primarily for business is generally based on a 50% rule. For example, if you have meetings in Orlando for two days, and decide to stay an extra day to play golf or hit a theme park – you’ve spent 2/3 of the trip working and can deduct the entire trip. To be able to deduct the golf or theme park, you need to make sure that you are entertaining a current or prospective client or business partner.

In Flowers vs. Commissioner, the Supreme Court identified three requirements to deduct expenses for business travel:

  • Expenses occurred away from home (preferably a different MSA);
  • The expenses relate to the operation of your business;
  • The expenses are necessary and the amount is reasonable.

Like all deductions, you must be able to defend any deduction to an IRS examiner, but determining reasonable travel expenditures takes into account the cost of the trip, the benefits received from the trip and the relative cost of the trip compared to the other expenses of the firm. A small coffee shop will have a harder time defending a global trip to visit different coffee shops to Japan than Starbucks.

If you combine business and personal travel but your trip isn’t primarily for business, you can’t deduct any of your transportation expenses. Furthermore, you can only deduct as travel expenses the amount you incur on days that are purely business.

Travel time (driving or flying) is excluded from the work-personal days formula. If you had three days of business and added two personal days, two days of traveling keeps the trip primarily business, but two days of travel, one business and two days personal would fail the test. However, many tax accountants extend the logic of IRS Letter Ruling 9237014, and advise clients that they can extend a stay over a weekend with the express purpose of getting cheaper airfare and lower hotel rates for an extended stay. In other words, the extension has to make economic sense.

You may also deduct travel expenses for family members if the family member is an employee and there’s a business reason for the person to be travelling. Traveling with a spouse who also works in the family business is usually deductible. A spouse who works for the business and drives you to a convention so that you can focus on work, can stay with you at the convention and typically have their expenses be deductible. Foreign travel expenses may also be deducted, but the rules are more restrictive. If you travel internationally and your trip lasts a week or less, the trip needs to be primarily (50%) for business in order to be fully deductible. For trips longer than a week, the trip needs to be more than 75% business in order to be fully deductible. In making your percentage calculation, you must include your travel days, weekend days and holidays. If you work the day before and the day after a weekend or holiday, then the weekend or holiday days count as business days, too.

It should be noted that excessive travel deductions are a sure ‘red-flag’ for IRS examiners. As with all deductions, it is important to do good planning and even better documentation. Keep a copy of your schedule, conference schedules and details that demonstrate that you have met the 50% rule for business. It’s one thing to take advantage of the rules as written, but you have to at least be able to demonstrate that you at least met the requirements of the law.

Medical Expenses

People often think you can easily deduct medical expenses as a personal tax deduction, but that usually doesn’t work. Taxpayers only get the deduction if they itemize–and only 35% of the population itemizes. But it gets worse because taxpayers who do itemize can only deduct medical expenditures in excess of 7.5% of their adjusted gross income (AGI).

If you own a small business you can much more easily deduct your healthcare expenses through the self-employed health insurance deduction and the health savings account option. If you run a one-person business, you can even double-deduct your healthcare expenses by using S corporations or a healthcare reimbursement arrangement.

The self-employed health insurance deduction works like this: If you’re self-employed as a sole proprietor, a working partner in a partnership, or a shareholder-employer who owns 2% or more of an S corporation, you can probably deduct your health insurance premiums on the first page of your 1040 tax return. In other words, your health insurance premiums probably become a tax deduction in their entirety.

There are a handful of rules for taking the self-employed health insurance deduction. You’ll need sole proprietorship profits, a partnership income share, or S corporation shareholder-employee wages at least equal to the self- employed health insurance deduction you want to take.

Another rule is that someone else, such as your spouse’s employer, cannot subsidize the health insurance. With partnerships, the health insurance needs to be a group health insurance policy paid for by the partnership. And with S corporations, the health insurance premiums either need to be paid directly by the S corporation or the S corporation needs to reimburse the shareholder-employee.

Health Savings Accounts

The self-employed health insurance deduction is a good deduction. But it doesn’t help out much with the stuff that’s not covered by your insurance: deductibles, copayments and so on. However, you can use another tax strategy to convert these costs into income tax deductions: the health savings account (HSA).

As long as your health insurance policy is prepared a specific way, you can contribute money to a special bank account called a “health savings account” or “HSA” and take an income tax deduction for the contribution.

In 2012, a single person can contribute $3,100 to the savings account and a family can contribute $6,250. If you’re 55 or older, you can add $1,000 to these values. Depending on the taxpayer’s top income tax rate, these contributions should save $1,000 to $2,000 a year in income taxes.

You can spend the money in your HSA on deductibles, copayments and most other “not covered by your health insurance” medical expenses. The only downside is that if you withdraw money from your HSA or spend the money on something other than healthcare before you’re age 65, you pay regular income taxes on the withdrawal and also a 20% additional tax.

To use the HSA, your health insurance policy must qualify as a high deductible health plan (HDHP). In a nutshell, a HDHP is a catastrophic health insurance policy that conforms to the rules that Congress created. To know whether a particular health insurance policy qualifies as a HDHP, you need to ask the insurance agent or insurance company.

With an HDHP, you get a self-employed health insurance deduction, thereby turning your health insurance into an income tax deduction. With an HSA account, you get a health savings account deduction, thereby turning your deductibles, copayments and other uncovered healthcare expenses into deductions. These deductions should save you thousands of dollars a year.

Double Deducting Healthcare Expenses

For many small business owners, the combination of a self-employed health insurance deduction and a health savings account will be the optimal solution. But some small business owners who employ only themselves or only family members may be able to do even better. These only-family-employee businesses may be able to deduct healthcare expenses as income tax deductions and employment tax deductions – a double deduction.

If you operate your business as an S corporation, treat health insurance premiums paid by the S corporation as wages. Treat any HSA contributions made by the corporation as shareholder-employee wages. When you do this, the health insurance and HSA amounts are reported on the shareholder-employee’s W-2 as wages subject to income taxes, but they aren’t reported as wages subject to Social Security and Medicare taxes. This means you save Social Security and Medicare taxes—the first deduction. When you later prepare your 1040 tax return, the health insurance and HSA amounts get treated as income tax deductions. This is the second deduction.

To get the double-deduction calculations to work right, you need to pay the shareholder-employee reasonable compensation. You must pay real wages at least equal to the wages that appear because the health insurance counts as wages.

S Corp Example – In order to double deduct $15,000 of self-employed health insurance and HSA contributions, the shareholder-employee should be paid another $15,000 in wages. The shareholder-employee’s total wages in this case would be $30,000 (the $15,000 in regular wages plus the $15,000 in health insurance and HSA contributions), but only the first $15,000, however, would be subject to Social Security or Medicare taxes.

An unincorporated one-person business run by someone who’s married has another way to double deduct: The owner can create a healthcare reimbursement arrangement (HRA), also known as a Sec. 105(b) plan, and then employ the spouse. The owner must set up an HRA for employees. The HRA says the business will pay $5,000 or $10,000 or $20,000 of any employee’s family healthcare expenses (including insurance). As the owner, you can’t be covered directly. However, when you hire your spouse, the HRA may provide coverage to your spouse-employee and to his or her family (which will include you).

If you set up an HRA, the healthcare expenses you reimburse become an employee fringe benefit expense on your business’s tax return. And that means you get the double deduction.

You save both income taxes and employment taxes.

One note of caution: the IRS tends to be pretty suspicious of sole proprietorship

Sec. 105(b) plans. You must ensure that your spouse’s job is real, well documented and paid at market rates. A one-hour a week job, for example, will not support a $20,000 a year HRA benefit.

Using HRAs and HSAs to get a double deduction doesn’t work as well for businesses with non-family-employees because you have to provide the HRA or HSA to all your employees. You can’t provide the benefit just to the owner or the owner’s spouse and kids. You can terminate a healthcare reimbursement arrangement. But terminating something like an HRA right before you hire a non-family-member employee probably violates the fringe benefit rules that say you can’t discriminate in favor of owners. A HRA works best for stable, two-employee husband-and-wife businesses.

If you or your spouse owns another business, that business needs to have the same HRA plan, too. You can’t create two businesses and have you and your spouse work in the “good fringe benefits” business. And then put all the employees into the “bad fringe benefits” business. That also violates the rules.

Obamacare

The healthcare legislation that became law in 2009 has minimal affect on healthcare deduction rules.

The most controversial aspects of the law affect businesses with over 50 employees.

If your firm employs fewer than 50 employees, you don’t have to offer insurance. The penalties for not offering insurance kick in when your head count rises above 50. If you employ 25 or fewer people and they earn minimum or modest wages, you can get a tax credit for the first two years you offer workers insurance. The credit runs as much as 35% to 50% of the insurance premiums you pay, but the calculations are tricky.

As a tax planning issue, most small businesses don’t need to get hung up on the politics around Obamacare. Focus on your business; let the politicians focus on the politics.

Tax Strategies for Small Businesses – Part 5

Incorporating or Forming an LLC

The Internet is full of websites claiming that huge tax savings are available to businesses that incorporate or form a limited liability company (LLC) – in a company’s own State, or another State or Country. There are real benefits (and costs) associated with incorporation/LLC, but the decision the decision needs careful study and a discussion with a tax professional or tax attorney.

Subchapter S Election for Corporations and Limited Liability Companies

The Subchapter S election, an option available for both corporations and limited liability companies, may work well as a small business tax savings strategy.

If you operate a small business as a sole proprietorship or partnership, you pay not only income taxes on your profits, but also self-employment taxes (for 2012, roughly 15% on the first $110,000 and then roughly 3% on any amounts above $110,000.)

If a business incorporates or forms an LLC and the business files the necessary paperwork to use the Subchapter S accounting rules, the business only pays the employment taxes on the part of the profit that the business specifically labels “wages.”

Example: If a business operates as a sole proprietorship and makes $100,000, the owner will pay $15,000 in self-employment taxes. If the owner re-forms the entity as an S corporation and pays him or herself a salary of $40,000, the owner will pay $6,000 in Social Security and Medicare taxes. An S corporation in this situation, saves the owner roughly $9,000 a year.

Sole proprietors and partners pay self-employment taxes. Owner-employees in an S corporation or regular corporation pay Social Security and Medicare taxes. The tax labels really don’t matter. If you are considering an S corporation and want help setting a low but reasonable salary (and that’s the secret for really saving money with an S corporation), contact your tax professional to discuss the costs and benefits.

Out–of–State and Offshore Incorporation

Incorporating in another state to avoid your home state’s taxes is a scheme that some unscrupulous online incorporation services promote. It doesn’t work. You can’t incorporate your California business in a state without income taxes and avoid California state income taxes.

Offshore incorporation fails to reduce taxes for the same reason that out-of-state incorporation does. If you’re operating in the U.S, you are liable for U.S. taxes. There is a “right” way to minimize state income taxes: relocate your business from a high-tax state to a low tax state.

Tax Strategies for Small Businesses – Part 4

The Startup Expenditure Rules

As discussed earlier, ordinary and necessary expenditures are tax deductible. Very few businesses start earning revenue the day they were formed – in fact, most business owners spend a good deal of money before their business is established and/or starts earning revenue. Because of prior abuses (or aggressive accounting, if you wish), tax law has specific rules around startup expenditures. It is important that all new small business owners understand these rules to maximize their tax savings and avoid costly mistakes.

Startup Expenditures

Startup expenses are the ordinary and necessary expenditures associated with setting up a business or investigating the purchase of an existing business. Among the items that count as startup expenses:

  • An analysis or survey of potential markets, products, labor supply and transportation;
  • Advertisements for the opening of the business;
  • Salaries and wages for employees who are being trained and their instructors;
  • Travel and other costs for securing prospective distributors, suppliers or customers;
  • Salaries and fees for executives and consultants, or for similar professional services;
  • Internet-related expenses including domain registrations fees and web consulting.

Start-up costs do not include deductible interest, taxes and research and experimental costs.

Organizational Expenses

Organizational expenses are the ordinary and necessary fees associated with initially organizing your new business. Among the expenses that may qualify as organizational expenses are:

  • City, County, State and Federal Incorporation Costs & Similar Government Fees;
  • Attorney Fees for Incorporating the Business;
  • Accountant and Tax Professional Costs.

For expenses incurred before a formal start of a business, the IRS has very specific guidelines. These guidelines treat expenses differently below $5,000, between $5,000 and $50,000 and above $50,000. Establishing the date you started your business is important, and should be given real consideration and appropriate documentation.

$5,000 or less in startup or organizational expenditures: You can deduct up to $5,000 in startup or organizational costs in the year you start the business.

Example: if you incurred $2,500 in startup expenditures and $2,500 in organizational fees in 2011, and your business starts in January of 2012, you may deduct the startup expenditures and organizational fees as business deductions in 2012.

$5,000 or more in startup expenditures & organizational expenditures: After the 1st $5,000 of organizational fees and $5,000 of startup expenditures, the remaining fees are treated as startup or organizational expenditures to be amortized. After you’ve spent $5,000 each in startup expenditures and organizational fees, you must amortize the remaining startup/organizational costs over 15 years, up to $45,000, excluding the $5,000 deductions for startup and organizational costs.

Example: In December 2011, you incurred $3,000 in startup expenditures and $12,000 in organizational costs for a business you started in January 2012 – you can deduct $5,000 plus $667 (1/15 of $10,000) in 2012, and deduct another $667 per year for the next 14 years.

More than $50,000 in startup expenditures: If you plan on spending more than $50,000, you should set-aside some money for a tax professional and an attorney to help you structure your expenditures. Most of the startup expenditures will need to be amortized over 15 years – but there are likely other strategies that can be suggested by a seasoned tax professional.

When an idea becomes a Business

Tax planning during the start-up phase is important. Many start-up costs that would be amortized over 15 years can be deducted as normal business expenditure once the business has been established. Whether it makes sense to take as many deductions of business startup costs as you can in the year you start a business depends on individual circumstances. In some cases, owners of startups may prefer to stretch out deductions over several years so that they can balance future revenue streams. In most cases, it is best to accelerate the start of the business to capture costs as normal business expenses. Your tax professional can be instrumental during the initial phase of any business.

The really important point in talking about startup expenditure is when the startup period stops and real operations begin. Only the expenditures made before real operations begin are classified as startup expenditures. A business would typically have revenue after operations begin, but it is not required.

Most tax professionals advise their clients to document the date that the business has officially started. The general principle is that the business has started when it is operating in its normal course. It’s always better to memorialize and document that date in case there is any dispute with an IRS examiner.

Example – Restaurant A: A new restaurateur incurs all sorts of expenses to open a new restaurant: site search costs, professional fees, menu development costs, training for wait and kitchen staff and so on. If these costs occur before the restaurant is open, the costs may have to be treated as startup expenditures and their deduction delayed.

Example – Restaurant B: Restaurateur B is a little more ‘tax-savvy’. While she is investigating the idea of starting a new restaurant, she keeps track of her costs with a strict limit in mind. Once she is relatively certain she is going to move forward with the venture, she decides to form a catering business or even a small food-cart. Once she’s formed this business, any expenditure related to expanding this business into a larger space would be an expansion of her food retailing operation, and could be deducted as normal operating expenses.

Timing the Start of Your Business

In many cases, the time of year is critical to whether you are classifying costs as startup/organizational or operating expenses. For example, if you think you can keep your startup/organizational costs to $5,000/$5,000 at the end of the calendar year – but don’t intend to start your business until the new year (maybe you have to give your old employer notice or wait out a non-compete) – it may make sense to spend up to the limits towards the end of the year, but cap your startup costs to the deductible limits and then spend the remaining costs after you’ve established a proper business start-date.

If you are going to start a business, you are likely going to lose money before you make any. These losses can be used as a deduction on your tax return if you have other income. If you work a regular job or for another business for the first part of the year and then start a business in the same year, you can net your wages with your business’s losses—and save taxes. This is especially important for anyone that is leaving a job with a generous severance package.

What happens if you don’t ‘start’ your business?

Startup expenditures for businesses that never start are difficult to deduct. If you spend money investigating a business opportunity and ultimately decide not to open, you normally cannot deduct these expenses as an individual. Unsuccessful startup expenditures that stem from an unfulfilled opportunity may be claimed as miscellaneous itemized deductions on a personal return.

It is therefore critical that you are careful about spending startup or organizational dollars on an endeavor that you are not confident will become a full-fledged business. Of course, many ‘startup/organizational’ expenditures can be expensed, as operational expenditures if analyzing a new business is a part of an existing business. If you already have an existing partnership, corporation or LLC, you should not need to worry as much about investigatory expense deductions.

One way or another, your tax return preparer will probably be able to get the deduction for the investigatory expenses onto your return.

Tax Strategies for Small Businesses – Part 3

The Importance of Accounting Records

Everyone in business must keep records. Good records will help you do the following.

Monitor the progress of your business.   You need good records to monitor the progress of your business. Records can show whether your business is improving, which items are selling, or what changes you need to make. Good records can increase the likelihood of business success.

Prepare your financial statements.   You need good records to prepare accurate financial statements. These include income (profit and loss) statements and balance sheets. These statements can help you in dealing with your bank or creditors and help you manage your business.

  • An income statement shows the income and expenses of the business for a given period of time.
  • A balance sheet shows the assets, liabilities, and your equity in the business on a given date.

Identify source of receipts.   You will receive money or property from many sources. Your records can identify the source of your receipts. You need this information to separate business from nonbusiness receipts and taxable from nontaxable income.

Keep track of deductible expenses.   You may forget expenses when you prepare your tax return unless you record them when they occur.

Prepare your tax returns.   You need good records to prepare your tax returns. These records must support the income, expenses, and credits you report. Generally, these are the same records you use to monitor your business and prepare your financial statements.

Support items reported on tax returns.   You must keep your business records available at all times for inspection by the IRS. If the IRS examines any of your tax returns, you may be asked to explain the items reported. A complete set of records will speed up the examination.

Kinds of Records to Keep

Except in a few cases, the law does not require any specific kind of records. You can choose any recordkeeping system suited to your business that clearly shows your income and expenses.

The business you are in affects the type of records you need to keep for federal tax purposes. You should set up your recordkeeping system using an accounting method that clearly shows your income for your tax year. If you are in more than one business, you should keep a complete and separate set of records for each business. A corporation should keep minutes of board of directors’ meetings.

Your recordkeeping system should include a summary of your business transactions. This summary is ordinarily made in your books (for example, accounting journals and ledgers). Your books must show your gross income, as well as your deductions and credits. For most small businesses, the business checkbook (discussed later) is the main source for entries in the business books. In addition, you must keep supporting documents, explained later.

Electronic records.   All requirements that apply to hard copy books and records also apply to electronic storage systems that maintain tax books and records. When you replace hard copy books and records, you must maintain the electronic storage systems for as long as they are material to the administration of tax law. An electronic storage system is any system for preparing or keeping your records either by electronic imaging or by transfer to an electronic storage media. The electronic storage system must index, store, preserve, retrieve and reproduce the electronically stored books and records in legible format. All electronic storage systems must provide a complete and accurate record of your data that is accessible to the IRS. Electronic storage systems are also subject to the same controls and retention guidelines as those imposed on your original hard copy books and records.

The original hard copy books and records may be destroyed provided that the electronic storage system has been tested to establish that the hard copy books and records are being reproduced in compliance with IRS requirements for an electronic storage system and procedures are established to ensure continued compliance with all applicable rules and regulations. You still have the responsibility of retaining any other books and records that are required to be retained.