Keeping
Your Tax Records
When
it comes to your taxes, good records are the best protection you can
have if the government decides to audit your returns. But just as
important as
your effective record keeping are the measures you take to make
certain that
your records are kept safe. While it may cause a chuckle to picture a
mythical taxpayer confessing to an IRS auditor that tax records were
destroyed by the family pet, it probably wouldn’t be nearly as
funny to give a
similar response in a real audit of your own.
The
Advantage of Good Records
A
good set of records can help you cut your taxes.
Detailed
records reduce the chance that you will overlook deductible expenses
when your tax return is prepared. After all, how many people remember
the exact details of their expenditures months after the fact?
Nothing is more frustrating than knowing you incurred deductions yet
not
being
able to prove them. The ultimate consequence of poor record keeping
is
enforced payment of more tax than the law requires.
Explicit
records provide the best assurance of a favorable
outcome
if you are audited.
Oral
testimony alone is seldom enough to prove the deductions you claim
on
your tax return – auditors want to see a paper trail of receipts,
logs, etc.
When
you’re missing adequate backup records, it can cost a great deal in
time and effort to get duplicates.
The
unfortunate fact is that many businesses balk at hunting down
receipts
for
past sales (you can’t really blame them since it raises their
expenses). Your ongoing record keeping effort is your best remedy to
counteract this problem.
Good
records help others who might have to handle your
financial
affairs in an emergency – e.g., an illness.
The
better your records are, the easier it could be for someone else to
temporarily “step into your shoes” to handle your monetary
transactions.
Tracking
Income
How
you track your income is largely dependent on the type of income you
are receiving. For certain kinds of income, you will receive
statements from the income payers to tell you the amount. These
statements are called “information returns” by the IRS. Examples
include:
Type
of Income Type of Information Return
Wages
Form W-2
Pensions/IRAs
Form 1099-R
Interest
Form 1099-INT
Dividends
Form 1099-DIV
Stock
Sales Form 1099-B
Real
Property Sales Form 1099-S
Miscellaneous
Income Form 1099-MISC
(e.g.,
rent, prizes,non-employee payments)
Gambling
Winnings Form W-2G
Unemployment
Comp Form 1099-G
Tax
Refund Form 1099-G
Canceled
Debts Form 1099-A
Form
1099-C
Be
sure to keep information returns you receive in a safe place so that
the amounts reported on them can be shown accurately on your tax
return. Payers must submit the data to the government as well as to
you. The IRS will compare what they have received with your return to
see that your
reporting
and their data match. If there’s a mismatch, you will get a letter
asking ‘Why?’ or assessing additional tax. Since the IRS may
misinterpret return reporting, check carefully before paying any
extra tax they try to assess!
Income
from Other Sources
Income
not traceable to information returns also needs to be reported on
your tax return. It could include such items as:
•
Receipts
from a self-employed business;
•
Rental
income;
•
Interest
income on a personal loan.
Taxpayers
who receive income from sources like these have a more complicated
job in tracking it. It’s recommended that you record it in a
separate ledger or through a computer spreadsheet program. In
addition, you
may
want to deposit the funds in a separate bank account earmarked for
that income alone.
Getting
Organized
No
one method is the only way to maintain your records. What’s
important is to develop a system that is the most convenient and
comprehensive for your situation, and then to stick to it. The IRS
estimates that a taxpayer who files a
1040
return with itemized deductions, dividend or interest income, and
some stock sales will spend about eight hours doing record keeping.
For a more complex return, such as one with rental properties or
self-employment income, add at least another three to six hours. The
following suggestions may help you organize your records, and also
reduce the time you spend doing so.
Decide
first if you will maintain your records manually or
by
computer.
•
Bookkeeping
software - Some
taxpayers, even though they aren’t operating a business, choose
computerized “bookkeeping” software that uses their check
register data to track their income and expenses by category. Monthly
and yearly reports conveniently recap the income and expenses,
especially if the accounts (income and expense categories) are
consistent
with
how the information is reported for tax purposes.
•
Spreadsheet
method – In
lieu of purchasing bookkeeping software, a spreadsheet file (for
example, in Excel) may be set up where you record your yearly income
and expenses by tax return category. If you normally itemize your
deductions, set up a separate sheet for each of the major deduction
categories – medical, taxes, contributions, etc. – as found on
Schedule A. For medical expenses, for example, record each expense by
provider’s name, type, date, amount paid, and payment method. Note
medically related auto
mileage
at the same time. At year’s end, sort income and expenses of the
same type together to get a yearly total. For income items, a
cross-check from the spreadsheet to the 1099 forms for all bank
interest or other income sources is an accurate way to verify that
all needed 1099s have been received. If your tax adviser gives you a
“tax organizer” to help you prepare for your appointment, you can
quickly transfer the totals from your spreadsheet to the organizer,
or, instead, you can provide your adviser with a copy of the
spreadsheet.
•
Manual
lists – If
you keep track of your records manually, the same type of system
applies as for a spreadsheet, except you’ll set up a paper sheet
for each category of income and expense that you normally have on
your tax return. Write each payment you receive or expense you incur
on the applicable list. At the end of the year, each list is ready to
be totaled. If you make your entries no less frequently than monthly,
you’ll find that the overall time you spend will be less, and the
accuracy of the information will be greater, than if you wait until
just before your tax appointment to put
together
the year’s lists.
Methods
for retaining source documents
In
addition to your lists of income and expenses, the receipts, canceled
checks, credit card slips, income statements, etc., that back up the
amounts need to be retained in case your tax return is audited. This
is true whether
you
computerize or manually summarize your data. Choose from the
following
methods the one, or combination of methods, that suits you
best.
Envelopes
–
Using several blank envelopes, write the tax year and
names
of the income and expense categories that correspond to your
spreadsheet or manual list of accounts. After you’ve
recorded an item on your list, insert the corresponding receipt,
canceled check, etc., into the envelope. By storing
the source documents by category throughout the year, instead
ofthrowing
all of them in a box to get to “later,” you’ll not only save
time but considerable frustration if you must search for a particular
item. There is also less likelihood that a receipt or other document
will be lost.
Store
the envelopes in a larger master envelope or box.
File
Folders – Some
taxpayers prefer to use file folders labeled by income and expense
categories. These work well for manually maintained records,
as
the lists can go right in the folders along with the substantiating
receipts, checks, credit card slips, etc. Small-sized receipts should
be taped or stapled to a letter-sized sheet of paper to prevent them
from falling out of the folder.
Binders
– A
binder, set up with dividers labeled by income and expense
categories, is also useful for keeping your lists and paper records.
three-hole plastic sheet protectors are convenient for keeping source
documents together by category in the binder(s). Binders are
especially useful for filing monthly or quarterly brokerage or bank
account statements.
Start
now –If
you aren’t already in the habit of keeping your records organized
and maintaining them contemporaneously, start now! The effort
will
be worth it in time saved when you prepare for your next tax return
preparation
appointment. And most likely your records l be more accurate than
they’ve ever been before.
Knowing
When to Discard Records
Tangible
property purchase and improvement
records
Taxpayers
often question how long records must be kept and how long the IRS has
to audit a return after it is filed. ANSWER: It all depends on the
circumstances! In many cases, the federal statute of limitations can
be used to help you determine how long to keep records. With certain
exceptions,
the
statute for assessing additional tax is three years from the return
due
date
or the date the return was filed, whichever is later. However, the
statute of limitations for many states is one year longer than the
federal. The reason for this is that the IRS provides state taxing
authorities with federal audit results. The extra time on the state
statute gives states adequate time to assess tax based on any federal
tax adjustments. In addition to lengthened state statutes clouding
the record keeping issue, the federal three-year rule has a number of
exceptions:
•
The
assessment period is extended to six years instead of three if a
taxpayer omits from gross income an amount that is more than 25
percent of
the
income reported on a tax return.
•
The
IRS can assess additional tax with no time limit if a taxpayer: (a)
doesn’t file a return; (b) files a false or fraudulent return in
order to evade tax; or (c) deliberately tries to evade tax in any
other manner.
•
The
IRS gets an unlimited time to assess additional tax when a taxpayer
files
an unsigned return.
If
no exception applies to you, for federal purposes, you can probably
discard most of your tax records that are more than three years old;
add a year or so to that if you live in a state with a longer
statute.
Examples:
Sue
filed her 2008 tax return before the due date of April 15, 2009. She
will be able to safely dispose of most of her records after April 15,
2012. On the other hand, Don filed his 2008 return on June 2, 2009.
He needs to keep his records at least until June 2, 2012. In both
cases, the taxpayers may opt to keep their records a year or two
longer if their states have a statute of limitations longer than
three years. Note: If a due date falls on a Saturday,
Sunday
or holiday, the due date becomes the next business day.
Important
note:
Even
if you discard backup records, never throw away your file copy of any
tax return (including W-2s). Often, the return itself provides data
that can be used in future return calculations or to prove amounts
related to property
transactions,
social security benefits, etc.
Records
to Keep
Longer
Than Three Years
You
should keep certain records for longer than three years.
These
records include:
•
Stock
acquisition data.If you own stock in
a corporation, keep the purchase records for at least four years
after the year you sell the stock. This data
will
be needed in order to prove the amount of profit (or loss) you had on
the sale.
•
Stock
and mutual fund statements where you
reinvest
dividends.
Many taxpayers use
the dividends they receive from a stock or mutual fund to buy more
shares of the same stock or fund. The reinvested amounts add to basis
in the property and reduce gain when it is finally sold. Keep
statements at least four years after final sale.
•.Keep records of home, investment, rental
property, or business property acquisitions AND related capital
improvements for at least four years after the underlying property is
sold.
This
is one of the helpful handouts about taxes that we provide. Feel free
to request others. We can email them to you.
Dimond
Tax Services
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Tax Preparation at Reasonable Prices
510-531-0534
