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 recordkeeping 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 recordkeeping 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 recordkeeping 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. Keeping Records of Deductions Fortunately, the IRS does not prescribe a specific format taxpayers must use for keeping records. Accuracy (not form) should be the key to your recordkeeping system. Everyone seems to have his/her own way of doing it. Some taxpayers, for example, use envelopes or file folders segregate receipts into different categories. Others simply keep all receipts in a container which they organize when tax time rolls around. No matter what recordkeeping system you prefer, strive for the accuracy an auditor would look for in an examination of your return. Make certain that your deductible expenses are backed up by sales slips, invoices, receipts, and/or canceled checks. In some cases, depending on the type of expense, you should get in the habit of keeping a timely log or calendar to track the purpose of your expenses. This is particularly true when you deduct business costs like car expense or travel and entertainment. Your log needs to contain details about costs, mileage, places traveled, people entertained, etc. A well-kept log can sometimes serve as a substitute for keeping all your receipts (be sure to check with your tax advisor about the circumstances under which this is possible). Besides business deductions, other expenses need to be tracked as well. The reverse side of this brochure provides a quick checklist for some of the most frequently used itemized deductions. The list is by no means exhaustive so be sure to check them out with your tax advisor if you have questions about items no on the listed. 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 (e.g., rent, prizes, non-employee payments) Form 1099-MISC 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. Knowing When To Discard 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 3 years from the return due date or the date the return was filed, whichever is later. However, the statute of limitations for many states in 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 tot he lengthened state statutes clouding the recordkeeping issue, the federal 3-year rule has a number of exceptions: The assessment period is extended to 6 years instead of 3 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 on 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 3 years old; add a year or so to that if you live in a state with a longer statute. Examples: Sue filed her 2002 tax return before the due date of April 15, 2003. She will be able to safely dispose of most of her records after April 15, 2006. On the other hand, Don filed his ’02 return on June 1, 2003. He needs to keep his records at least until June 1, 2006. 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 3 years. Important Note: Even if you discard backup records, never throw away your file copy of any tax return (including W-2’s). 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 3 Years You should keep certain records for longer than 3 years. These records include: Stock acquisition data. If you own stock in a corporation, keep the purchase records for at least 4 years after the year you sell the stock. The 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 4 years after final sale. Tangible property purchase and improvement records. Keep records of home, investment, rental property, or business property acquisitions AND related capital improvements for at least 4 years after the underlying property is sold. Quick Checklist of Itemized Deductions Medical Expenses Medical insurance premiums, prescription drugs, doctors, dentists, hospitals, lab fees, medical equipment, transportation, parking, eyeglasses, certain capital expenditures, chiropractors, psychologists Taxes State, local income taxes, certain foreign taxes, real estate taxes, personal property taxes Interest Home mortgage interest (within limits), certain points paid on home mortgages, interest paid on loans related to investment property (e.g., stock unimproved land) Charitable Contributions Cash and non cash donations to: agencies of U.S., state, or U.S. possessions; religious, educational, or scientific organizations; war veterans’ groups; fraternal societies (under special rules) Casualty Losses Work-Related Expenses Investment Expenses Gambling Losses To Extent of Winnings   The purpose of this page is to provide current information on tax, financial and business developments. It suggests general tax planning ideas that may be appropriate in certain situations. The information and opinions are generalizations and may not apply to all taxpayers; it is important that you seek appropriate advice before implementing any of the ideas suggested.