Keeping Tax Records
Every year, taxpayers go through the ritual of gathering the information needed to file their federal income tax return. Once completed, those records are often filed with those of prior years.
In this article, we're going to discuss the long-term recordkeeping requirements for individual taxpayers. As part of that discussion, we'll not only talk about the records the Internal Revenue Service (IRS) expects taxpayers to retain, but also how many years they need to maintain those records before disposing of them.
Filing a tax return is a paperwork intensive effort, the records needed to complete a federal income tax return include:
- W2 forms from all employers.
- A 1090G, if a taxpayer received a refund of state or local income taxes.
- Any 1099 Form received for the payment of dividends, income tax withholding, or other forms of income.
- Receipts for itemized deductions that will be taken on Schedule A.
Records and receipts for any other income or expense that might affect the taxpayer's federal income tax liability.
Recordkeeping for Expenses
If an individual is eligible to deduct travel, entertainment, transportation, or charitable gifts, they're going to need to provide proof of such expenses. In this case, adequate records are considered written evidence documenting these payments. Examples of acceptable written evidence include receipts, canceled checks, bills, or paid invoices that support all claims.Generally, individuals should create a complete written record of all expenses claimed on an income tax return using the following four dimensions:
- Amount: the actual cost of the expense and the most common form of this written evidence is a receipt or invoice.
- Time: a written record of the dates traveled on business or when clients were entertained. If the expense involved local travel, the dates of car rentals, train tickets, or taxi fare.
- Destination: the name of the city or town traveled to, the address of the restaurant, or the place of entertainment. In the case of a gift, keep a written description of the gift.
- Business Purpose: a written record of the purpose of the business expense, as well as the professional relationships of all individuals involved.
Individuals wishing to claim charitable gifts of money now have three options available to prove they made this donation:
- Bank Records: includes canceled checks, credit card statements, or a statement from the bank or credit union showing the name of the charity, date, and amount of donation. Credit card statements need to show the transaction posting date as well as the name of the charity.
- Written Communication: information received from the charity must show the name of the organization, date, and contribution amount.
- Payroll Deductions: if a taxpayer wishes to deduct a donation made via regular payroll deductions, they will need to retain their pay stub, IRS Form W-2, pledge card, or another document provided by their employer that shows the charity's name, date, and the amount of the donation.
In the case of charitable donations, the IRS requirements no longer allow written logs, diaries, or notes made by the taxpayer at the time of donation. These types of records are no longer considered sufficient proof of the donation's value.
Maintaining Accurate Records
There are a good number of reasons to maintain accurate tax records. They can help identify the exact source of all income, they can help taxpayers track their deductible expenses, and they can aid in the process of preparing a tax return. This information is also invaluable when faced with an audit of a return.
The basic kinds of records to maintain include:
- Proof of Income: including bank and brokerage statements, Form W-2, Form 1099, and Form K-1 for individuals involved with a partnership and / or a Subchapter S corporation.
- Investment Gains and Losses: statements received from mutual funds and brokerage houses, Form 1099, and Form 2439 (Notice to Shareholder of Undistributed Long-Term Capital Gains).
- Deductible Expenses: all written documentation received from charities, in addition to canceled checks, receipts / sales slips, and invoices.
- Home / Housing Costs: receipts that can be used to document major improvements made to a home, closing statements, and insurance records. This information can be used to adjust the cost basis of a home when it's sold.
When it comes to providing proof of payments, it's important to maintain for each type of payment:
- Cash, Credit, or Debit Cards: amounts paid, name of the payee, as well as the dates of all payments.
- Checks / Electronic Funds: in addition to the above-mentioned information for cash, taxpayers need to record the check / reference numbers and the dates these transactions were posted to bank accounts.
Taxpayers should also keep records associated with: alimony paid, casualty and theft losses, child care expenses, charitable contributions, education expenses, un-reimbursed business expenses, gambling winnings or losses, retirement account contributions, mortgage interest paid, moving expenses, pensions / annuity payments, taxes paid, and tips received.
If the above list looks familiar, that's because these are the categories of deductions, as well as sources of income, that are accounted for when completing a tax return.
Retaining Tax Records
As stated at the beginning of this article, taxpayers often find themselves asking a very reasonable question: How long do I need to keep my tax records? The answer to this question is relatively straightforward. The Internal Revenue Code requires taxpayers to keep their records for as long as they might be needed to prove a claim on a tax return.
Essentially, this requirement translates into a "period of limitation," that applies specifically to tax returns. The table below outlines the periods of limitations that apply to individuals. The timelines mentioned below start with the return's filing deadline. If a tax return was filed before its due date, the timeline still begins on the filing deadline.
Tax Record Period of Limitation
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