Hold on to those tax records But for how long?
By Caryn M. Feldman, CPA, MST
Maintaining tax records and receipts that corroborate what is claimed on your tax return can be a time consuming task. However, maintaining proper tax records is critical should the IRS later audit your return. Tax records are your first line of defense against the challenge of an audit.
What are the basics? While it is important that your tax records be accurate, the IRS generally does not require any particular form of recordkeeping. One of the best records that can be used to substantiate a particular expense is a canceled check. You should keep all canceled checks that relate to any items that you need or think you will need to prepare any tax return. You should also retain any receipts, sales slips and invoices that refer to items that might be included on your return.
These records include records of expenses that can be claimed as itemized deductions. Thus, you should keep records of any unreimbursed medical and dental expenses, including receipts showing the dates you paid them and receipts for transportation primarily for medical care. You should also retain canceled checks verifying the payments of any federal or state estimated tax payments, real estate and personal property taxes, as well as charitable contributions. If you perform services for a charity, be sure to keep records showing your out-of-pocket expenses.
In addition to keeping information that can be used to support deductions on your tax return, you will also need to maintain records that will substantiate the income reported on your return. This includes Forms W-2 indicating your wages and income tax withholdings from employment and Forms 1099 showing compensation earned as an independent contractor. You should also keep other Forms 1099 showing interest, dividends and other types of income, as well as financial statements you receive from any brokerage houses. It is also important that you keep copies of your tax returns and all related schedules and attachments.
A question my clients always ask is how long they need to keep these records. In short, you need to keep them for as long as the IRS can potentially challenge you on a particular item claimed on your return. This time frame is generally 3 years from the date you file your income tax return, or, if later,
2 years from the time you pay the tax. Sometimes, this time limit can be extended to 6 years and there is no limit of time for the IRS to bring an action against someone who has filed a false or fraudulent return.
In some cases, you should keep records longer than the regular IRS examination periods. You should definitely hold on to any records to indicate your basis in property, as basis is the yardstick for measuring taxable capital gain or loss. Basis includes the amount you paid for property and any major improvements made to it. You will also want to permanently retain certain documents, such as, trust documents, partnership agreements, wills, divorce decrees, leases, etc.
Although many homeowners may no longer need to keep track of basis for selling their principal residences due to the 1997 Taxpayer Relief Acts exclusion of $250,000 of gain from the sale of a principal residence ($500,000 for married taxpayers), most homeowners of higher-priced homes should maintain their records carefully in order to minimize their tax, in case inflation should push the gain upon eventual sale above the threshold amounts.
The kinds of expenses you should maintain are those that increase the tax basis on your home. These fall into two categories: those incurred at the time of original purchase and those improvements made over time that substantially add value to your home or prolong its life. Acquisition costs can include inspection fees, legal fees, appraisal fees, and title search costs. Some of the improvements that will reduce your gain include a new roof, bathroom and kitchen renovations, heating equipment, window replacements and landscaping.
Expenses that keep your home in good repair usually wont reduce your gain unless they are part of an extensive remodeling or renovation plan.
Good recordkeeping is the first step to sound tax planning. The sooner you begin organizing your tax data, the better off youll be. All the careful tax planning that you have done will be for naught if you cannot produce the appropriate records at tax-filing or upon subsequent IRS examination.
Caryn M. Feldman, CPA, MST is a tax manager at Walter & Shuffain, P.C. located in Norwood, MA, a public accounting firm providing tax, audit and business consulting services to individuals and closely-held businesses. For more information on maintaining your tax records, please call Caryn at 781-769-5300 or e-mail her at firstname.lastname@example.org.