Are you a tax record pack rat--hanging on to every tax return you've ever filed as well as all supporting documents and receipts? Or perhaps you toss out old tax returns either at home or in your business whenever the spirit moves you, or when cabinets and storage areas overflow with too much paper.
Either way, it makes good tax sense to periodically review your record-keeping habits. Organized, accurate tax records can help reduce your yearly tax bill and may even bail you out of an IRS audit.
Keeping good tax files is necessary if, for some reason, you need to submit an amended return; they can also be helpful to the survivor, executor or administrator of your estate. Above all, you have to be able to retrieve records when you need them. If you can't locate the tax records you need, you may spend hours--even days--going back to various sources to request statements and receipts.
If your business has limited space for tax records, James DeJesus, a tax partner with accounting firm Deloitte & Touche LLP in New York City, suggests keeping the past two years' records on site and storing remaining ones in a storage space or in a warehouse devoted to recordkeeping. You should also create copies or backup files for your tax documents and store them off site in case of a fire or natural disaster. This is true not only for tax records but for vital records such as your accounts receivable ledger. You want to be able to remember who owes you what. Warns DeJesus, "If you don't have backup files to provide this data, your business could be significantly interrupted if you were hit with a natural disaster."
Joan Szabo is a writer in McLean, Virginia, who has reported on tax issues for more than 11 years.
Something To Hold On To
When auditing a taxpayer, the IRS generally asks the individual to provide supporting documents for specific deductions. "If you can't find receipts the IRS has asked you to produce, you could lose the benefit of some deductions and end up facing a penalty," says DeJesus.
There are two types of records that will satisfy the IRS. The best are receipts or canceled checks showing the amount of the expenses, the date and who was paid. Diaries or other after-the-fact records, like expense account logs, are second best.
According to the IRS, it's not necessary to keep every tax return you've ever filed. The agency has some general guidelines on the types of records to keep, how long to keep them and what you can discard. Here's what the IRS and the tax specialists we consulted recommend:
*Annual tax returns. The IRS says you should keep your business and personal tax returns for at least three years from the date you filed them. This includes all receipts, canceled checks and records needed to support your deductions. While this is the general rule, you may want to keep your tax returns and the supporting documents longer--because the IRS can investigate your return beyond three years under certain circumstances.
Accountant Ralph Anderson tells his clients to keep returns and supporting documents for six to 10 years after filing a return. "If you have a substantial understatement of income, specifically 25 percent or greater of the income shown on the return, the IRS can go back six years to question your return," says Anderson, a partner with the New York City accounting firm M.R. Weiser and Co. Keep in mind there is no time limit if the IRS suspects a fraudulent return.
If you've lost a tax return, you can ask the IRS to send you a copy and all attachments. The agency warns, however, that returns filed six or more years ago may not be available. To request a copy of your return, complete Form 4506, Request for Copy or Transcript of Tax Form. The cost is $14 and should accompany Form 4506 when you mail it to the IRS.
- Equipment purchases. If you are depreciating any major pieces of equipment, keep records related to the purchase price and any depreciation already claimed. DeJesus recommends you save these records for at least four years after you dispose of the equipment.
- IRA and other pension records. It's a good idea to keep indefinitely a record of the funds you contribute to a pension plan. These records are useful when you start to withdraw money, especially if you've made some nondeductible IRA contributions and need to determine the tax-free and taxable parts of the withdrawal.
- Medical and dental expenses. If you find yourself in a situation where your unreimbursed medical and dental expenses are greater than 7.5 percent of your adjusted gross income (AGI), allowing you to take these costs as a deduction, be sure to keep the medical bills and canceled checks or receipts to show the date you paid them. Because you can include transportation expenses you incurred for medical care as a medical expense, the IRS suggests you keep a log of your mileage for this purpose, plus tolls and taxi or bus fares. To calculate the cost of using your car for medical reasons, the IRS allows you to deduct 10 cents per mile for the 1997 tax year.
- Basis of property. The exception to the six-year rule applies to records that relate to the basis, or cost, of your home. Tax experts say you shouldn't toss any records showing the purchase price of your home, any purchase expenses and the cost of any improvements.
The Taxpayer Relief Act of 1997 will have an effect on this recommendation. Under the new law, you can exclude $250,000 if single and $500,000 if married filing jointly for the gain on the sale of your residence if it took place May 7, 1997, or later. This change eliminates the need for many homeowners to keep capital improvement records that prove how much you invested in your home. But tax professionals say that doesn't apply in all cases. For example, records verifying improvements you've made to your home should be kept indefinitely if you plan to live in the home for a long time or if its value is rapidly increasing.
Under these circumstances, your gain could be higher than the $250,000 or $500,000 exclusion, which means you'll have to pay taxes on any gain above those limits when you sell the home, says DeJesus. In those cases, you'll want to have receipts showing the cost of improvements so you can figure the home's basis. Anderson explains, "Your cost basis increases and your gain decreases by the amount spent improving your home."
- Charitable work. If you itemize deductions, be sure to keep records of out-of-pocket expenses when volunteering for charity. If you use your car when doing volunteer work, you can deduct unreimbursed fuel expenses directly related to volunteering. If you don't want to deduct your actual expenses, the IRS says you can use a standard rate of 12 cents per mile to figure your charitable deduction in 1997; the rate will increase to 14 cents per mile next year. Parking and toll fees can also be deducted.
- Travel and entertainment expenses. If you claim a deduction for unreimbursed travel expenses, you have to keep detailed records showing the amount of each expense for items such as transportation, meals and lodging. Record the date of departure and return for each trip, the number of days you spent on business, the name of the city you traveled to, and the business reason for the travel or the business benefits you expect to achieve.
On entertainment expenses, if an individual expense is less than $75, you can simply record the necessary information in an expense account book and not worry about keeping receipts. The information you need to record is the amount spent, dates, locations, and people entertained.
- Interest expenses. The IRS recommends that you keep statements, notes and canceled checks to prove your interest payments on a mortgage. Your lending institution provides you with Form 1098, which indicates the interest charges you've paid.
- Capital gains and losses. If you sell an appreciated asset, such as stock, be sure you have records showing when you acquired the asset, how you used the asset, when you sold it, your original cost, the gross selling price and any expense associated with the sale. You need similar records if you suffer a capital loss.
- Miscellaneous deductions. If you have a number of unreimbursed business expenses, you may be able to deduct them as miscellaneous deductions if the total is more than 2 percent of your AGI. To support these deductions, you need to keep receipts, canceled checks or any other evidence. The types of expenses that qualify include the cost of subscriptions to professional and trade journals and membership dues for professional associations.
While keeping track of tax records may seem tedious, it can prove worthwhile. Not only will good records provide you with the support you need to reduce your tax liability, but they could also get you out of a bind if you ever find yourself facing an IRS audit.
For additional details on keeping and discarding tax records, you can request IRS Publication 552, Recordkeeping for Individuals, directly from the IRS.
Deloitte & Touche LLP, 2 World Financial Ctr., New York, NY 10281
IRS, (800) 829-1040
M.R. Weiser and Co., 135 W. 50th St., New York, NY 10020, (212) 641-6832