Recordkeeping: What You Need to Know Before, During and After Tax Time

If you claim that you drove 50 miles to the doctor, or spent $2,000 on a new computer for your business, you need to be ready to prove it. So keep good records. So let's look at what you should be keeping track of and how.
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One of the most important best practices regarding your individual tax return is to keep good records for the items you put on your tax return. Income items, tax deductions, and tax credits -- all of them. The documents and receipts related to deductions and credits you take on your tax return support the amounts during a tax audit, if needed. It is a funny thing, but sometimes the IRS audits a taxpayer's tax return and generally if you cannot prove the existence of a tax deduction or support a tax credit, the IRS may deny it on the tax return. If you claim that you drove 50 miles to the doctor, or spent $2,000 on a new computer for your business, you need to be ready to prove it. So keep good records.

So let's look at what you should be keeping track of and how:

Types of Records to Keep

You should keep copies of your tax return information with all the supporting documents. You should keep documents that identify sources of income and expenses. You should also keep documents to back up claims for credits as well as for adjustments and deductions. Items that can be used as records for income and investments include Forms W-2, Forms 1099, bank statements, brokerage statements, and mutual fund statements. Items that can be used as records for expenses include canceled checks, receipts, sales slips, invoices, and account statements. If you own your home or sell real estate you own, keep records such as closing statements (when purchased and when sold), mortgage statements, purchase and sales invoices, proof of payment, insurance records, receipts showing costs of improvements, and Form 2119, Sale of Your Home (if you sold a home before 1998).

What Information You Need To Track

If you travel for your business, you must be able to substantiate the business use of a vehicle with written documentation. This generally includes a record of the dates of business trips, customers visited, purpose of the trips, number of business miles traveled, and the total number of miles the vehicle was used during the year. If you deduct actual expenses, you must save records for gas, oil, insurance, licenses, and other car maintenance receipts.

You must be able to prove your deductions for travel, entertainment, business gifts, and local transportation expenses. You should keep adequate records or have sufficient evidence that will support your own statement. When required for medical reasons, your miles traveled to and from the doctor, pharmacy, or hospital and travel away from home are deductible and should be recorded.

Keep records of your volunteer expenses and your charitable mileage that is directly incurred in giving services to a charitable organization. Keep your receipts or canceled checks from recognized charities. A receipt or bank record is required for all cash contributions and must include the name of the charity, the date, and the amount of the cash contribution.

Proof of Expenses

To deduct an expense on your tax return, you must be able to prove that payment was made and the payment was for something deductible. In most instances, the IRS has considered a cash receipt or canceled check as adequate proof of payment. However, because some banks no longer return canceled checks, the IRS will accept certain other information from a bank account statement as proof of payment. The statement must show the check number, amount, the date the bank posted the check to the account, and the name of the payee.

If you pay for expenses by credit card or electronic funds transfer, you also may be able to use an account statement to prove expenses. For electronic funds transfer, the statement must show the amount transferred, the date the transfer was posted to the account, and the name of the payee. For credit cards, the statement must show the amount charged, the transaction date, and the name of the payee. If the expenses are withheld from your paycheck, you can use your pay statements to prove payment.

Once proof of payment has been established, it is still necessary to determine the tax treatment of that payment. It is important to keep other documents, such as detailed receipts listing the items purchased, to show the relationship between those expenses and the deduction claimed.

How Long You Should Keep Your Records

If there are any transactions which you feel might be questioned in the future, be sure to retain your canceled checks and documentation. You should keep records as long as they are relevant for your tax situation. For example, if you take a deduction for property you use in your business, including standard mileage for a vehicle, you should keep records for that property for at least three years after you dispose of the property. Although it is important to keep your tax returns and records for at least three years, if the IRS suspects fraud, it may request information beyond that time span.

There is no magic formula for record keeping and tax return support documentation. It is a personal decision on how much effort to go to and how much information to save and even how long to save. It generally depends on facts and circumstance and personal choice. However, more documentation is generally better and certainly safer than less or no information. Accordingly, review your situation and at a minimum create a folder or shoe box or whatever works for you and save your documents as you see fit. You do not always need a file cabinet with folders for every letter of the alphabet and by every line of the tax return, but documentation to support the deductions and credits on your tax return is certainly a wise use of time for the largest annual financial transaction you are likely to have each year. So start early this year getting organized and save that tax information before you have an urgent need.

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