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Tax record keeping tips

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Every year after Tax Day, I get emails from my financial institutions and local office supply stores about upcoming shredding days. On these dates, I and all my neighbors and fellow customers can bring our documents we would like turned into confetti to prevent identity thieves from using any of the information.

That's a welcome service. But there are some documents, especially tax-related ones, that you need to hang onto for a while.

Here's an overview of the tax material you need to keep and for how long.

Your 1040: The main record everyone should have and keep forever — more on how long you need to keep tax material later — is your actual form 1040. That includes all attached schedules and other forms you also sent to the Internal Revenue Service.

Not only is a 1040 a good indicator that you fulfilled your annual tax-filing obligation, but you'll want it handy if the IRS comes to with questions about something on it.

You'll also need the form's original information if you later find you need to file an amended return.

1040 forms also come in handy for non-tax reasons, such as applying for a loan. And your return is a great reference and guide for filing future tax returns.

Requesting Old Tax Returns
If you don't have all your old 1040s, here are some ways to get
your prior filings or the information in them from the IRS.

You can view key data from your most recently filed tax return,
including your adjusted gross income, and access transcripts by creating
an online taxpayer account at IRS.gov.

Request a copy of a previous return by sending the IRS Form 4506,
Request for a Copy of Tax Return. There is a charge for such copies.

If you don't want to pay, you can opt instead to get a free tax transcript, which is a printout of the key info entered on your return. Getting this is easy to do online at Get Transcript or by calling the IRS toll-free at (800) 908-9946.

You also can file Form 4506-T, Request for Transcript of Tax Return, or Form 4506T-EZ, Short Form Request for Individual Tax Return Transcript, to get the information.

 

Income statements: We are taxed on our income, so it makes sense to keep records that show what you earned. There are many sources of income, such as wages, dividends and interest, sales of capital assets, and partnership or S corporation distributions.

The type of records you have to prove your income depends on how you got it. Your salary, for example, will be on your W-2. You also might want to hold onto your final pay statement/paycheck stub of the tax year. It could show potentially deductible expenses withheld from your paycheck.

Investment earnings show up on a variety of 1099 forms. This includes statements of accounts that are still paying dividends and/or capital gains, as well as those when you finally sell any assets.

And if you have investments in retirement accounts, either traditional tax-deferred plans or Roth versions that are tax-free, these statements will help you with any tax due when you start taking distributions.

The bottom line is that any document that shows you got paid needs to go into your files.

True, these income records tend to work in the tax collector's favor, showing that you got money from which Uncle Sam is due a part. But these records also can prove that some amounts, such as tax-exempt interest or qualified investment earnings, are not subject to tax or are taxed at lower rates.

Tax-deductible expenses: Most taxpayers claim the standard deduction, but if you do itemize, you'll definitely want to keep records of those expenses that are deductible on Schedule A.

These itemized deduction records include such things as medical expenses, charitable contributions and acknowledgement receipts from the nonprofits, mortgage interest, real estate taxes, state and local income taxes, and property losses in a major disaster.

Then there are the other deductions, technically known as adjustments to income and still referred in the tax world as above-the-line deductions, that anyone can claim, regardless of whether they use the standard deduction or itemize. These are for such things as educators' out-of-pocket expenses, contributions to retirement accounts, and interest you paid on a student loan.

Finally, there are records connected to any tax credits you can claim. Tax credits offer dollar-for-dollar reduction of any tax you owe. In the case of refundable tax credits, where you have more credit than tax bill, you can get the excess credit as, you got it, a refund.

Tax credits, like above-the-line deductions, are available to eligible taxpayers regardless of which deduction method is used

Housing records and taxes: A quick detour here on home-related documents. Even if you don't use them for immediate tax-filing deduction purposes, you need to keep residential records. When you eventually sell, there will be tax consequences and the documentation could help you make sure it's as small as possible.

Many homeowners who sell their primary residences won't owe tax on the profit. Up to $250,000 in home sale profit for single owners, or $500,000 for a jointly-filing married couple, is non-taxable. That amount applies when the seller(s) have lived in the house for at least two out of the past five years.

Any residential sale profit over those exclusion amounts is subject to capital gains tax, which is zero percent, 15 percent or 20 percent, depending on your taxable income.

If your home sale profit is more than the excludable amount, good records of improvements to your property, from a structural addition to total re-do of your kitchen to landscaping, could help you get under the no-tax number.

Allowable upgrades — remember, these are property improvements, not just repairs and maintenance — add to your home's basis, which is subtracted from your sales amount to arrive at your profit. The larger your basis, the lower your profit … and potential tax.

Until you sell your home, you need to hang on to all documents that show these improvement costs.

How to store tax records: OK, you've got all this stuff. How and where do you keep it?

Any way that works for you.

While the IRS recommends you keep relevant tax documents, there is no federal tax law or tax agency regulation detailing a preferred way to keep your tax records. That's because every taxpayer situation is different.

If you're a paper devotee, then set up a filing cabinet system. 

Flying-Papers

Personally, I love the protection that redundancy offers, so I have paper records as well as digital copies of tax records and other financial documents. 

You can use a dedicated hard drive, thumb drive, or a cloud storage system. I use USB drives and the cloud. Again, I'm a backup freak. You do you when it comes to your documentation comfort level. 

The one constant for any record keeping system is that you store in it any material that will help you answer any filing follow-up questions the IRS might have.

Tax record keeping timing: Now that you know what to keep and where you're going to stash it, the next question to answer is for how long?

The old joke is forever, since technically the IRS can come asking questions any time it suspects a taxpayer committed fraud.

But more realistically for most of us who do our best to get our tax returns right each year, there are some shorter time periods in connection with your tax records. These are the period of limitations set for particular tax circumstances.

These time frames are how long you have to amend your return to claim a credit or refund or how long the IRS has to review your filing and assess additional tax in connection with your return.

If you —

Then you have —

File a return and circumstances 2, 3 and 4 below
don't apply to you

3 years

Don't report income that you should and it is more than 25% of the gross income shown on your return

6 years

File a fraudulent return

No Limit

Don't file a return

No Limit

File a claim for credit or refund after you filed your return

The later of
3 years or 2 years
after tax was paid

File a claim for a loss from worthless securities
or bad debt deduction

7 years

The years noted above generally refer to the time period beginning after the return was filed. Returns filed before the due date are treated as being filed on the due date.

Here's hoping you never have to dig out old records to justify a tax claim to an IRS auditor. But if you set up a solid record keeping system and stick to it, if that happens, you'll be ready.

You also might find these items of interest: 

 

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