Don't Mess With Taxes

Photo by Alexander Grey on Unsplash

You made it through Tax Day. Now it's time to store all that information you used to fill out your Form 1040.

While it's tempting to just toss it all, don't. It often takes the Internal Revenue Service a while to process filings. The agency could come back weeks, months, or even years from now with a question about an entry on your return.

Just to be safe, you need to hang on to some of the material for as long as the IRS has to question your filing. Once that statute of limitations passes, then you can (probably) toss it.

The parenthetical probably is mine, not the IRS', as I'm an inveterate document hoarder. That's easier nowadays with all the digital capabilities.

In the end, your record keeping is up to you. But there are some IRS guidelines about what to keep and for how long. Here's a quick review.

Your 1040: The main record everyone should have and keep forever is your actual form 1040. That includes all attached schedules and other forms that accompanied its delivery to the IRS.

Not only is a 1040 a good indicator that you fulfilled your annual tax-filing obligation, you'll need it for reference if the IRS has 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.

A Form 1040 also comes in handy for non-tax reasons, such as applying for a loan.

And your annual return is a great reference and guide for filing future tax returns.

Income statements: It is an income tax, 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, partnership or S corporation distributions, and self-employment earnings.

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, such as your mortgage interest or real estate taxes, you need to keep these 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, generally 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. 

Personally, I love the protection that redundancy offers. Most of my records are digital, which a couple of back-up safeguards. But I also hold on to some paper records as well. But 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.

And your answers are key. The IRS notes, in the statement below from IRS.gov, that we taxpayers bear the burden of proof when it comes to our tax form entries.

"The responsibility to prove entries, deductions, and statements made on your tax returns is known as the burden of proof. You must be able to prove (substantiate) certain elements of expenses to deduct them. Generally, taxpayers meet their burden of proof by having the information and receipts (where needed) for the expenses. You should keep adequate records to prove your expenses or have sufficient evidence that will support your own statement. You generally must have documentary evidence, such as receipts, canceled checks, or bills, to support your expenses. Additional evidence is required for travel, entertainment, gifts, and auto expenses."

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.

In addition, the IRS says to hang on to employment tax records for at least four years after the date that the tax becomes due or is paid, whichever is later.

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: 

• The importance of good, and separate, business records
• Confused by Form 1099-K? Check out IRS' updated FAQs
• Tips on rebuilding tax and other records lost in a disaster

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