By Jason Watson (Google+)
There are time limits for certain records and those will be discussed later, but there are some general reasons for creating a good recordkeeping system.
Identify Sources of Income: This can seem silly since most taxpayers don’t want to prove additional income for the IRS to simply tax. However, certain income sources might be non-taxable, and you should always separate business income from non-business income. How sources of income are presented on your tax returns can have a large impact of your tax consequence.
Keep in mind that the IRS has the right to review bank deposits during an audit. For example, if you lent money to your son to buy his first car, and you’re depositing the payments the IRS will consider this income unless you keep good records proving the money is actually loan payments to you and not income.
Keep Track of Expenses: The IRS does not necessarily announce an amount of unclaimed tax deductions, but many tax professionals agree that deductible expenses are commonly missed for the basic lack of memory. You buy something in March, and a year later you forget and you lose the deduction. Who did you talk to on the phone last Wednesday, and what did you have for lunch? Hard to recall, even with ginseng and crossword puzzle exercises. Developing a good recordkeeping system will help with tax amnesia.
Property Basis: This is absolutely critical, and the one most overlooked reasons for maintaining good records. As a tax preparation firm, we spend a ton of time trying to minimize your tax consequence. It’s our job, and you expect us to do it well. But if taxpayers don’t keep track of what they paid for something (basis) such as stocks, business asset or real estate the accuracy of the tax return often suffers.
The most challenging property is stocks- the IRS and the SEC now require brokerage firms to maintain cost or purchase history information, and report this to you on your tax forms. They also require that this information transfers with the stock if you move securities to another brokerage firm. Having said that, we’ve seen mistakes with this information so we still encourage taxpayers to maintain his or her own record of what stocks they purchased, the price and the date.
The classic example is a person who buys stock through an employee stock purchase program, holds onto it for twenty years, retires, moves the stock into another account, and then sells it. Without historical cost or purchase information, the gains and subsequent taxes is impossible to accurately compute. In the past we’ve reconstructed cost information through Yahoo! Finance which works most of the time, but good recordkeeping can prevent this exercise
Homes and other real estate such as rental properties can also prove problematic. Sure, you have the HUD or closing statement from the purchase, and you’ll get another one for the sale. But improvements to the property such as a new roof, appliances, furnace, additions, etc. will all add to your property basis (cost) and can reduce your tax consequence. Sure, you get a big exemption for the sale of your primary residence, but how long is that going to last for? Congress might eliminate that at any time. And rental properties and other real estate investments don’t enjoy this exemption.
Tax Return Preparation: All the above reasons boil down to tax preparation. Keeping good records will ensure that your tax returns are comprehensive and accurate, and you won’t waste a bunch of time piecing together information. Of course, we like it too.
Audits: If your tax returns are examined by the IRS, much of your success will hinge on your recordkeeping skills. Keep in mind that if you comply with the IRS and provide all the requested documentation, the burden of proof is on the IRS. Conversely, if you are missing information or you refuse to provide your records, the IRS and Tax Court will assume the information does not support your tax return as filed, and you will receive a tax bill. Check out our article on IRS audits at wcginc.com/Audits.pdf.