What records do I really need to keep?
With the 2017 tax filing season in full swing, we frequently are asked this question. The IRS recommends that taxpayers keep all sales slips, invoices, receipts, canceled checks or financial account statements, stock brokerage statements, Forms W-2 and 1099, and other documents that prove the amounts shown on a return as income, deductions, and credits. The IRS will also accept in limited circumstances certain financial account statements, such as bank and credit card statements, as proof of payment instead of requiring canceled checks.
Certain areas such as auto expenses, meals and entertainment and charitable contributions have even more stringent documentation requirements. Failure to comply with these requirements could render perfectly legitimate deductions worthless, so it is important to understand those requirements and maintain your records accordingly.
Remind me again why I need to keep these items
While these are examples of what the IRS suggests should be kept, many taxpayers seem surprised when they lose the audit lottery and these types of things are actually requested. Audits of self-employed individuals and those with other income that is not reported by the payer to the IRS, such as rent, are not uncommon. Success in these audits is greatly impacted by the records that are kept and provided. In these types of audits, it is the norm for the IRS to request all bank and investment statements to reconcile deposits into these accounts to the income being reported. Unfortunately, the burden of proof often lies with the taxpayer. When the IRS is looking at a deposit from two and half years ago and the taxpayer can’t identify and support that it is from a non-taxable source like an expense reimbursement or gift, it is highly likely that the IRS is going to assert that it should be taxable income. In these cases, taxpayers often assume they can quickly go online and get this information from their bank only to find out that the bank records don’t go back far enough. Ordering a year or more of bank statements, cancelled checks, deposit slips and the like typically takes some lead time and frequently comes with more than a nominal charge (not to mention it adds to the already high anxiety most taxpayers feel when under audit!).
Now I understand what I need, but how long do I need to keep all of this?
A related issue when it comes to documentation is how long records should be kept. Many people know there is a three year statute of limitation and assume that is long enough. Some others would point out that the statute of limitations can be extended to six years in certain circumstances and say that is long enough. The best answer is really six years after an item has been reported on a return, which could be much longer than six years after the documentation was created. As an example, if you sell stock in a privately held corporation that you have held for 20 years, you really need to keep the records that establish the basis in that stock until 6 years after you sell that stock.