Double Check Your Documentation – Better to be surprised now than during an audit
After filing a tax return, most of us are simply relieved another tax year is done. Before moving on to next year, please spend a moment organizing your records. It will help tremendously should you need to refer to them at a later time.
Your tax return is completed and you can exhale a big sigh of relief. Not so fast. Do you have adequate support documentation if the federal or state authorities decide to review your tax return?
Here is a check-list to help your recordkeeping. At minimum, make sure your records include the following;
- A copy of your signed tax return and all supporting documents sent with your tax filing
- Copies of any worksheets that support your tax filing
- Canceled checks of deducted items
- Receipts supporting deducted items
- Bank statements
- Investment statements
- Form 1099s (all forms)
- Form 1095s (to support having valid health insurance)
- Mortgage statements (including annual interest paid 1098 tax forms)
- Business K-1 tax forms
- Credit card statements
- Copies of any major purchases or sales (example: home closing documentation)
- Mileage logs for business, charitable and medical transportation
- Proper documentation for business meals and cell phone use
- Receipts for any charitable donations (both cash and non-cash donations)
- Support for all your itemized deductions
- Child care receipts and reporting
- Educational expenses
- Substantiation for value of large donations of property
- Proof of fair market value for any inherited items of value
Now is also a good time to review your capital improvement files. Capital improvements are money you spend to improve the value of your home, secondary residence or other high value property/equipment. These records are needed to support your calculation of value and gain/loss when you sell your property. Consider creating a spreadsheet that recaps each of these expenditures.
When to toss
Don’t toss old records too soon. The typical rule is to retain federal tax records for as long as they may be needed. This is usually the later of 3 years after the filing due date or when you actually file your tax return. But be careful, state rules can differ and if your income is understated by more than 25% the look back for audit increases to 6 years. Finally, remember to keep records of fixed assets as long as you own them plus three years.
Missing a Form? Not an Excuse.
At the start of each year our mail boxes begin to fill up with information tax forms. They include W-2s, 1098s, 1099s and the new 1095-A. If you fail to receive a form, you are still liable for the tax it creates. Here are some tips to avoid this possible audit risk.
Very few banks return your cancelled checks. So what do you need to do if required by the IRS to prove your deductions? Often this means staying ahead of the game at year-end.
Year-end is a good time to ensure you have proper documentation to substantiate your tax deductions. This is important as many banks start deleting online documentation that is over one year old.
Two things have happened over the past ten years that have greatly reduced the ability to have a canceled check as proof when the auditor comes calling. The first is the advent of online bill paying services. The second is a regulation that was passed in 2003 commonly known as Check 21. With online bill paying, you pay a bill via an online banking service. Your only receipt is often just an entry in your checking account. With Check 21, the law allows banks to digitally capture the check and then destroy the paper copy without returning it to you. So what do you do if you need proof that you paid for a tax deductible item?
- Know your bank. Understand what your bank keeps and for how long. This includes digital statements and digital copies of checks (both front and back). Understand if there are any fees charged if you need to request copies of payments.
- Retain copies of all bank statements. Review your records to ensure you have copies of all monthly bank statements. This is often the starting point for an IRS agent that wants proof of payment, so it should be yours as well. These copies may be in either paper or digital format. Download online copies of your statements and place them in a password protected file.
- Collect copies of tax related proof of payment. Go through your statements and mark the payments that will, in all likelihood, be used as a tax deduction. Make sure you have copies of the front and back of each of these payments. If you do this work now, the copies are often still available online for no fee. Even online bill payments often have a digital copy that can be used.
- Get independent acknowledgements. If you have larger payments you should also make sure you have independent acknowledgement from the merchant or organization to substantiate the deduction. This is true for charitable contributions of $250 or more, and any business or medical expenses.
While having the traditional “proof” of an expenditure is now harder to come by, the IRS understands that approved technologies are changing the type of substantiation available for them to review. By being on top of this documentation at the end of each year, you can save yourself a lot of headaches should you ever need to prove your deductions.