Educating the Masses to Help You Save On Taxes

Keep those tax records or you might be sorry!

One of the most common questions I hear from clients is, “how long do I need to keep these records?” and more often than not, half the IRS audit problems we see could have been avoided by better recordkeeping. Because the IRS has been ramping up audits, I thought this would be a good time to cover this issue. In this post I will focus on personal recordkeeping while the next one will cover the business side of recordkeeping.

Essentially tax payers need to hold on to supporting documentation for income and/or deductions for a tax return until the period of limitations for that return runs out. Generally that time period depends on the amount of time you can amend your return, claim a refund or the RIS can assess additional tax.

The basic records that should be kept for IRS tax purposes are:

• 1040 Tax Returns: Keep legible copies of your personal tax returns and supporting statements and schedules
• Income: W-2’s, 1099’s, Bank Statements, Brokerage Statements and K-1’s
• Expenses: Sales Slips, Invoices, Receipts, Canceled checks or other proof of payment, Written communications from qualified charities
• Home: Closing Statements, Purchase and Sales Invoices, Proof of Payment, Insurance Records, Receipts for improvement costs
• Investments: Brokerage Statements, Mutual Fund Statements, 1099’s and Form 2439

The minimum amount of time that the basic records should be kept for IRS tax purposes:

Fred’s Tax Tip: Scan or photocopy all of your supporting documentation. Many carbon paper receipts will fade quickly leaving you with a box of little blank paper slips and the IRS generally will not find that amusing.

No More Mr. Nice Guy

People have gotten lulled into a sense of security with the IRS’ campaign over the last decade of a “kinder, gentler IRS”. However, with the mounting Federal deficit it is looking like “Mr. Nice Guy” is no more. I’m working with a client right now who is dealing with a nasty audit because of poor recordkeeping.

This client had prepared his own return several years ago and included in his itemized deductions cash charitable donations. Two years later the IRS sent him an Audit Notice denying the cash charitable contribution unless the taxpayer provided documentation of the charitable deduction.

So, thinking it would be a simple matter to resolve, he replied to the IRS letter with an official statement listing the dates, check numbers and the amount of cash donations given to the charitable organization. The IRS refused to accept the charitable organizations statement because the auditor thought that the taxpayer could have produced it himself.

This is the point when the taxpayer contacted our office and became a client. After we filed a tax court petition to resolve the audit the auditor requested copies of the cancelled checks (front and back) for all of the cash donations made to the charitable organization.

Normally that wouldn’t be a difficult request to satisfy, but because our client closed the bank account 3 years ago he had to pay $150 for the copies of the checks and had to wait 30 days for them to arrive. Because of the delay in getting the copies back from the bank, the IRS auditor referred our clients’ file to the IRS council to prepare for trial.

Unfortunately, now if this case goes to court, the taxpayer will need to hire a tax attorney to proceed with the case. So what could our client have done differently to avoid this current situation?

1. Keeping his bank statements and canceled checks along with the  charitable organizations statement for the cash charitable deductions

2.  Contacting an experienced tax professional (not his brother-in-law or his bff) the instant he received an IRS audit notice to avoid delays & problems. (This is not a time to do-it-yourself.)

3.  Bringing in a tax professional early enough would provide the opportunity to reply to the IRS Audit with the proper documentation in enough time to close the case and the whole situation would be wrapped up in a few months rather than dragging out for a few years.

So, now you can see how something that might appear extremely simple to rectify can snowball into a nightmare scenario before you know it.  Which is why I highly recommend that any person  who is faced with an IRS letter or audit, use an experienced tax professional to resolve the problem.

Fred’s Tax Tip: All records need to be scanned into a computer and backed up offsite with an electronic storage service.  This step safeguards against fire, theft, flood, computer virus and other disasters. When in doubt as to whether or not to keep the record, keep the record and consult your tax professional.