Which Tax Records To Keep

Death & Taxes

Which Tax Records To Keep

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By Roy Lewis

The questions I hear constantly -- in and out of the tax season -- have to do with record keeping. What records might you need to prepare your tax return? What records should you retain after filing your tax return? What are you required to keep? How long should you keep 'em?

Here's a list of some of the records you should put aside for tax time. This list is by no means comprehensive -- in fact, it's really focused on investment issues. You may have certain "twists" in your tax situation that will require additional record keeping. For more information, check out IRS Publication 552.

One key to tax-time sanity is creating some type of filing system (or computer-based accounting system) that will allow you to track and maintain this information throughout the year to make your annual search for tax records a bit less... well... taxing (sorry for the miserable pun, but you knew it was coming, right?). If you use a computer-based system, note that you still need to keep the original paper documents listed here too, because the IRS won't just take your word on the accuracy of your computer data.

  • Keep confirmation reports of stock purchases and sales, including the execution prices and trade dates.

  • Keep all statements and reports sent to you by your brokerage, mutual fund company, or other investment services company, and from other sources. Perhaps most important are 1099 forms, which show your proceeds from sales of securities (1099-B) and other capital assets; as well as interest income (1099-INT); state tax refunds and other government payments (1099-G); dividend income (1099-DIV); Social Security earnings (1099-SSA); and distributions from IRAs, pensions, and annuities (1099-R). Also, if you own a home, rental, or investment property, remember to hang on to that year-end mortgage interest statement (1098) that you'll receive from your lender.

  • Keep records of how you acquired any securities (such as through purchase, inheritance, etc.) and your cost basis.

  • If you participate in a dividend reinvestment plan (for stocks and/or mutual funds), keep track of the dividends you receive, how many shares are purchased with them, and at what price. This information is necessary to help you calculate the new cost basis for your shares. You might set up a computer spreadsheet for each separate plan/stock to keep track of these details. For those of you who are not computer-spreadsheet literate, a three-ring binder can be effective, since it will allow you to add sheets of paper wherever you need to.

  • Keep records of contributions to IRAs and other retirement plans. If you make nondeductible contributions to an IRA, make sure you declare these on IRS Form 8606 so that you don't end up paying a second tax on them down the line. You should have a year-end account statement as well as receipts for your contributions.

  • If one of your securities becomes worthless, keep any documentation relating to that -- especially something that includes the date on which it became worthless. But, remember that there are methods you can use to dump these worthless stubs without going through the reporting hassles of the worthless stock deduction. See my article "Worthless Stock" in the Taxes FAQ area.

  • Keep records relating to interest expense and how you used the borrowed funds. This is an advanced topic, but it's an important one. For more information, consult IRS Publication 535 and Publication 550.

  • If you plan to deduct travel or meal expenses for investment-related travel, keep records of exactly what the trip involved. Know, though, that many investment-related trips are not deductible, such as travel to attend a shareholder meeting or an investment seminar. IRS Publication 463 and Publication 550 will give you more details.

  • Keep records of improvements made to your home. These can be added to your basis price, decreasing your taxable gain when you sell the home. Additionally, you'll want to keep records of expenses related to selling your home. They can also be deducted from your capital gains. Now, many people will tell you that this is no longer required because of the capital gain exclusion on the sale of your home. But, what Congress giveth, it can also taketh away. There might be future law changes that restrict (or even eliminate) the home sale gain exclusion, so keeping these records is always a good idea.

  • If you donate stock to a charitable organization, keep records of what you donated, the date of the donation, your cost basis for the shares, and their fair market value (FMV). Keep track of cash donations, too. You'll want to do this because your deduction will be based on either the cost of the original shares or the FMV of the shares donated. Read more about this in my article "Charitable Contributions of Stock" in the Taxes FAQ area.

  • If you give stock away to a friend or relative, keep records of what you gave, the date of the gift, your cost basis for the shares, and their fair market value, since the person receiving the shares will likely be required to use your original tax basis to compute any future gain or loss on the sale of the shares. This is discussed in the "Gifts of Stock" article in the Taxes FAQ area.

  • Keep records of expenses for professional help, such as tax preparers and advisors, legal counsel, etc. In fact, keep records (both invoices and canceled checks) of all deductible expenses... just to be on the safe side.

    What to Save After You Prepare Your Return

    You've completed your tax return and find that you have enough records to fill a large dump truck and a small wheelbarrow. Now what? How long do you have to hang on to all this stuff? Well, the answer is a bit complicated.

    Unless fraud, evasion, or a substantial understatement of income is involved in your tax return, Uncle Sam generally has only three years to tap you on the shoulder and ask to see the underlying documents necessary to support information reported in your tax return -- a pleasant process known as an audit.

    Remember, unlike the "innocent until proven guilty" assumption used by our criminal justice system, with the IRS you must prove the validity of your tax return. You have to sweat out three years before you can rest easy that your return hasn't been selected for audit. Usually that countdown period begins on the date the tax return is required to be filed (April 15th). If you file after your normal filing date, the three-year clock begins to tick on the date that the IRS actually receives your return.

    This three-year period is commonly called the "statute of limitations." (Don't confuse it with the statue of limitations -- that's under a few pigeons somewhere in New Jersey and has nothing to do with taxes.) In some cases, the statute of limitations can extend for a longer period of time, but normally you're looking at three years.

    As an example, your year 2000 individual income tax return will be due on April 16, 2001 (because April 15 falls on a Sunday). Even if you file your tax return on January 25, 2001 (or any other date prior to April 16), your three-year statute of limitations clock will begin to run on April 16th. This means that your statute period for the 2000 return will expire on April 16, 2004. If you decided to "extend" the due date of your tax return by submitting an automatic extension form, you have also extended your statute of limitations. So, if you file your return on June 20, 2001, your statute will not expire until June 20, 2004.

    Much of what you need to keep in the form of records depends directly on the statute of limitations for an IRS review. Here are some guidelines:

    Your copy of the tax return: Keep it forever. That's right. You never want to dispose of your copy of the tax return. You never know when this document will come in handy. Remember that, in many cases, the IRS destroys the original returns after four or five years. It's always best to have your copy to fall back on. I'd also like to see you keep your W-2 forms with your tax return indefinitely. Why? You never know when you might need your W-2 slips to correct a Social Security earnings statement. Copies of your W-2s can be very valuable in future years... and they don't take up much space.

    Canceled checks, deposit statements, and receipts: Generally, keeping these for three years is enough. Because of various combinations of the statute of limitations and technical carry-back and carry-forward provisions in the code, though, keeping them for longer than three years is preferred -- five years is better, and seven years is best. But make sure that these canceled checks and receipts are only for transactions that have an impact on this single year... such as receipts for your itemized deductions or interest income. In other words, if a receipt is for something that won't appear on your tax return for several years (such as home improvements), then you'll want to hang on to it for at least three to seven years beyond when it actually appears on your return.

    Stock trade confirmation receipts/statements: Keep these statements for at least three years after both ends of the transaction (both buy and sell) have closed. Again, five or seven years are even better. For example, say that you bought 200 shares of Gap stock in 1981 and sold them in 2000. You'll want to hold on to both the buy and sell confirmations until at least April 2004. In effect, you will have held on to the 1981 purchase statement for about 24 years -- but that's what's required to prove both ends of a stock transaction.

    Improvements to property: Keep proof of those improvements until at least three years after the sale of the property in case you need to prove your basis in the property when it was sold. This is true for rental property, investment property, and even your own personal residence. Remember when you added that new backyard deck and patio to your rental property in 1987? Well, you'd better still have that receipt -- and keep it with receipts for other improvements to that property for at least three years after you sell it. In cases like this, it is very possible that you'll have records 10, 20, 25 years old or older. It's not uncommon if you're retaining your records appropriately. And again, keeping these records five or seven years beyond the sale date is even better.

    Escrow closing documents: Keep these a minimum of three years after the property is sold. You'll want to retain both the purchase escrow and sales escrow statements. Much like your stock confirmation statements, you'll need to show both sides of the transaction and be able to prove your improvements. And, as always, keeping the records for five or seven years past the sale is an even better bet.

    The key is to think before you throw anything out. Don't just simply throw out some records because somebody gave you an arbitrary time period to hold your records. Take a look at the document and see if it has any impact on any future or prior tax transaction that is not yet out of the statute of limitations period. If you think there may be some future impact, then keep it. If there is no future impact, then you can likely introduce it to your personal shredder. Think before you shred and you'll be just fine.

  • This forum and the information provided here should not be relied on as a substitute for independent research to original sources of authority. The Motley Fool does not render legal, accounting, tax, or other professional advice. If legal, tax, or other expert assistance is required, the services of a competent professional should be sought. In other words, if you get audited, don't blame us.