Death & Taxes

Paperwork to Keep for Tax Time

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By Roy Lewis
August 31, 2001

Preparing your taxes requires a lot of paperwork. In fact, the IRS estimates that if you prepare a Form 1040 with Schedule A (itemized deductions), Schedule B (interest and dividend income), and Schedule D (capital gains and losses), you'll spend almost eight hours on record-keeping alone. This doesn't even count learning about the law, preparing the forms, or assembling/copying the return. Sheesh.

Why does it take so long? Because there are a lot of pieces of paper to sort and file. You might be thinking that you'll get everything you need to prepare your return in early January. But that's not necessarily true. If you want to stay on top of the game, and hopefully reduce this expected eight-hour record-keeping time, there are things that you should save and file during the year. Let's take a few minutes to look at some of the "stuff" that you'll want to retain.

Investment paperwork
You probably receive a lot of paperwork from the folks with whom you have accounts, whether it's your broker, your mutual fund company, or your 401(k) provider. Here's a list of what you should keep:

  • Keep confirmation reports of stock purchases and sales, including the execution prices and trade dates. It's important that you can prove the purchase price of any stock that you sell.

  • Keep all statements and reports. 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). You'll generally receive these statements in mid-January for the prior year.

  • 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 they purchase, and at what price. This information is necessary to help you calculate the new cost basis for your shares. You might set up a chart for each separate investment to keep track of these details. A three-ring binder can be effective, as 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 year-end account statement as well as receipts for your contributions. And if you make contributions to a Roth IRA, make sure that you keep track of those contributions so you can remove them (without tax or penalty) later on in life.

  • If you donate stock to a charitable organization, keep records of what you donated, the day of the donation, your cost basis for the shares, and their fair market value. Keep track of cash donations, too.

  • If you give stock away as a gift to a friend or relative, also keep records of what you gave, the day of the gift, your cost basis for the shares, and their fair market value.

What to save after you prepare your return
So you've completed your tax return, and you 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?

Unless fraud, evasion, or a substantial understatement of income is involved in your tax return, Uncle Sam generally has only three years in which to tap you on the shoulder and ask for the underlying documents necessary to support information reported in your tax return. Remember, unlike the common "innocent until proven guilty" principle, 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 LATER of the date that the tax return is required to be filed (usually April 15), or the date that the tax return was actually filed.

How long you have to keep your paperwork depends directly on the statute of limitations, but here are some guidelines:

  • Your copy of the tax return: Keep it forever
    That's right. You never want to dispose of your copy. 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.

  • Cancelled checks, deposit statements, and receipts: Keep for at least three years
    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 cancelled checks and receipts are only for transactions that have an impact on this single year only, 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 appears on your return.

  • Stock trade confirmation receipts/statements: Keep for at least three years after sale
    Again, five or seven years is even better. For example, say that you bought 200 shares of Whoa Nellie Brake Co. (ticker: HALT) 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 a quarter century -- but that's what's required in order to prove both ends of a stock transaction.

  • Improvements to property: Keep at least three years after sale
    Keep proof of those improvements in order to prove your basis in the property when it is sold. This is true for rental property, investment property, and even your personal residence. Remember when you put that new roof on your rental property in 1987? Well, you'd better still have that receipt -- and keep it with receipts for the 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 for 10, 20, 25 years or longer. And again, five or seven years beyond the sale date is even better.

  • Escrow closing documents: Keep at least three years after sale
    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. The key is to think before you throw anything out.

This listing is not all-inclusive; there may be things that are specific to your individual tax issues that aren't discussed here. But these will give you the highlights of the most important issues.

The easy answer, Fools? Keep everything. Throw out nothing. Spend your kids' inheritance on storage space.

Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks Roy owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.
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