Tax Record Keeping

Pack rats Beware

There's an old saying that "the devil's in the details." Many people with carefully constructed financial plans have watched their plans come unraveled because they fail to keep the records they need to meet Internal Revenue Service (IRS) rules. Good record keeping may be as appealing as visiting the dentist, but organizing your records systematically and early will save time and energy as well as aggravation. Adopting investment and tax strategies within your financial plan can prove ultimately futile if you are unable to document and substantiate your methods to the IRS.

Good sense advocates holding onto records the IRS deems important and discarding those that no longer are necessary. Unfortunately, the IRS offers very few specifics. Rather, they insist on "sufficient documentation" and a policy of "adequacy and accuracy." However, they do "strongly advise" you to hold onto W-2 forms, 1099 forms, stock brokerage statements and tax returns from prior years. IRS guidelines generally correspond to the statute of limitations for return filing. Thus, assuming legitimate returns are filed, these records should be kept for at least 3 years from the date the return is filed.

Well-organized records may allow you to maximize your miscellaneous deductions (which includes fees for tax advice, investment management and employee business expenses) and exceed the 2 percent of adjusted gross income floor for miscellaneous deductions. Aside from helping you to recall and itemize these deductions, keeping receipts, canceled checks, and other records may be necessary to verify those items reported and answer IRS skepticism. Other records to be kept include receipts for all medical and dental expenses, canceled checks, insurance reimbursement, direct payment and premium payments records. Logs for business use of a car, home computer and certain other business tools are also important.

Copies of state and local tax returns, real estate tax statements, and canceled checks paying these taxes should be kept if a deduction for these taxes is taken. With the stricter reporting requirements and documentation necessary for charitable contributions (that now includes a special receipt from the charity for gifts over $250), it is also necessary to retain receipts as well as descriptions of non-cash property donated to charities. For the home mortgage interest deduction, bank statements, bank notes and canceled checks should be retained. Other significant records to be held onto would include partnership, trust and S Corporation Schedule K-1s, records of transactions by your account executive, and closing statements from the sale of your home.

Charitable Donation Receipts

Giving to charity is an integral part of many financial plans. Giving to charity not only benefits the community but can provide substantial tax savings as well. However, to get that valuable tax deduction, certain record keeping rules have to be followed.

Generally, taxpayers may deduct on their returns contributions of money or property made to a charitable organization. Donation of money or property to charity also removes the asset from the donor's estate. Recent IRS regulations require receipts to show the money is really being given to charity. Charities are required to provide receipts for donations greater than $75 if the charity gives something of value, such as a banquet dinner, in return. In cases of such a "quid pro quo" (something for something else OR this for that) contribution, the receipt tells the fair market value of the item of value (the "quo"). The donor taxpayer may only deduct the difference between the "quid" (this) and the "quo." (that)

Another regulation requires charities to provide a receipt, or contemporaneous written acknowledgment for goods and services, for contributions in excess of $250. Individual donors are also required to keep these receipts to prove such donations were made. Unlike years past, a canceled check or account statement is no longer sufficient proof. This rule is to be taken seriously for if you are audited and cannot provide the receipt, the deduction will be denied. Relief may be granted if the charity files a contemporaneous return with the necessary information.

Charitable giving strategies range from the simple to the complex. In order to take advantage of them, both the strategies and the record keeping rules must be understood and followed. Working with your tax advisor and financial planner is the surest way to successfully integrate charitable giving into your financial plan.

Tax Audit Nightmares

One of the most frightening experiences for a taxpayer is to receive the following type of letter from the IRS:

"Dear Taxpayer, we have selected your federal income tax return for the years shown below to examine the items checked at the end of this letter. We have scheduled an appointment for you..."

If you receive a letter similar to this from the IRS, it does not mean that you should panic. The IRS often conducts routine inquires that can easily be satisfied. In some cases, the IRS merely conducts a mail audit. In other, more complicated cases, a face to face meeting can be demanded.

In the event that you are chosen for a personal audit, it may be a good idea to take your financial advisor, CPA, or an attorney licensed to practice before the IRS to the meeting. Most issues are resolved satisfactorily by following these guidelines. If an impasse still persists, you can take the IRS to court. However, the process can be complex, time-consuming, and possibly more costly than it is worth.

Remember that your best defense is consistency, cooperation, and confidence in handling the situation in a professional manner.

Keeping good records will help you, your tax preparer and your financial planner better serve your needs, save you money and help you meet your financial goals. Stuffing everything in a shoe-box is tempting; but, remember, the details are in that box and that's where the devil can be found. Your financial planner and tax advisor can help you get your records in order.