How To

7 Record-Keeping Tips That Will Make Tax Prep a Breeze

photo: JD Hancock

By now you’ve probably received your W-2s, 1099s and other forms necessary to complete your 2010 tax return.

If you’re super-organized, you may have even already filed your taxes and the question now is, what should you do with all those forms, receipts and other documents you used to prepare your return?

Many people err on the side of caution and keep all tax documentation for years on end, or until their filing cabinets literally overflow.

The truth is, you don’t need to keep tax-related stuff forever – but you shouldn’t get rid of it right after receiving your refund, either.

Throw away past tax returns and the supporting documents too soon, and you may find yourself in the middle of an IRS audit, lacking the evidence to back up all those tax deductions and credits. Approximately 1.4 million of 2009 tax returns were audited, according to the IRS. Though that’s only 1% of all tax returns, the chances of being audited are higher if your household income exceeds $100,000.

More importantly, being organized helps you avoid missing tax deductions or credit opportunities because you forgot about a certain expense or lost the receipt.

“You can avoid headaches at tax time by keeping track of your receipts and other records throughout the year,” says IRS spokesman Clay Sanford.

Here are seven record-keeping tips that will save you those headaches.

1. Know the general rules on old tax returns

Since tax returns are amendable and auditable for three years, you shouldn’t toss any tax information, including copies of your tax returns, for that length of time at the very least.

However, if income reported on your tax return is off by more than 25% than your actual income for the year, the statute of limitations for the IRS sending you an audit request is six years. Worthless securities claims can be audited within seven years.

2. Use Mint.com

Mint.com is great for keeping tabs on expenses you could use as tax deductions – even seemingly complex issues like keeping track of sales tax you’ve paid on items purchased throughout the year.

Categorize your purchases throughout the year and check off the “tax related” box for each transaction that may be tax-deductible. Come tax time, search for “tax related” items and instantly pull all relevant transactions.

For large purchases, take it a step further by annotating the sales tax portion, since it might be tax deductible. Split each transaction to annotate the exact amount of sales tax paid and categorize that as “sales tax.” Again, you can later search for all “sales tax” transactions.

Your data stays in the system as long as you have a Mint.com account, but you should download your transactions at least once a year onto your computer as a backup.

3. Keep big-purchase documents longer

Keep documentations on big-ticket items as long as the item is in use. For instance, a home will be in use until you sell it, but a retirement account could be utilized over the course of your lifetime. If you were able to qualify for a home energy tax credit, save a proof of purchases on windows, insulation, air conditioners, etc., with the energy rating listed, for at least three years.

4. Investments

Keep and review records of your investment losses from previous years because if you exceed the amount you can deduct as a capital loss from an investment, you can potentially keep deducting that loss in future years until the full amount is deducted. Sanford provides this example:

Bob and Gloria sold securities in 2010. The sales resulted in a capital loss of $7,000. They had no other capital transactions. Their taxable income was $26,000. On their joint 2010 return, they can deduct $3,000. The unused part of the loss, $4,000 ($7,000 − $3,000), can be carried over to 2011.

5. Log business mileage

If you use your car for business, write down the mileage used as you go. It’s tough to remember individual trips at the end of the year, and you’ll need to be able to explain your mileage if you are audited. Keep that diary for at least three years.

6. Charity receipts

When you donate money to charity, save your canceled check or your electronic records. If you keep electronic records, such as within Mint.com, you can add this in the charity/gifts category.

If you donate clothing or other non-cash items, Sanford recommends keeping receipts given to you when dropping off your goods. If the receipt is blank, instantly estimate what you donated and write it on the receipt.

If you went to a charity event, you can deduct the amount you paid minus the worth of what you received. For example, if you went to a charity dinner, price out a similar dinner. Then deduct this amount from the cost of the event. Make a note on Mint.com in the descriptions area of the transaction explaining how you estimated what was deductable and what wasn’t.

7. When in doubt, ask the IRS

The IRS has a help line you can call for free with any record-keeping questions: 1-800-829-1040.