Recordkeeping 101: The Why, What, and How for a Rewarding Tax Season

Admit it: Do you have a shoebox full of “important” papers that you *think* might be needed for your taxes? Do you know what’s in there? Are they in your junk drawer? The kitchen counter? The dining room table? In some online account that you don’t have the password for? Some combination of the above?  

We get it. “Preparing” for tax preparation can be daunting. Everyone’s tax situation is different, and as a result, there are no “one-size-fits-all" guidelines available as to what to keep, how long to keep it for, and what your tax professional actually needs to see versus what you need to keep as support documentation. The sheer volume of documents (with weird combinations of letters and numbers) is enough to make anyone stress!  

Today we want to put some of those anxieties to rest, for both you as an individual taxpayer, and for your clients. We can help you and your clients understand what to keep (and perhaps more importantly, why), and for how long. This helps your tax professional get your taxes filed correctly, prepares you in the event there are any questions on your return, and allows for efficient tax planning. 

Why keep records 

Before we review what needs to be kept, it’s important to understand why records need to be kept, both before and after the tax return is filed for the year.  

Including 90% of the information on the return is good enough, right? 

We all want to get that tax return filed so we can move on to more…exciting things in our lives. But, getting it “done” and getting it done “right” (i.e., accurately and to your maximum benefit) are two different things. The tax code is complicated (understatement!) and your tax professional knows some credits, deductions, and elections that may apply to you, but they cannot help you get them if you don’t have the appropriate documentation. 

In addition, your tax professional is not a mind-reader. They cannot know all of the miscellaneous income sources you may have, such as a part-time “gig”, hobby income, or small amounts of interest that are not reported on tax forms. Remember that the law states that all income is taxable unless there is an exception; therefore, it’s better to over-share than under-share information with your tax professional. They can help you determine the proper tax treatment of less common items. The last thing that anyone wants is for there to be interest and penalties related to an inaccurate return. 

While the burden of proof is ultimately on the taxpayer (more on this below), the tax professional cannot sign a return that (among others) lacks a reasonable basis or is an unreasonable position. So, while your tax professional is not responsible for “auditing” your documentation, we may ask you for the documentation that you do have to ensure the tax position is reasonable. 

Once a tax return is filed, it’s done, right? 

There’s a pesky little thing called the statute of limitations we need to worry about, along with the “A” word…audit. Ick. Audits generally start two ways: matching errors, or being picked for a random audit. When the statute of limitations expires, the IRS can no longer assess additional tax, allow a claim for refund by the taxpayer, or take collection action. But, within that time frame (generally, three years - but with all things, there are exceptions), they may ask for additional documentation to substantiate items claimed on the tax return. The taxpayer generally has a short amount of time to collect and submit this documentation, so it’s important to have everything related to the tax return filed in one place for easy access.  

In addition, there may be some items that you’ll need even past the statute of limitations to ensure accuracy of future returns. This is particularly true for those who have stock options, a Schedule C business or Schedule E rental with depreciating assets, or for those with a combination of deductible and non-deductible contributions to an IRA.

What records to keep 

We’ll start with the easy ones: make sure to keep all documents that say “tax document” on them. It is also prudent to keep all year-end financial statements. Pay particular attention to documents that substantiate any credits or deductions, such as charitable contributions, child care, HSA, or retirement contributions made outside of your employer. Also, for those who move across state lines, be sure to keep all of the details of the move and related change in residency.

Burden of proof 

Ugh. This is sounding more and more like an episode of Law & Order! But, this time, the burden of proof is on YOU - the taxpayer. Well, what does that mean exactly? Burden of proof means that if asked, you must be able to substantiate entries made on your tax return. Some common items: 

• Medical bills: If you paid a large amount of medical bills that were unreimbursed, your tax professional may ask you for a summary excel sheet showing dates and amounts. But, it is up to you to ensure that you can produce copies of the actual receipts if needed. 
• Education costs: Some non-tuition educational expenses can count towards an education tax credit. Your tax professional needs to know the amount of those expenses, but you are responsible for keeping copies of the receipts for books, computers, and other claimed expenses. 
• Mileage logs: Whether you are claiming mileage for a business, managing your rental, medical reasons, or charitable reasons, an estimate is not good enough. If you are audited, you will be required to produce a mileage log that contains the date, starting and ending location and resulting mileage, and reason for the trip. While odometer readings are not required, they can help show your diligence in proper recordkeeping. It is best to keep records at the time of the trip, rather than trying to go back and recreate the log at the end of the year. Remember that there are many apps that can help you keep track of this to make it easy!   
• Home improvements: If you sell your primary residence, your tax professional will ask you for your basis, which broadly speaking is the original purchase price plus improvements. So, while home improvements are not tax deductible at the time, those records can be crucial once you sell your home, especially if you stay in one place for many years. As home prices continue to increase, more and more people realize a taxable gain on their home which may have been able to have been avoided if the taxpayer had had detailed documentation showing an increase in the basis of their home. Again, you do not need to submit every receipt to your tax professional but they need to know that you have it, if needed.      

That sounds like a lot of shoeboxes!

Organizing your tax documents can be a daunting task, but your recordkeeping is only as helpful as your ability to find a specific record. Generally speaking, it’s best to keep documents with the tax return they support - even if that means you have duplicates. 

Use a system that works best for you, whether that be paper documents in labeled folders in a file cabinet (ideally, water and fire-proof), or taking advantage of electronic recordkeeping options. Digitization has numerous benefits, including saving space and having the ability to back up your important documents. Be sure to download any tax statements that are available through online accounts, in case you lose access later on. When possible, obtain electronic copies of receipts, or make copies, lest they fade. 

Whatever method you use, it is essential that your documents are secure and easily accessible. 

How long to keep records 

You should keep copies of your tax returns, other forms, and related records for at least as long as the statute of limitations. The statute of limitations requires that the IRS assess, refund, credit, and collect taxes within specified time limits. However, with the ease of electronic record-keeping options, keep at least the actual tax return indefinitely, even if you choose to discard the supporting documentation once the statute of limitations expires. 

Generally, taxpayers should keep records for a minimum of three years from the date they filed the tax return. The filing of a tax return is typically the event that triggers the running of the statute of limitations. However, the date the limitations period begins to run differs for timely and untimely filed returns. Reach out to your tax professional if you have any questions about your situation. To be safe, it is best to keep all records for seven years. 

The good news is that once you create a system, it gets easier—and less worrisome!

Keeping well-organized tax records is the most important part of a taxpayer’s responsibilities. Still unsure what kinds of records you should save, or how long to keep them? We can help you keep your shoes in their shoebox, and your dining room table available for dinner. Consulting with your XY Tax Solutions tax professional is the best way to get your questions answered—and may help save you money or avoid making costly mistakes when filing your tax returns this year. 

About the Authors

Sarah is a Senior Tax Specialist with XYTS and has a diverse financial services background of over 15 years in the risk management, insurance, and tax industries. She has a Bachelor's Degree in Economics and a Master's Degree in Business Administration. She is an Enrolled Agent and is currently pursuing a Graduate Certificate in Taxation.  Sarah is passionate about financial literacy and helping others recognize the importance of tax planning. Outside of work, she enjoys hiking, music, reading, and travel.

Alli Whittle is a Tax Specialist for XY Tax Solutions. Alli's favorite part about her job is working alongside her rockstar teammates on Team XYTS. The positive environment these tax experts cultivate every day makes it a pleasure to show up for work—even on Mondays. In her free time, you can often find Alli reading personal development books or binge-watching Netflix with her family, including her two kids, Emma and Jamie.