Keeping Good Tax Records

Keeping good tax records can be easy if you come up with a system and stick with it. Figuring out which documents are the right ones to keep is only half the battle. Keeping them organized requires discipline, without which you’ll be left with an unruly shoebox overflowing with receipts.

But worry not: Online tools are available to help you stay organized. If you’re not tech savvy, there are plenty of tried and tested methods to keep you organized.

“We’re seeing much more of this, little apps like Expensify you can buy for your smartphone. They really appeal to some people.”

- Mark Schwanhausser, financial services analyst

The first step in efficient documentation management is figuring out which documents to keep and how long to keep them. Some, such as the monthly statements for bank, credit card, investment and retirement accounts, are obvious. Others might not be so obvious. You may need a pharmacy receipt as proof of a medical expense or the receipt for a summer camp for a possible child-care credit.

When it comes to receipts, there are two questions: Which ones do you keep and for how long? The answers vary by taxpayer.

The rule of thumb among experts is seven years, although Internal Revenue Service resources offer some scenarios in which shorter retention periods are acceptable. Carol W. Thompson, an enrolled agent and tax expert in Springvale, Maine, suggests some documents be kept even longer than seven years. Among the documents in that category are any related to physical assets, such as a home, automobile or office equipment.

Some purchases — especially if they are related to a business expense — depreciate over time. Related documents must be kept for as long as you own the property or item. The IRS warns that documents related to real estate transactions should be kept until all tax obligations for the property have been settled — in some cases a year or longer after the sale.

Just as important is recognizing it’s OK to toss out some receipts.

“You don’t need to keep everything,” said organizational expert Jodie Watson, owner of Los Angeles, California-based Supreme Organization. “In most cases you don’t (need) grocery store receipts — unless you want them for your own records, to know what you spent on groceries.”

For generations, people have filed their paper receipts in case IRS auditors come seeking hard proof of expenses reported on a return. Many people find that the ink fades on the paper and the paper is tough to organize.

It doesn’t have to be that way. Watson says some simple organizational steps applied all year can make the process less overwhelming.

“You do need some sort of file system, whether it’s a file cabinet or a tote box or a desktop file,” Watson said. “Whatever it is, you do need some sort of system where you can label things.”

She suggests you have one box just for income-related documents and another for any other documents. Just keeping the tax-related documents separated from the others is a big first step and a time-saver when sifting time arrives.

Keep the documents in each box organized either by date or by category. Either is effective, Watson said, but stick to one for the course of a year. Mixing the two methods will only confuse matters.

She recommends basic office supplies such as binder clips or an accordion file to keep similar documents together.

If you are concerned about the ink fading on receipts, make copies and file them instead. The trick is to do it consistently. Receipt scanning could become a recurring “appointment” on your weekly or monthly calendar. While you're at it, place the originals in an accompanying envelope marked “original receipts.” It may be slightly unruly, but that’s OK. Those receipts are just there for backup.

Going paperless with your tax documents not only is good for the environment, but also allows more flexibility with the filing system. Many banks and credit card companies allow customers to download their records into their own computers, creating backup copies. Likewise, important paper documents may be scanned as digital PDF files and stored on a computer. Those files may be tagged or otherwise marked up with notes without compromising the actual document.

Watson knows that some people are leery of keeping a digital file alone, but she suggests they give it a trial run.

“Do one thing, perhaps a bank statement, paperlessly,” she said. “Start with one type of document and see how that goes. Then add others.”

While the IRS is OK with digital records, it reminds taxpayers that they must able to be reproduced “in a legible, readable format” and that retention requirements for paper records also be applied to digital records.

Finally, digital files must be stored in a secure place. Online storage, or “cloud” providers, such as DropBox, Google and SugarSync provide some of these basic services.

Personal finance software like Intuit’s Mint.com or Quicken can help you keep track of your expenses and even categorize those that are tax deductible. It’s often possible to export these records, if needed, or transfer them directly into tax software like TurboTax, which can make tax time easier.

Mark Schwanhausser, a senior financial services analyst for Javelin Strategy and Research in Pleasanton, California, is keeping his eye on online and smartphone services focused solely on organizing finances.

“We’re seeing much more of this, little apps like Expensify you can buy for your smartphone,” he said. “They really appeal to some people. There are a lot of little pieces that are here to help us with our finances.”

Expensify uploads transactions from a bank account into a user-friendly database, where the user may add notes or “tag” expenses with keywords. Online services such as Mint.com can import and index transactions from various accounts and tag them with notes.

Free online calendars, such as those offered by Google and Yahoo, can also be a good place to note expenses that go with appointments.

Schwanhausser said these online services are also growing in popularity among financial institutions.

Smaller banks and some credit unions are implementing these same types of services with their online banking sites, just as start-up companies and big banks have already been doing.

As telecommuting opportunities grow, more people write off the expenses of a home office. While the rules around this write-off can be very strict, Carol W. Thompson, a Springvale, Maine, tax expert who also teaches certification courses for tax practitioners, says there are potential write-offs that many people miss.

The home office expense includes more than just the cost of Internet service at your home and a separate phone line. Every other expense that goes with maintaining a home is also a potential write-off — from the electric bill and trash bill to the homeowner's insurance premium.

Likewise, receipts for improvements to the home office — from something minor like adding shelves to major improvements such as installing lighting or moving walls — should be filed away as potential write-offs.

Thompson said home office write-offs are taken at a fraction of the expense, not a whole expense. Do not, for example, claim the electricity for the entire house as a write-off. The deduction only applies to the area designated as office space.