Record-Keeping for Federal Income Tax Purposes

Record-keeping serves a variety of purposes in managing our day-to-day personal financial affairs. And, since income taxes go hand-in-hand, they should be taken into consideration in deciding what records to keep.

First of all, why keep records?

From an income tax perspective, there are some good reasons for keeping proper records:

• Keeping good records will make it a lot easier to prepare your income tax return
• Good record-keeping practices will help you identify your sources of income, and avoid overlooking any items that need to be reported on your tax return
• If you keep track of your expenses, you will be able to take advantage of tax deductions and credits.
• You will need records to keep track of the basis of your property, such as your home or other assets, in order to accurately calculate any gain or loss on an eventual sale.
• Having the proper documentation to support the items you report on your tax return will give you peace of mind, knowing that if you are ever audited, you will be able to confidently present your case.

What records to keep

Throughout the year, you will have receipts, statements, and other documents that you will need to keep for income tax purposes. Often, these will serve more than one purpose. For example, if you purchase a home, the closing statement may contain tax-deductible expenses, but this document serves various other purposes as well, such as for insurance, property taxes, home equity loans, and others, and should be kept in your permanent personal files. The medical bills you receive will show how much you were reimbursed by the insurance company, and will also determine whether you can claim an itemized deduction for income tax purposes.

Some records that you will need for income tax purposes are records you have to maintain yourself, such as a tip diary, or a log or diary of business-related travel expenses and mileage.

Other records will be the standard forms you receive at year-end, such as your W-2, 1098 and 1099 forms. You may also receive year-end summary statements for your investments.

There may be other receipts that you keep specifically for income tax deductions, for example, charitable donations, job-hunting expenses, moving expenses, and for purposes of the tax deduction for state sales tax. How you decide to accumulate and file these documents will depend on your personal preferences, organizational habits, and filing system. But the important thing is to keep them. Without the proper documentation, it will be difficult to reconstruct your expenses, and to substantiate them as tax deductions.

Of course, keeping absolutely every bill and receipt you receive during the year may be unnecessary and in the end may just generate more work to sort everything out when it comes time to do your tax return. So, as you go about your business during the year, trying to decide whether something should be kept, it is helpful to be aware of some general guidelines regarding what you will need to prepare your income tax return.

General guidelines to follow during the year

You should keep records to substantiate the income and expenses you report on your tax return, documents that support the basis of your home and other assets, and records related to your investments.

Income

You should basically keep everything that involves income. As a general rule, all income that you receive, in the form of money, goods or services, is taxable unless it is specifically exempt. And you will determine what income is exempt when you do your taxes. The following are examples of the documentation you should keep:

Employees:

• Work contract or offer letter
• Paycheck stubs or pay statements
• Tips – You must keep a daily record of tips in order to report them to your employer to have social security, Medicare, and federal income tax withheld. You will also need this record to report your actual tip income on your tax return. If you don’t have another record, You can use IRS Form 4070A, Employee’s Daily Record of Tips
• Documentation of awards, bonuses, stock options, and other incentives
• W-2 – Wage and Tax Statement
• Unemployment compensation statements and Form 1099-G

Self-employed and business owners:

• Sales orders or tickets
• Invoices
• Billing statements
• Fee billings
• Cash register receipts
• Credit card statements
• Electronic funds transmittals
• Bank statements
• Other receipts

Others:

• Bank statements (for deposits)
• Brokerage statements
• Receipts for rent and royalty income
• Purchase and sale agreements
• Social security benefits
• Receipts of alimony – You should keep a copy of your divorce decree, written separation agreement, separate maintenance or support decree
• Diary of gambling winnings and losses
• W-2G – Certain Gambling Winnings
• 1099 Forms for interest, dividends, capital gain distribution, and other types of income
• Form 1099-R - Distribution From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., if you received a distribution.
• K-1 Forms (for partnerships)
• Worksheets for determining taxable portion of pensions, annuities, and social security benefits

Expenses

The records you keep of expenses should be separated between:

• Business expenses, if you are self-employed or are the owner of a business, and expenses incurred in order to generate income, and
• Personal expenses, certain of which may be deducted as:
• Adjustments to income - deductions from gross income to determine Adjusted Gross Income (AGI)
• Itemized deductions, if you can itemize rather than taking the standard deduction, and
• Credits, which are a direct reduction of tax.

During the year you may not know, for example, if you will be able to itemize. You will probably want to keep the necessary receipts in case it turns out that you can itemize. If in doubt about whether you will need to keep a receipt, it may be a good practice is to make a notation on the receipt itself as to what it was for, and then keep these in a desk drawer, file folder, envelope, box, bin or wherever else you will be able to find them when you do your taxes.

Proof of Payment

One of the basic concepts involved in substantiating expenses for federal income tax purposes is proof of payment. Whatever the form of payment, the important data you should have are

• Payee
• Date
• Amount
• Purpose of payment
• Any transaction reference number

Forms of proof of payment include cash receipts, canceled checks, credit or debit card statements, electronic funds transfer confirmations or statements, and payroll deductions. All these forms of payment are accepted as proof of payment, provided they present the information described above. You may need to add specific notations or attach additional explanatory documentation.

Business expenses and expenses for producing income

Expenses related to your business income from self-employment or as a sole proprietor will probably be part of the accounts payable cycle of your business accounting system and record-keeping. If you have expenses related to investments or income-producing property, such as rental property, and you don’t have a formal accounting system, you will need to set up a way to keep track of them. In general terms, documentation of these expenses should include:

• Requisitions
• Quotations and bids
• Purchase orders
• Maintenance or service requests
• Receiving documents or proof of delivery
• Invoices
• Payment vouchers
• Canceled checks
• Credit card statements
• Bank statements

If you have a home-based business, you will need to keep records to support your deduction for the allocated portion of your household expenses that correspond to the business use of your home. This documentation includes:

• Rent receipts if you are renting your home
• Depreciation calculations if you own your home
• Utility bills

Personal expenses

Adjustments to income

• Receipts for educator expenses – books, supplies, and materials used in the classroom
• Form 5498 - IRA Contribution Information
• Form 1098-E - Student Loan Interest Statement
• Form 1098-T - Tuition Payments Statement
• Documentation of contributions to a Health Savings Account
• Receipts for moving expenses – travel expenses for you and your family, and costs of transporting your household goods and personal effects
• Payment vouchers for a self-employed health insurance plan
• Payment vouchers for contributions to a self-employed SEP, SIMPLE, or other qualified pension plan
• Receipts for alimony paid

Itemized deductions

Medical and dental expenses

• Doctors’ bills
• Hospital bills
• Bills for outpatient treatments
• Receipts for medical office visits
• Receipts for prescription medications
• Receipts for other medical expenses allowed as itemized deductions
• Bills for medical insurance premiums
• Records of insurance reimbursements
• Receipts for transportation expenses that are primarily for and essential to medical care. You can keep a diary of gas, oil, and other actual expenses directly related to that transportation, or you can keep a log of the miles you drive your car for medical purposes and use the standard mileage rate. Keep receipts for parking fees, tolls, taxi fares, and bus fares. These are deductible under either method.
• Health Savings Account (HSA) and Medical Savings Account (MSA) - Keep a record of any qualified medical expenses you paid with a distribution from one of these accounts.

Taxes

• Form(s) W-2 and Form(s) 1099-R for state and local income tax withheld from your wages and pensions
• Payment vouchers and cancelled checks or other proof of payment for estimated state and local income tax payments
• Copies of your state and local income tax returns. If you had to pay, you can deduct the tax paid. If you received a refund, you may need to include the refund in your income for federal income tax purposes. In this case you should receive Form 1099-G -Certain Government Payments.
• Mortgage statements for real estate and personal property taxes
• Tax assessments for real estate and personal property taxes you paid
• Actual receipts showing general sales taxes paid, if you don’t use the optional state sales tax tables
• Closing statement on purchase or sale of home (for real estate taxes)

Interest

• Mortgage statements and proof of payment
• Form 1098 - Mortgage Interest Statement, if you paid interest of $600 or more
• Closing statement on purchase or sale of home (for points)
• Proof of payment of investment interest

Gifts to charity

• Proof of payment for contributions paid by cash, check, credit card or payroll deduction
• Receipts from charitable organizations, showing the name of the organization, amount and date of the contribution
• A written statement from the organization is required for contributions of more than $75, from which you derive some benefit
• Written acknowledgement from the organization is required for contributions of $250 or more
• Receipts for out-of-pocket expenses incurred while doing volunteer work for a charitable organization. Keep a record of actual expenses when using your personal vehicle, or use the standard mileage rate. Keep receipts for parking fees, tolls, taxi fares, and bus fares under either method.
• Receipts from charitable organizations for contributions of property, showing:

• Name of the organization
• Date and location of contribution
• Reasonably detailed description of the property
• Record of fair market value of the property (appraisals, quotes)
• Record of cost or other basis of the property (original invoice)
• Terms of any conditions attached to the contribution

• Written acknowledgement from the charitable organization of your donation of a car, boat, or aircraft with a claimed value of over $500.

Casualty and theft losses

• Insurance claim report - to prove that you had a casualty loss
• Title to the damaged property – to prove that you are the owner
• Evidence of your basis in the property damaged (for example, if it was your home, your purchase agreement, closing statement or other record of cost, plus the cost of improvements you have made)
• Appraisal, to determine the decrease in the fair market value of the property as a result of the casualty
• Police report – to prove a theft loss
• Title to the stolen property or copies of invoices or receipts
• Copy of insurance reimbursement

Job expenses and other miscellaneous deductions

For employee business expenses:

• Log or diary of business expenses.
• For transportation expenses you must show:
• business purpose
• For travel expenses:
• business purpose, and
• business benefit gained or expected to be gained
• For entertainment expenses:
• business purpose,
• business benefit gained or expected to be gained
• nature of business discussion or activity
• date, place, nature, and duration of business discussion
• identities of persons who took part in business discussion and entertainment activity
• For gifts:
• Information about recipients that shows their relationship to you

• Copies of expense reports you submit to your employer
• Hotel bills
• Receipts for restaurant, and other entertainment expenses
• Receipts for gifts to clients, customers, and others related to business
• Airfare vouchers
• Receipts for taxi fares and public transportation
• Receipts for gas, oil and other actual expenses if you use your personal vehicle for business and use actual expenses
• Log of business miles if you use your personal vehicle for business and use the standard mileage rate
• Receipts for parking and tolls

For other work-related expenses:

Work-related education:

• Receipts for tuition, books, supplies or other education-related expenses
• Receipts for public transportation (from your place of work to your place of education)
• Receipts for actual expenses if you use your personal vehicle to get to your place of education
• Log of miles when you use your personal vehicle and use the standard mileage rate
• Receipts for purchase and upkeep of uniforms used only on your job
• Receipts for purchases of tools used only on your job
• Proof of payment of dues to professional organizations and chambers of commerce
• Proof of payment of licenses and regulatory fees related to your occupation or profession
• Proof of payment of union dues (paycheck stubs if withheld from your paycheck)

For job-hunting expenses:

• Proof of payment of employment and outplacement agency fees
• Receipts for costs of preparing and sending your of a resume to prospective employers
• Receipts for travel expenses to look for work or go to interviews
• Log of mileage for travel expenses if you use your personal vehicle and use the standard mileage rate

Other miscellaneous deductions:

• Receipt for tax return preparation fee
• Proof of payment for a safe deposit box if you use it to store income-producing documents
• Receipts or proof of payment of appraisal fees for determining loss of fair market value due to a casualty or the fair market value of donated property

Credits

• Child and dependent care expenses
• Receipts for payments to a daycare center, nursery school, or other dependent care center
• Receipts for payments you make to someone to come to your home to care for your dependent
• Records showing the name, address, and taxpayer identification number of the care provider. (You can use Form W-10 to request the required information.)
• Paycheck stubs or pay statements (if you receive dependent care benefits from your employer)
• Education expenses (Hope or Lifetime Learning Credits)
• Proof of payment of tuition
• Tuition and fees statements
• Receipts for purchases of course-related books, supplies, and equipment
• Financial aid awards (grants, scholarships, and fellowships)
• Adoption expenses
• Proof of payment of adoption fees, court costs, attorney fees, travel expenses (including meals and lodging), and other expenses directly related to adoption
• Mortgage interest credit
• Mortgage credit certificate from your state or local government
• Mortgage statements and proof of payment
• Form 1098 - Mortgage Interest Statement, if you paid interest of $600 or more
• Foreign tax credit (could be taken as an itemized deduction instead of a credit, or if the tax is on excluded foreign income, you cannot take a credit)
• Copies of foreign tax returns
• Copies of foreign tax withholding statements
• Other proof of payment of foreign taxes
• Retirement savings contributions credit
• Documentation of contributions to an employer-sponsored retirement plan or an IRA
• Credit for electric vehicles
• Invoice, purchase and sale agreement, title or other documentation as proof of purchase of a qualifying electric vehicle

Basis of Assets and Investments

Your home and other real property

Your basis is the purchase price you paid, including certain settlement costs, plus the costs of capital improvements that increase the value of the property, lengthen its life, or adapt it to a different use. You should therefore keep the following records:

• Purchase and sale agreement
• Closing statement
• Title
• Mortgage agreement
• Insurance policy
• Proof of payment of capital improvements:
• Putting an addition on your home
• Replacing the roof
• Rewiring your home
• Installing central heat or air conditioning
• Paving your driveway
• Proof of payment of assessments for local improvements:
• Roads
• Sidewalks

Investments

The basis of stocks, bonds or other investments you buy is generally the purchase price plus any commissions and fees. Your basis will be affected by stock splits, capital distributions, reinvested dividends, and other events. You should keep:

• Stock certificates
• Brokerage statements
• Mutual fund statements
• Statements from investment companies
• Statements regarding any type of pension or retirement account
• 1099 Forms
• 2439 Forms (Notice to Shareholder of Undistributed Long-Term Capital Gains)

Final Notes

Having the appropriate records and documents does not necessarily guarantee you will be able to take advantage of the corresponding tax benefits. Your eligibility for exemption of certain income, and for certain tax deductions and credits will be determined when you do your tax return. But in order to determine whether you qualify for these tax benefits, you will still need to have records and documentation.

The above listing of records to keep is not intended to be all-inclusive, but rather as a guideline and reminder. You will need to keep abreast of changes in the tax law each year to see what new deductions and credits you may be able to take, and the records you will need to substantiate them.

If you choose to keep your records on paper rather than, or in addition to an electronic format, you can organize your paper documents in folders and files, just as you would with electronic documents. All references to records and documents include both electronic and printed format.

By keeping up with your record-keeping throughout the year, you spread the income tax preparation workload out over the year and significantly reduce the time and energy you will have to put into getting your records together when it comes time to actually prepare your return.

The time it takes you to keep logs or diaries of your expenses, make notations on receipts, and generally organize your records, will pay significant dividends at year-end.