Client report.(tax return preparation) - The National Public Accountant

MARCH/APRIL 1999

Gathering together all of the pertinent information and records that are needed to prepare a tax return can be quite annoying and boring. But it is essential that you compile the right information so that your return can be prepared properly. Maintaining records also is critical so that if the IRS later audits the return, you will be able to withstand the challenge. Sometimes, you even need to retain records to fend off potential challenges on returns for years subsequent to the year of the return to which the records directly relate. And records are a first line of defense against penalties.

What are the basics? While your records must be accurate, the Internal Revenue Service generally does not require any particular form of record keeping. One of the best records of having paid a particular expense is a canceled check. Keep your canceled checks that relate to any items that you need or even only think will be needed to prepare any tax return that you may have to file.

You also should retain receipts, sales slips, and invoices referring to items that might be included on a return. Of course once your return has been has been prepared and items have, in fact, been included in the return as deductions or in some form or another it is imperative that you keep records supporting the claimed tax treatment.

In addition to keeping records to support deductions, you will also need to keep records to keep track of what income you will need to report on your tax return. These include Forms W-2 showing wages from employment and Forms 1099 showing compensation from any independent contracting work you performed. Apart from Forms 1099, separate accounting books and records are needed for independent contracting jobs. There are a whole series of other Forms 1099 showing interest, dividends and other types of income, which you should keep, along with financial statements from brokerage houses. Of course, you should also keep copies of your tax returns. Also, keep copies of related schedules and attachments with the returns.

Another question that arises with respect to record keeping is how long you need to keep the records. The short answer is you need to keep them for as long as the IRS can potentially challenge you on the item to which a particular record relates. This period generally is 3 years from the date you file your income tax return or, if later, 2 years from the time you pay the tax. If you file your return before the due date, the IRS gets to measure the 3-year period from the actual due date. Sometimes, the so-called limitation period is 6 years. There is no limit for the IRS to bring an action against someone who has filed a false or fraudulent return.

In some cases, you should keep records longer than the regular limitations period. For example, you should permanently keep records of your basis in property. Basis is the yardstick for measuring tax gain or loss and usually is the amount you paid for property and major improvements to it. Note: Although many homeowners may no longer need to keep track of basis for selling their principal residences due to the 1997 Taxpayer Relief Act"s exclusion of $250,000 of gain from the sale of principal residence ($500,000 exclusion for married taxpayers), most homeowners of higher-priced homes should keep records since the chance remains that inflation may push them above the $250,000 threshold at some future date.

You also should permanently retain certain documents. For example, keep trust documents, wills, partnership agreements, business contracts, divorce decrees, leases and the like.

We explained the importance of keeping records so that your tax return can be properly prepared and so that claimed items can be backed up in the event of an audit. (Despite a popular misconception that the IRS Reform Act of 1998 shifted "the burden of proof" on audits to the IRS, the 1998 law does not relieve any taxpayer of the obligation to keep proper records to substantiate deductions and tax basis.) Here, we focus on common records that are needed in connection with taxes on your personal income.

You should keep records of expenses that can be claimed as itemized deductions. Thus, you should keep records of un-reimbursed medical and dental expenses, including receipts showing the dates you paid them and receipts for transportation primarily for, and essential to, medical care; payments of state income tax including any Forms W-2 from employment and canceled checks of payments of state estimated tax or any additional state tax paid with your return (which also should be retained); records and canceled checks showing interest payments on your home mortgage and payments of real estate and personal property taxes.

You also need records of charitable contributions. For cash contributions, keep a canceled check or a receipt from the charity showing the amount and the date of the contribution. For a contribution of $250 or more, you need a written acknowledgment from the charity containing very specific information and you generally must get this before you file. Additional records are needed for contributions of property other than cash. If you perform services for a charity, keep records showing your out-of-pocket expenses.

You must keep records of stock, mutual funds, bonds and other similar investment property. Retain information on how and when any such assets were acquired - including additional shares purchased by reinvesting dividends. For these items and other types of assets, you must keep track of your basis, which is used to measure your tax gain or loss when you sell an item. Basis is ordinarily your cost but is different for property acquired by gift or inheritance or in a divorce. It is especially important to keep records of the basis in your home, which you may not sell for several years. Records of sales also need to be kept, along with commissions and other charges.