Though we’re months away from tax season, it’s a great time to start thinking about how to organize your financial records. What makes tax time so stressful for many people is the fact that they have to do a lot of record keeping in a short amount of time. Instead of procrastinating, get a head start now so you can relieve a ton of stress and make filing your tax return much easier and faster.
Why Should You Keep Financial Records?
We typically need to keep fewer records than we do. However, if you understand why you need to keep certain records in the first place, that will help you determine what to keep and what to toss.
Here are 6 reasons why you need to keep records:
1. Identify your sources of income. If you receive income from a variety of sources, having complete records will help you separate business income from non-business income or taxable from non-taxable income.
2. Make an insurance claim. It’s a good idea to keep receipts for large purchases—like jewelry, appliances, electronics, and sporting goods—in the event you need to prove the original purchase price to an insurer or to make a warranty claim.
3. Get a loan. When you apply for a large loan to purchase a home or business, for instance, you must produce several years’ worth of income, banking records, and more.
4. Keep track of your property basis. You need to keep records that show the basis, or cost, of your home so you know if there is a gain or loss when you sell it. The adjusted basis includes the original purchase price plus the cost of any improvements you’ve made to the property. You also need this information to figure depreciation if you rent out part of your home or use it for business purposes. See Publication 530, Tax Information for Homeowners and Publication 551, Basis of Assets for complete details.
5. Keep track of investment gains and losses. You need to keep records that allow you to determine your basis in an investment (such as stocks, bonds, mutual funds, and exchange-traded funds), so you know if there is a gain or loss when you sell it. See Publication 550, Investment Income and Expenses for more information.
6. Support information you submit on your tax return. If you were ever audited by the IRS, you’d be very happy to have all the documents that back up the tax return in question. Taxpayers are responsible for what’s submitted on their tax return—even if it was prepared by an accountant. Being able to quickly produce back up documents for income, tax deductions, and tax credits, can help you avoid having to pay additional tax and penalties.
What Financial Records Should You Keep?
Now that you know the reasons why records are important, here’s a list of basic financial documents you should keep related to your income, expenses, home, and investments:
- Form W-2
- Form 1099
- Form K-1
- Bank statements
- Brokerage statements
- Receipts that document tax deductions or credits (such as charitable contributions, mortgage interest, real estate taxes, child care, and medical expenses—for a complete list refer to Publication 552, Recordkeeping for Individuals)
- Credit card statements that contain tax-related transactions
- Auto mileage logs
- Real estate closing statements
- Receipts that document substantial home improvements
- Insurance records
- Retirement account information
I recommend that you attach all tax-related paperwork to your tax return each year and file it away in a legal-size clasp envelope that’s clearly labeled with the tax year.
Having tax returns on hand can help you (or your accountant) prepare future returns. Additionally, in the event of your death tax return copies would greatly assist the administrator of your estate.
How Long Should You Keep Financial Records?
Since you can amend a tax return for up to 3 years or be audited for up to 6 years (in some cases), most people say that’s enough time to hang on to them. However, I recommend you keep old tax returns forever and here’s why: The IRS says, “You must keep your records as long as they may be needed for the administration of any provision of the Internal Revenue Code. “Any provision” of the IRC is pretty broad!
Additionally, the IRS recommends that you keep a copy of every W-2 you receive in your lifetime until you begin receiving Social Security retirement income. Those forms would be the only way to confirm your earnings in a particular year and reconcile an error in your benefits.
Instead of pulling out W-2 forms and keeping them in a separate file, it’s just easier to save your entire tax return. Yes, it takes up more space in your filing cabinet or attic, but for me keeping the full backup is worth it.
Use an Easy Recordkeeping System
I created a step-by-step video that shows you exactly how I organize my personal records. When you sign up at SmartMovesToGrowRich.com it’s one of several information gifts you receive. You’ll also get 2 free chapters from my award-winning book, Money Girl’s Smart Moves to Grow Rich, which is an easy-to-understand guide to personal finance.
Being stress-free at tax time—while everyone else is rushing around—is a great feeling! So take a little time to get organized now and set up a system that will keep you level-headed about taxes for decades to come.