Tax Planning Includes Good Recordkeeping
An important part of tax planning is recordkeeping. Although we seem to focus on documents/records at tax time, good records should be maintained throughout the year. A good recordkeeping system can make it easier when it comes to filing a tax return, but it also helps you address any communication received from the IRS during the year and may help you better understand your financial circumstances. Records can be kept on paper or electronically.
When setting up a recordkeeping system, keep in mind that the system should enable you to do the following:
- Identify sources of income: You should be able to identify all sources from which you received money or property during the year and to determine whether the funds/property received are taxable income. Once identified as taxable, you should be able to separate which of these sources are business income, and which are personal/nonbusiness income.
- Keep track of expenses: Knowing what expenses you incurred will help you identify whether the expenses qualify as deductions/credits. Good recordkeeping will prevent you from overlooking potential deductions/credits.
- Prepare returns: Maintaining good records throughout the year will make it easier to file a return as all needed documents will be available and organized. It may also enable you to file your return quickly.
- Substantiate items on you return: Although you may be entitled to claim a deduction/credit on your return, the law requires that you have documentary support to substantiate the claimed deduction/credit. Good records will enable you to provide proof of the deductions/credits claimed on your return should the IRS question your return.
The IRS recommends that taxpayers keep records for three years from the date the return is filed. At a minimum, your recordkeeping system should include the following records:
- All documents relating to income sources such as wage statements, bank statements, brokerage statements, virtual currency transactions and records from sales of property.
- All receipts, canceled checks, or documents which substantiate deductions/credits claimed on a return.
- Copies of prior year returns and letters/notices received from the IRS.
- Records relating to the purchase of property should be maintained until the property is sold. In the case of real estate, documents of all capital improvements made to the property should also be kept until the property is sold. These documents will be used to determine the basis of the property. Basis is used to determine the gain/loss on the sale of the property.
- If you have a business, all records regarding the income and expenses of the business. If the business has employees, all employment tax records must be maintained for at least four years from the time the employment tax is due or paid, whichever is later.
- Information regarding health insurance coverage for yourself and your family. If you purchased insurance through the market place and are claiming the premium tax credit, you will need to keep records regarding the premiums paid and any advance credit payments received.
Now that tax season is officially open, it is time to start gathering documents and setting up a recordkeeping system.