Finance Tax Time

When preparing your taxes, the goal is obviously to deduct every last penny you can. Many people are amazingly good at it. Just keep in mind you need receipts for the deductions.

List of Tax Records To Keep

Filling out and filing tax returns is really a quest to conquer the mountain. In this case, the mountain is your gross income. The IRS helpfully lets you know this by making you write it down right away and repeat it in various places on your 1040 form. How nice of them.

To conquer the mountain, you start shaving it down by claiming deductions. The more you can claim, the better off you are. Some people have lots of deductions that help in this regard. Others create lots of interesting deductions to do the same. Whatever you approach, keep in mind you need receipts to support those deductions should the IRS ask to see proof. Here is a list of common tax records you need to keep to support those deductions.

1. Mortgage Interest Payments. One of the great things about owning a home is the mortgage. Oh, wait. The great thing is the mortgage interest deduction, not the mortgage. To prove the amount you have been paying the piper, you should keep the form 1098 you receive from your lender each year. Given the fact the deduction is usually sizeable, make sure to keep it in a safe place.

2. Dependent Support. If you claim someone as a dependent, you may be in for a surprise. You need to be able to prove that you provide more than 50 percent of the support for that person. Happily married parents usually do not have problems, but the IRS likes to zing divorced parents on this issue. Keep records in the forms of receipts, checks and invoices in such a situation.

3. Home Repair Receipts. No, you do not have to show the receipts each year. The issue really comes up when you decide to sell your home. To cut your tax bill, you should claim all repairs and improvements you made since owning the home. Guess what, you need receipts to support those claims. In simple terms, save every receipt related to your home or risk losing the deductions.

4. Medical Expenses. Health care costs are out of control as we all know. If you are claiming deductions related to medical care, keep those receipts and bills.

Obviously, there are other areas where you need to keep receipts, but these are some of the more common places where people fall down on the job. In general, you should keep all the receipts for three years, but I suggest doubling that number. With home repair or improvement expenses, you need to keep them for five years after you get around to selling your home.

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Keep or Toss - And When?

Record Retention

By Teri Kaye, CPA

As a Certified Public Accountant, I work with my clients’ banking and business records all the time. As a mom, I handle my own family’s banking, credit card and other financial records. In both capacities, I have learned how important it is to safely retain financial records. If you have ever applied for a loan or been through a tax examination, you also know the need to have adequate records. But what are adequate records and how long do you need to keep them?

In general, except in cases of fraud or substantial understatements of income, the IRS can only assess additional tax for three years from the date the return was filed, (or, if later, three years after the return was due). For example, if you filed your 2005 personal tax return by its original due date of April 17, 2006, the IRS would have until April 15, 2009 to assess a tax deficiency against you. If you filed your return late, the IRS generally would have three years from the date you filed the return to assess a deficiency.

However, the assessment period is extended to six years if the IRS asserts that more than 25% of gross income is omitted and is indefinite if the IRS asserts fraud on a return. In addition, the assessment period doesn’t begin to run until a return is filed. Therefore, if the IRS claims that you never filed a return for a particular year, it can assess tax for that year at any time (even beyond three or six years), unless you can prove that you did file. Proving that you filed would entail providing a copy of the return and proof of mailing (such as the green “return receipt” from the U.S. Postal Service.

Retaining tax returns (along with their proof of mailing) indefinitely and important records (bank statements, check registers, receipts, expense logs, sales invoices, computer backups, W-2s and 1099s, etc.) for six years after the return is filed should, as a practical matter, be adequate. If you file your returns electronically, be sure to get copies from the company that prepared and/or filed your return; it is required to provide you with a paper copy of the return.

The six year retention rule is extended for assets and transactions that affect more than one tax year. For instance, if you buying real property, or other investments, or obtaining or making loans, the records for the purchase or origination should be kept for six years after the ultimate sale or payoff. In addition, documentation on any improvements or other costs required to be capitalized should also be kept until six years after the sale.

For any business with an employee, keep complete and accurate record of hours worked and hours paid for. Have a written payroll policy that states how employees are to record their time and that they must submit the information to the employer. Include rules for overtime (i.e., does it need to be approved in writing in advance by a supervisor). Keep all these records for three years after the employee has been terminated. For all employment records, including tax returns and timecards, keep these records for at least four years.

In the event you have a transaction generating a loss carry-forward, such as the sale of an investment at a loss, you should keep the records relating to the underlying transaction as proof of the loss, until six years after the loss has been fully utilized or expired. In particular, remember that if you reinvest dividends to buy additional shares of stock, each reinvestment is a separate purchase of stock, and the records of each reinvestment should be kept for at least six years after the return is filed for the year in which the stock is sold.

For Individual Retirement Accounts (IRAs) you should keep records of contributions and distributions, Forms 8606, 5498 and 1099-R until all the money is withdrawn from all the accounts and an additional three years has passed.

When new property takes the basis of old property, records relating to the old property should be kept until six years after the sale of the new property is reported. For example, suppose you bought a car for business use in 1998 and you traded it in on a new car for business use in 2001. If you sold the new car in 2006, your basis in the new car will determine whether you have a tax gain or a tax loss on the sale, and your basis in the new car is determined, at least in part, by your basis in the car you traded in 2001. Accordingly, records relating to your old car should be kept until 2013 (i.e., for six years after your 2006 return is filed in 2007).

If separation or divorce becomes a possibility, be sure you have access to any tax records affecting you that are kept by your spouse. Or better still, make copies of the tax records, since in such situations, relations may become strained and access to the records difficult.

As many of us have learned this year with the various hurricanes, and other disasters, the calculation of the casualty and theft loss deduction is determined in part by your basis in the damaged or stolen property. You need to have records to support that basis, until six years after you file the return claiming the loss deduction.

To safeguard your records against loss from theft, fire or other disaster, you should consider keeping your most important records in a safe deposit box or other safe place outside your home. In addition, consider keeping copies of the most important records in a single, easily accessible location so that you can grab them if you have to leave your home in an emergency.

If records are lost or destroyed, it may be possible to reconstruct some of them. For example, a paid tax return preparer is required by law to retain, for a period of three years, copies of tax returns or a list of taxpayers for whom returns were prepared. Similarly, other professionals who assisted you in a transaction may retain records relating to the transaction. Consider contacting, your banker, investment broker, realtor and attorney for records.

Your state may have different rules so consult your State taxing authority to request information regarding their record retention rules.

Today, with the prevalence of computer scanning equipment and software, it is easier than ever to maintain complete records for years. My firm invested in state of the art scanning, storage and retrieval technology and now instead of having a filling room, we scan our files and clients’ records and store them electronically. This not only satisfies the retention requirements, but also allows easy access. No more looking in cabinet after cabinet or boxes in storage.

Whether you keep hard copies of tax returns, proof of filing and other financial records, or scanned copies, it is important to set a policy about what you will keep, how you will keep it and when you will destroy it (by shredding so your identify and information are protected).

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The United States is a nation of entrepreneurs. There are literally tens of millions of self-employed individuals that enjoy pursuing their dream business. Of course, few of you enjoy the paperwork and confusing tax issues that arise from owning your own business.

Many self-employed individuals are considered “sole proprietors” or “independent contractors” for legal and tax purposes. This is true regardless of whether you are turning a hobby into a business, selling an indispensable widget or providing services to others. As a self-employed person, you report business revenue results on your personal income tax return. Following are a few guidelines and issues you should keep in mind if you are pursuing your entrepreneurial spirit.

Schedule C - Form 1040.

As a self-employed person, you are required to report your business profits or losses on Schedule C of Form 1040. The income earned through your business is taxable to you as an individual. This is true even if you do not withdraw any money from the business. While you are required to report your gross revenues, you are also allowed to deduct business expenses incurred in generating that revenue. If your business efforts result in a loss, the loss will generally be deductible against your total income from all sources, subject to special rules relating to whether your business is considered a hobby and whether you have anything “at risk.”

Home-Based Business

Many self-employed individuals work out of their home and are entitled to deduct a percentage of certain home costs that are applicable to the portion of the home that is used as your office. This can include payments for utilities, telephone services, etc. You may also be eligible to claim these deductions if you perform administrative tasks from your home or store inventory there. If you work out of your home and have an additional office at another location, you also may be able to convert your commuting expenses between the two locations into deductible transportation expenses. Since most self-employed individuals find themselves working more than the traditional 40-hour week, there are a significant number of advantageous deductions that can be claimed. Unfortunately, we find that most self-employed individuals miss these deductions because they are unaware of them.

Self-Employment Taxes - The Bad News

A negative aspect to being self-employed is the self-employment tax. All salaried individuals are subject to automatic deductions from their paycheck including FICA, etc. In that many self-employed individuals often do not run a formal payroll for themselves, the government must recapture these taxes through the self-employment tax. Simply put, you are required to pay self-employment taxes at a rate of 15.3% on your net earnings up to $87,900 for 2004. For net income in excess of $87,900, you will pay further taxes at a rate of 2.9% on the excess.

In an interesting twist that reveals the confusing nature of the tax code, you are allowed a partial deduction for the self-employment tax. Simply put, you are allowed to deduct one-half of your self-employment taxes from your gross income. For example, if you pay $10,000 in self-employment taxes, you are allowed a deduction on your 1040 return of $5,000. Many self-employed individuals miss this deduction and pay more money to taxes than needed.

Health Insurance Deduction

This used to be a very messy area for self-employed individuals, to wit, you received little tax relief when it came to your health insurance bill. This was a particular burden for small business owners when considering the astronomical cost of health insurance. All of this has changed and you now may deduct 100% of your health insurance costs as a business expense.

No Withholding Tax

Unlike a salaried employee sitting in a cubicle, you are not subject to withholding tax on your paycheck. While this sounds great, you are required to make quarterly estimated tax payments. If you fail to make the payments, you are subject to a penalty, but the penalty is not the biggest concern.

A potential and dangerous pitfall of being self-employed is failing to pay quarterly estimated taxes and then getting caught at the end of the year without sufficient funds to pay your taxes. The IRS is not going to be happy if you fail to pay your taxes and you will suffer the consequences in the form of penalties and interest. Making sure you pay quarterly estimated taxes helps avoid this situation and it is highly recommended that you follow this course of action.

Record Keeping

You must maintain complete records of all business income and expenses. Simply put, document everything. Create a filing system for each month and file every receipt, etc. All business travel expenses must be documented, including auto mileage you incur when performing business tasks. Office supply stores sell business mileage books that you can keep in your car and use whenever you travel. If you have any doubt about documenting something, just do it!

In Closing

As a self-employed individual, your focus and time is spent on making your business successful. Your focus is not on the complexities of the tax code and how to limit the amount of taxes you owe. If any of the information in this article is new to you, then it is highly likely you have paid far more in taxes than required.

Richard A. Chapo is with http://www.businesstaxrecovery.com - recovery of business taxes through tax help and tax relief. Visit http://www.businesstaxrecovery.com/articles to read more business tax articles.

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