Ah, the wonders of financial documentation…
Today’s topic has the benefit of ensuring your Northeast United States “financial fortress” is as airtight as it can possibly be, which has its own advantages.
Financial Documentation Strategies For Northeast United States Taxpayers
“You get older and you learn there is one sentence, just four words long, and if you can say it to yourself it offers more comfort than almost any other. It goes like this: At least I tried.” –Ann Brashares
Many of our Northeast United States clients have never received that dreadful notice from the IRS, initiating an audit — or, much worse, the KNOCK on the door! If you never have, you probably don’t keep much financial documentation.
If you have, you are probably terrified to part with a single receipt.
But remember, either way, we’re in your corner.
However, the IRS is one of the few courts where failure to produce proof of your claims results in the assumption that you are guilty of tax fraud.
(This is part of the reason why you ALWAYS want a professional on your side in these matters. Would you go to court without an advocate? Would you go before a court with a software-generated defense? “Your honor, here is my lawyer, Siri.”)
So, it’s imperative that you are able to protect yourself. And, as great as we are — some of this still does fall in your court. That’s why you must save all the financial documentation used to create your tax returns, in order to defend yourself in the case of an audit.
The tax courts consistently slap down arguments that don’t rely upon financial documentation. That’s the big takeaway here.
So, take some time this week to make sure that you have a workable system that enables you to follow these guidelines:
1) Retain a paper copy or receipt of any tax-relevant transaction. Scan these documents and archive them electronically, or acquire them in an electronic format. If the purchase has a manual or warranty, store all the documents in the same electronic and physical location.
Sadly, the IRS has ruled bank or credit card records to be insufficient financial documentation. As a result, just keep your statements long enough to reconcile your account.
If the purchase was a business or tax-deductible expense, record the expense and why it justifies the deduction. Store this information with or on the receipts.
2) Keep brokerage statements indefinitely for taxable accounts. You are responsible for reporting the cost basis of any security you sell to calculate the capital gains tax. For a mutual fund with 30 years of reinvested dividends, each dividend payment is part of the cost basis. As a result, the cost basis can sometimes be computed only if you have the complete transaction history.
Without knowing the cost basis, the IRS could argue that the entire value of the investment be treated as gain.
If you have lost the record of how much you originally paid for an investment, instead of selling and paying 15% or more of the value in taxes, you can use that investment as part of your charitable giving. Gifting appreciated stock avoids the tax owed and still qualifies for a full deduction. Oddly enough, the IRS still asks for the original purchase date and price for gifted securities, but leaving these blank has no effect on your tax owed.
Many custodians keep several years of electronic copies of brokerage statements available. And they are now required to send any known cost basis electronically when you transfer securities to a new custodian. If your current custodian has the correct cost basis of your securities, you probably no longer need to keep brokerage statements. However, an approach of “better safe than sorry” is always advisable with the IRS.
3) Keep IRA nondeductible contribution records forever. You may need those records every year that you withdraw money in retirement to show that a portion of the withdrawal is not tax-deductible.
Or to avoid the hassle, clear out nondeductible IRA contributions by converting all of your IRA accounts to Roth accounts.
4) Keep partnership documents, contracts, commission, or royalty structures forever. This includes property records, deeds, and titles, especially those relating to intellectual property. It also includes any transfers of value for estate planning purposes.
5) Save ALL of your tax returns. After you file, save the paper and/or electronic copies with the rest of that year’s financial documents.
Tax returns and all the supporting financial documentation must be kept for at least seven years. The IRS can audit your return for up to three years from your filing date. However, the three-year limit only applies to good-faith errors.
If the IRS suspects you underreported your gross income by 25% or more, they have up to six years to challenge your return. And because we can all file for an extension at the October 15 deadline, you must keep your records for at least seven years.
Regardless of those rules, though, if the IRS suspects you filed a fraudulent return, no statute of limitations applies. Because the IRS is run and organized by fallible people (with all of their attendant biases, emotions, etc.), we suggest keeping your tax returns and documents forever.
Unfortunately, whenever the IRS challenges you, the burden of producing evidence that your claims are true rests entirely with you, so you had better have your financial documentation in order.
Taxpayers collectively spend six billion hours, or 8,758 lifetimes, annually trying to comply with the tax code. Fortunately, as I previously mentioned, YOU don’t have to be the one doing all the heavy lifting. We are on your side…
To your (extended) family’s lasting financial and emotional peace…
d.f. o’brien & co.