How to Make Tax Filing Easier with a Record Keeping System

Record Keeping Tips That Could Save You Time and Money on Your Taxes

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When tax time comes around, do you dig frantically through piles of papers looking for the documentation you need to prepare your tax returns? Are you unsure of which records you should keep and which ones you can safely throw away? Why not make your life easier and ensure that you don't miss any deductions by organizing your record keeping system early in the year and keeping it up-to-date? Here's how.

Why You Should Keep Records

With so much of everyone's financial lives existing online or in electronic form, it is much less likely for people to keep all of their relevant records in one place. That is not to say that the record keeping strategy you adopt cannot be electronic, it simply means that it should be organized and keep everything you need in one secure place. If you keep paper records, invest in a water- and fire-proof safe. Perhaps consider keep multiple copies in different locations. If you decide to go digital, you'll have to scan in those records you have in hardcopy, but most importantly, be sure to keep the files secure and have a backup.

Not only does having organized records make it easier and less frustrating for you to file your tax return, but it also ensures that you can take advantage of every deduction or tax credit you're eligible for. Most importantly, keeping records also enables you to explain an item on your return that the Internal Revenue Service (IRS) might question in an audit.

Simply put, keeping accurate records can get you all of the tax benefits you're eligible for and prevent you from having to pay additional taxes and penalties for unsubstantiated items.

Records You Should Keep

Your checkbook, personal budget software, or online banking tools can help you remember income and expenses that should be reported on your tax return, but the checkbook or software alone aren't sufficient documentation to prove the deductibility of an expense.

In addition to proof of payment (canceled checks, credit card receipts, etc.), you also need invoices, receipts, sales slips, or other written documentation that spells out exactly what you paid for. Deductions that you need to document may include alimony, charitable contributions, mortgage interest, child care expenses, and real estate taxes. If you make payments in cash, get a dated and signed receipt showing the total amount and an itemized description of what was purchased.

To prove that you correctly claimed income from investments such as stocks, bonds, and mutual funds, you need to be able to determine your basis and whether you have a gain or loss when you sell. Your records should show the purchase price, sales price, and commissions, dividends received in cash or reinvested, stock splits, load charges, and original issue discount (OID). An Excel spreadsheet is a great way to track this information, but even a statement from your broker or financial advisor or a handwritten schedule will do.

If you have deductible expenses withheld from your paycheck, such as union dues, medical insurance premiums, or 401(k) contributions, be sure to keep your pay stubs as proof of payment.

Still not sure what your should hold on to? Here are some of the most common specific records you should keep:

  • Form W-2 and 1099
  • Bank statements
  • Brokerage and mutual fund statements
  • Form K-1 (for partnerships)
  • Sales slips
  • Invoices
  • Credit card receipts
  • Canceled checks or other proof of payment
  • Home purchase and sales agreements, closing statements, and insurance records

How Long You Should Keep Records

Although legally you are only required to keep tax records for three years from the date you filed the related income tax return, you should keep a copy of your actual tax returns, W-2s, 1099s, etc., indefinitely. The IRS destroys original tax returns after three years, and you or your heirs may need information from the returns at some point, or you may eventually need to prove your earnings for Social Security purposes.