Why Keep Records There are many reasons to keep records. In addition to tax purposes, you may need to keep records for insurance purposes or for getting a loan. Good records will help you:
Identify sources of income. You may receive money or property from a variety of sources. Your records can identify the sources of your income. You need this information to separate business from nonbusiness income and taxable from nontaxable income.
Keep track of expenses. You may forget an expense unless you record it when it occurs. You can use your records to identify expenses for which you can claim a deduction. This will help you determine if you can itemize deductions on your tax return.
Keep track of the basis of property. You need to keep records that show the basis of your property. This includes the original cost or other basis of the property and any improvements you made.
Prepare tax returns. You need records to prepare your tax return. Good records help you to file quickly and accurately.
Support items reported on tax returns. You must keep records in case the IRS has a question about an item on your return. If the IRS examines your tax return, you may be asked to explain the items reported. Good records will help you explain any item and arrive at the correct tax with a minimum of effort. If you do not have records, you may have to spend time getting statements and receipts from various sources. If you cannot produce the correct documents, you may have to pay additional tax and be subject to penalties.
What Records to Keep You need to keep your the tax returns. This would include 1040 and state returns but also corporate, sales tax, payroll and any other returns you file. Here are the most common items you need to keep to verify income on your tax return. Form(s) W-2 Form(s) 1099 Bank statements Brokerage statements Form(s) K-1
Following are the main documents you need to substantiate expenses and deductions you claim. Sales slips, Invoices and Receipts
Canceled checks or other proof of payment Written communications from qualified charities
How Long Must You Keep the Records You must keep your records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Generally, this means you must keep records that support items shown on your return until the period of limitations for that return runs out. If you are someone who likes to keeps records forever and are happier that way there is no rule saying they need to be discarded. My father kept all of his tax returns dating back to the 1950s.
Generally, the statute of limitations extends for 3 years after you file a tax return or the due date of the return whichever is later. The exceptions are 6 years when the income is 25% greater than what you reported on your tax return and no expiration in the case of fraud. There are often other special situations where you should keep records longer. For example, you should keep records of all capital improvements to your home. These may be needed to prove the basis of your home. You should keep records of all purchase of stock and bonds until the statute of limitations has run out when you sell them. Records may be kept in electronic format instead of paper documentation.