Don't trash tax documents just yet
By Sandra Block
USA Today
Now that April 15 has passed, you may be tempted to build a bonfire out of your tax documents and perform a celebratory dance. Dance if you must, but don't torch those documents. You'll need them if the IRS has questions about your return.
In the event of an audit, the burden of proof is on you to prove that the information on your tax return is legitimate. And the IRS doesn't have to rush. It has a minimum of three years from the due date of your return to conduct an audit, says Suzanne Schmitt, tax analyst for RIA, a provider of tax information and software.
If the IRS believes you underreported your income by more than 25 percent, it has six years to audit your return. There's no statute of limitations on an audit if you failed to file a return or if the IRS believes you committed fraud.
So what does that mean in practice? Most tax advisers recommend keeping copies of your returns and supporting documents for at least six years. Some suggest keeping your tax documents forever, as long as you have the storage space. At the very least, keep copies of your tax returns so you can prove you filed, Schmitt says. Even if you filed electronically, "keep a hard copy of your return," she says.
Along with your tax returns, here are some tax-related documents you should save:
• W-2s and 1099s. Your W-2s show how much an employer paid you and the amount of taxes withheld. The 1099 forms show how much income you received from interest, dividends and other sources.
• Canceled checks and receipts for your deductions. If you're audited and can't support your deductions, the IRS may deny the deduction or reduce it, resulting in a larger tax bill, Schmitt says.
Some deductions require more than a canceled check. For charitable contributions more than $250, you need a written receipt from the charity.
• Investment records. Hold on to documents showing the price you paid for stocks and mutual funds. You'll need them to show your "basis" — the amount subtracted from the proceeds when you sell. Don't assume your broker or financial adviser will be able to provide these records, Schmitt says.
• Mortgage records. Keep records that show the price you paid for your home, closing costs and money spent on improvements. You'll need them to figure out your taxable gain, if any, when you sell.
Single homeowners who have lived in their homes for two out of the past five years can exclude up to $250,000 in profit from taxes. Married homeowners can exclude up to $500,000. That doesn't mean you should skip the record keeping, says John Sestina, a Columbus, Ohio, financial planner.
The real estate boom sharply increased the value of homes in many high-cost areas, pushing some home-sale profits above the thresholds. In that situation, records of your home's purchase price will help reduce your tax bill, he says.
Similarly, permanent improvements, such as a new roof or a kitchen remodeling, can be added to the basis, further reducing your taxable gain, Sestina says.
While the number of audits the IRS conducts has been steadily increasing, the chances you'll be audited are still pretty slim. In fiscal 2004, the IRS audited a little more than 1 million taxpayers, which works out to 1 in every 129 individual returns. For taxpayers who earned $100,000 or more, the rate was about 1 in every 68 returns.
But the IRS doesn't have to launch a full-scale audit to increase your tax bill. Every year, the IRS sends out millions of "correction notices" to taxpayers.
The letters typically request payment of taxes, correct information on your return or additional information about a specific item on your return.
In many cases, the letters are triggered by a discrepancy between information reported to the IRS and information on your return.
These letters are less intimidating than a face-to-face audit, but you could still end up paying more.
Your best defense is a prompt response with documents that support the information on your return.
