Step 1-2

What Records are Necessary

IRS regulations state that records required to be maintained by the IRS must be accurate, but no particular form is required. However, other IRS guidelines specify the following:

• Taxpayers whose only income is from salaries, wages, or similar compensation for personal services rendered are required by the IRS to be prepared to show how each item of income and expenses on the return was computed. Therefore, the only records you need to keep are records to support your income and deductions. See Step 3 for a listing of types of proof the IRS will allow to substantiate your deductions.

• Taxpayers who are in business or self-employed must keep primary and secondary records. Primary records are those documents upon which individual transactions of buying and selling merchandise, supplies, services, and business assets are recorded. Examples are: invoices, vouchers, bills, receipts, tapes, detailed inventory lists, canceled checks, duplicate deposit slips, bank statements, etc. Secondary records are the permanent books, worksheets, tallies, etc., which list or summarize the primary records into classifications of income or expenses. These records into classifications of income or expenses. These records may consist of a simple book or record, a simple set of books, or a complicated set of records in which numerous analyses, consolidations, or summarizations are made to achieve the final product.

AUDIT-PROOFER'S STRATEGY RULE

For all taxpayers there are at least three aspects to proper recordkeeping that are necessary to sustain a deduction: (1) You must know the tax rules. (2) You must keep adequate records of your deductible expenses. (3) You must keep proofs (receipt, canceled checks) of your expenses.

(1) You need to know the rules under which an expense is deductible or income is reportable. Knowing the rules helps you to become tax-wise, thereby translating into saving tax dollars. By knowing the rules, you focus your time and energies on those things that are important, or those expenses that are tax deductible. For example, if you know that your aerobic exercise program is not deductible, you won't waste your time keeping track of the expense and the receipt.

(2) You need to record your tax deductible expense, or keep track of them in some way. This can be done by buying a tax recordkeeping book, or by setting up a simple system you design yourself. For example, if you use your checking account for all your disbursements and income, you already have a means of keeping track. All you have to do next is to mark your check register in some way to indicate deductible expenses; you could circle the check number, or underline the payee in red. Just by keeping track of your tax deductible expenditures, you will help yourself immensely in preparing your tax return.

(3) You need to maintain proof of your expense. A very simple way to maintain proof is to set up a file box with jacket folders for the appropriate receipts and documents. A minimal attempt could be made just by keeping receipts in a shoe box. But keeping receipts and documents is just part of the job. You should also be able to locate the right receipt with the right canceled check, and provide an explanation of what the expense was for. For example, a receipt and a canceled check paid to the Girl Scouts might not be sufficient to substantiate a charitable contribution. The expense must be able to meet the rules, or the IRS may disallow it if your proof doesn't support the rules. In this example, the IRS may suspect you purchased Girl Scout cookies (not deductible in full; only the excess value over their fair market value is deductible), paid to send your daughter to a weekend camp, or made on a purchase of supplies for your Girl Scout daughter.

It's also important you know what proof is required to be kept. You will find that information in Step 3.

A good recordkeeping system will bridge all three aspects so that you'll be readily prepared to support any item on your tax return the IRS may question.

Next Section: Travel & Entertainment Expense Records

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