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The following information offers some great ideas and suggests the use of simple personal finance tools to help us organize our tax information better. Let’s go back to the basics and get our taxes ready for the next step: easy entry into our favorite money management software or tax preparation application.
Around the first week of April, kitchen tables nationwide are taken out of commission by piles of tax records. The clutter is more than a mealtime inconvenience — it could be costing you some big bucks come tax time.
According to the General Accounting Office, the average taxpayer overpays the IRS hundreds of dollars every year by overlooking deductions and missing chances to itemize — opportunities that get buried in the forest of W-2s, 1099s, and quarterly and year-end statements each family generates throughout the year.
Stop letting the dollars slip through your fingers and into Uncle Sam’s pockets. Here’s a streamlined, simple, easy-setup, quick-bake system to once and for all get it done and get organized for the IRS.
The simple three-folder tax filing system
Kick the “pile it and file it later” approach: It doesn’t work. Trust us. The following three-folder system — a basic organizational method — is just as easy to manage year-round. Depending on the complexity of your taxes, you can add folders to best suit your needs.
Folder No. 1: Income
What goes here: Every penny you earn that is reported to the IRS (salary, dividends, earnings, distributions, even that paltry $3.42 in checking account interest) comes with a paper trail. To keep it all straight, write all income sources (and amounts earned) on a single sheet in your “Income” folder as they occur. (Yeah, it’s easier to do as the year progresses, so vow to start doing it for the rest of the year.)
IRS prep work: As corresponding records of interest, earnings, distributions, and dividends arrive (e.g., 1099s and W-2s), verify their accuracy and check each off on your income cover sheet. These official docs (for everything from freelance work, jury duty payments, and nearly every investment transaction) should have everything you need to account for income when you do your taxes. (Note: Some 1099s will be reported to the IRS immediately after a taxable event, such as savings bond redemptions and gambling winnings. Don’t forget those come April; the IRS certainly won’t.)
Folder No. 2: Expenses and deductions
What goes here: The amount deduction detritus can quickly dwarf the Manhattan phone book. Take lots of tax deductions? Create separate files for the major categories (e.g., charity, medical, business) where canceled checks, utility bills, statements, and receipts go. If that’s more than you need, establish a single catchall envelope for records related to the current tax year. Here you’ll keep mortgage statements, investment-related expenses, medical bills, child-care costs, and non-reimbursable/employment-related gas, food, and lodging receipts.
IRS prep work: Uncle Sam offers a “standard deduction” to most taxpayers. Many states, however, are not as generous. Before you bother itemizing, eyeball your biggest potential deductions and see how close you come to the state and federal standard deduction allowances. (Many taxpayers itemize on one and not the other.) Not even in the ballpark on either? Take Uncle Sam’s offer and call it a day. Though be sure to note any itemized deductions that can be carried over to future returns, such as capital losses that exceeded the limit last year.
Folder No. 3: Investments
What goes here: If only the year-end statement were a sufficient record of annual account activity! Alas, it’s not always. That’s why we get monthly/quarterly/annual statements, purchase receipts, sale confirmations, year-end overviews, dividend notices. Oh my! To add to the confusion, the IRS isn’t even interested in certain records until you dispose of the investment (which could be decades for some investors).
The easiest way to segregate investing paperwork is by how it’s taxed. Create separate folders for:
- Deductible/tax-deferred investments — records that prove your annual contributions to qualified retirement plans; Roth contribution records (so you aren’t taxed twice); and distribution records (1099s) once you start taking distributions.
- Nondeductible investments — records for IRA contributions that aren’t eligible for preferential tax treatment.
- Taxable investments — statements (or confirmation slips) that prove the cost basis of your investment (reinvested dividends, capital gains, capital losses, mergers, 1099s, and K-1 forms). Thankfully, most brokers issue combined 1099s for those with multiple brokerage accounts. Note for long-term buy-and-holders: Create separate folders for each stock. Your tax pro (if you use one) will cry tears of joy — reflected in a lower tax-prep bill.
IRS prep work: Purchases, losses, interest, dividends, sales — all stock-related activity — will generate corresponding 1099s (or K-1 forms for certain trusts or partnerships) that the IRS will get, too. Keep proofs of purchase, such as trade confirmations or annual statements; dividends paid; split/merger/buyout notices; deductible investment expenses; and proof of security received as a gift or inheritance until you sell.
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