The three-folder system can help you keep accountant's costs - and your sanity - in check.
Tax time means producing documentation for the IRS on your expenditures, earnings and possible deductions. Which is much, much easier said than done. The problem is that if you don’t keep paperwork — or if you don’t know where to find it easily — it could cost you money in lost deductions.
Maybe this past tax season was extra hectic for you. If so, it’s good to make changes now that will make the process easier next season. (Resolutions aren’t always for New Year’s, after all.)
Before we introduce a helpful three-folder system as a way to stay organized, just a quick reminder from Kerby Accounting & Business Solutions: Taxpayers are required to keep all backup information supporting tax returns for seven years. (I always recommend keeping actual returns forever, but shredding supporting documents after seven years.)
First, get three folders.
One folder is for income, a.k.a. “any penny that you earn,” according to the Motley Fool money-management consultants, in the form of paychecks, distributions, etc. Checking-account interest counts. Keep a piece of paper in the folder where you keep a running tally of income of any kind, its source and amount. Make sure corresponding documents — like 1099s and W-2s — match these amounts.
The second folder is for expenses and deductions.
These would include cancelled checks, receipts and statements for things like your mortgage payments, medical bills, work-related lodging and travel, and charitable donations. This folder, according to the Motley Fool, can be tricky depending on how many expenses and deductions you have. One folder may do. Or, you may need to break them out into smaller categories, such as Medical, Child Care and Charity, for example.
Be aware that some itemized deductions can be carried over to your return in the next tax season. Ask Kerby Accounting & Business Solutions which one of these may apply to you.
Your third and final folder is for investments.
Monthly, quarterly and annual investment statements should all go here, as well as documentation supporting the buying or selling of investments, and dividend notices. Roth contribution records should also live in this folder, along with IRA contributions that are non-deductible, and taxable investment statements that reflect the value of your investment (showing things like capital gains, capital losses and mergers). Your accountant can go over the specific contents that should be in your Investments folder.
Again, if you are an active investor, creating separate sub-files for each investment vehicle may be helpful. (It will also likely impress your accountant.)
Clients at Kerby Accounting & Business Solutions are also offered an organizer with last year’s data on it, so they know what is needed for each tax season. This helps them stay on track in collecting and retrieving documents. It also makes it easier to see changes that should be made — like if the clients is a first-time home buyer, or if they add a new dependent to their return.
It’s not imperative you use this particular tax-document organization system, it’s just important you have one that works for you. Remember, organized tax documents means it’s less likely a potential deduction gets left by the wayside. It can also reduce the tax-preparation cost when it comes time to drop your folders off at the accountant’s office.