Record keeping is not just about keeping an account of how much you spend, earned and paid in taxes; it is also important for clearing an IRS audit and avoiding tax debt. Your tax records must include the receipts of the expenses that you claimed on your tax return, income statements, and balance sheets of your assets, liabilities and equity in your business (if any). These records help you to:
- Monitor your taxes
- Prepare financial statements
- Identify the source of receipts for tax and financial planning purposes
- Prepare returns and keep a record of the tax returns filed
- Have the documentary proof of deductions, credits, and income reported on tax returns
You must keep a record of deductible expenses if you claim them on your tax return. If after an IRS review, some of the expenses are found to be wrongly claimed, the IRS will disallow these expenses. Disallowed expenses often result in a tax debt.
When processing a return the IRS checks each deduction and credit claimed. If they find that a deduction or a credit has been wrongly claimed, they recalculate the amount of taxes to be paid. Shortly thereafter, a notice is sent to inform the taxpayer about the disallowed deductions, and the amount of the resulting tax liability.
If this tax deficiency remains unpaid, the IRS begins collection actions. It’s important for taxpayers to remember that after the filing deadline, penalties and interest are charged on the tax debt every month.
Keeping and updating your record of deductible expenses, income sources and amounts, helps in better financial and tax planning. Also, the prevention of errors can help one avoid tax problems and a confrontation with the IRS.