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What Tax Records to Keep and For How Long

Filing your taxes isn't just a once-a-year endeavor. Maintaining good records throughout the year—and disposing of old ones when appropriate—not only provides you with greater confidence now when you prepare your tax return, but it also provides you with documentation you may need down the road.

Lucky number six. One of the most common questions we’re asked is, "How long should I keep my tax returns?" Although you can get away with keeping them only three years, we recommend you keep all federal and state income tax returns and supporting documents for a full six years. Why so long? Once you've filed your returns, the IRS has up to three years to assess additional taxes. However, it can take up to six years to make a tax assessment if the IRS determines that you omitted a substantial amount of income from your return. You may believe your returns are accurate and all-inclusive, but the IRS may feel differently. Be sure to file your U.S. Postal Service or electronic mailing receipts with your returns, too. If your return is ever lost or misplaced, having a receipt showing the date the return was submitted will save you from penalties.

File it, but don't forget it. Some events produce documentation that should be kept permanently: settlement records from all of your home purchases and sales, investment purchases, divorce agreements, etc. But just because an event ends doesn't mean that the documentation process should. Before you move your records to the attic, remember that regularly filing “updates”—home improvement receipts, records that show a return of capital on your investments, estate and gift tax returns under which you received property, etc.—will help to compute your gain/loss when you sell. There are other situations in which you would benefit from keeping records, including any nondeductible contributions you have made to an IRA or Roth IRA. Review your personal and financial history with a professional to ensure you have all your bases covered.

So, how complete are your files?

Potential Constitutional Challenge of I-1098

Below is a news release by the Tax Foundation (nonpartisan and nonprofit tax research group based in Washington, D.C.) headlined Constituional Challenge to Income Tax Would Follow Success of Initiative 1098 in Washington reporting from a new study by Joseph Henchman, tax counsel and director of state projects at the Tax Foundation.


Washington, DC, October 26, 2010 - If Initiative 1098 passes next week, Washington will have its first income tax, and it will almost certainly face a strong constitutional challenge, according to a new study by Joseph Henchman, tax counsel and director of state projects at the Tax Foundation.

"Since the income tax was ruled unconstitutional in Washington," said Henchman, "Evergreen State voters have rejected constitutional amendments to permit one six times. The vote in 1973 was 77% against the tax despite approval by the legislature and the governor."

Popular opposition to income taxation has always been strong in Washington, one of the seven states with no personal income tax. The other six are Wyoming, South Dakota, Nevada, Texas, Florida and Alaska. Tennessee and New Hampshire impose no wage tax but do tax interest and dividends. Washington would be the first state since Connecticut in 1991 to enact a personal income tax.

Even if it is constitutional, it is certainly unlike any other state's income tax, out of the norm in two respects: it would apply to all adjusted gross income with no exemptions or deductions, and it would apply only to high-income earners.

"Just as several other states are overturning so-called millionaires' taxes or allowing them to expire," said Henchman, "Washington would be adopting one."

Comparative rankings of state tax climate by the Tax Foundation and other research groups uniformly praise Washington's current system of forgoing a tax on wages and other personal income, and those rankings would plummet if a personal income tax is enacted. Oregon's competitive posture in the region would rise markedly, as Washington would be matching Oregon's taxation of high wages, while Oregon maintains its competitive advantage of being the only state in the region with no general sales tax.

In many cases, high-income Washington taxpayers would pay a higher fraction of their income when faced with a 9% rate than Oregonians would facing a 9.9% or 11% rate because of more generous treatment in Oregon of some income sources.

The study is Tax Foundation Special Report, No. 186, "Washington Voters to Consider High-Earner Income Tax," by Joseph Henchman, Tax Counsel & Director of State Projects, and is available at http://www.taxfoundation.org/publications/show/26803.html.

The Tax Foundation is a nonpartisan, nonprofit organization that has monitored fiscal policy at the federal, state and local levels since 1937.

Washington Initiative Measure No. 1098 (I-1098)

Washington State is one of a handful of states without a state income tax. Lawmakers have attempted to institute a Washington State income tax in prior years with little success. Currently, Bill Gates Sr., a prominent Seattle area attorney, is promoting a new Washington State income tax on individuals with adjusted gross income above $200,000 and joint-filers with adjusted gross income above $400,000 (the initiative also reduces state property and business taxes). Proponents of I-1098 argue that it would raise $2 billion annually for education and health services from only 1.2 percent of all Washington households. Opponents of the tax believe that it would hinder the state's ability to attract talented executives and business people and argue that state lawmakers could lower the income thresholds with a majority vote two years after the initiative is enacted.

Here is an article from the Olympian that discusses the initiative.

Below is the Ballot Title and Summary from the Secretary of State's website, as well as a hyperlink to the complete text of the initiative:

Ballot Title
Statement of Subject: Initiative Measure No. 1098 concerns establishing a state income tax and reducing other taxes.

Concise Description: This measure would tax “adjusted gross income” above $200,000 (individuals) and $400,000 (joint-filers), reduce state property tax levies, reduce certain business and occupation taxes, and direct any increased revenues to education and health.

Ballot Measure Summary
This measure would establish a tax on “adjusted gross income” (as determined under the federal internal revenue code) above $200,000 for individuals and $400,000 for married couples or domestic partners filing jointly; reduce the limit on statewide property taxes by 20%; and increase the business and occupation tax credit to $4,800. The tax revenues would replace revenues lost from the reduced levy and increased credit; remaining revenues would be directed to education and health services.

Click here to see the complete text of Initiative 1098.

Bush Tax Cuts Quiz and Calculator

The Tax Foundation, which is a nonpartisan tax research group based in Washington, D.C., has created a 10 question quiz that allows users to test their knowledge of the expiring Bush-era tax cuts and what President Obama is proposing to do about them.

The quiz is part of the Tax Foundation's series on the expiring Bush-era tax cuts, which includes blog posts, studies, FAQ's, and a calculator that shows users what their 2011 tax burden will be if the tax cuts expire.

Many of the questions can be answered from some of our prior blog posts and hyper-linked articles.

Ask a Tax & Estate Attorney

Question: Should I use a Will or Living Trust to pass property to my loved ones at death?

Answer: It depends. Both Wills and Living Trusts can effectively pass property to your loved ones at death. Generally, people use Living Trusts to avoid probate because, in many states, the probate process is arduous, time consuming, and expensive. But in Washington, the probate process is, in most cases remarkably simple, efficient, and inexpensive, so Living Trusts, which tend to be more costly to create and require lifetime administration, may not be the best choice. Sometimes people tout taxes as a reason for Living Trusts, but there is no obvious tax advantage to a Living Trust over a Will. Both Wills and Living Trusts can be used to save death and income taxes. So more times than not, unless there are other reasons compelling for trusts (e.g., real estate outside of Washington, asset management concerns, privacy concerns) we recommend Wills. That said, there is no "one size fits all." Determining which vehicle is best for you depends upon your particular circumstances and desires.

Do you have a tax or estate question? Submit your question to askus@brownsterling.com.

Recent Changes to the Tax Law

According to a BNA Tax Management and Weekly Report by Brett Ferguson, the House passed a bill (H.R. 5297) that includes $12 billion in tax cuts for small businesses. The White House said President Obama will sign the bill into law.

Democrats have argued that the bill will create as many as 500,000 jobs, while Republicans argue that the bill provides unnecessary reporting requirements that will burden small business owners.

The bill will extend the 50 percent bonus depreciation provision for one year and increase the dollar limitation of the Section 179 deduction to $500,000 for depreciable property not exceeding $2,000,000. The bill will allow business owners to deduct the cost of health insurance for the purpose of computing 2010 self-employment taxes. In addition, investors in small businesses would be allowed a 100 percent exclusion for capital gains from the sale of certain small business stock. Furthermore, the bill provides an increase in the allowable deduction for startup business expenses.

The tax cuts are offset by a provision that allows individuals with 401(k), 403(b), and 457(b) plans to roll the pretax balances into Roth IRAs. If the rollover is made in 2010, then the taxpayer can pay the tax over two years in 2011 and 2012. Additional revenues would come from a provision that requires individuals who receive rental income from real propety to file 1099 informational returns to the IRS and to service providers if payments have totaled $600 or more during the year for rental property expenses.

We should see more dramatic changes to the tax laws in the coming months. Be sure to stop by for more updates.

Source: House Votes to Send $12 Billion In Small Business Tax Cuts to Obama, 29 TMWR 1283, Brett Ferguson.