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Today we’re getting back to the basics by answering the following question: what is the single most effective way to save money on taxes?
The answer may surprise you, though it shouldn’t. It’s quite simple and you may even roll your eyes once I tell you. But don’t stop reading after the next line, because this tax saving strategy is important.
The single most effective way to boost tax savings is documentation.
That’s right, documentation. Think about it – if you don’t document expenses, no CPA can help you regarding tax deductions. You spent $5,000 on a seminar and related travel? Great, prove it. You gave $25 gifts to each one of your clients? Show me the support.
Without documentation, you’re out of luck.
As your CPA, I’m not here to audit you. But the IRS isn’t your CPA, and they’d love the chance to dig through your financial lives. They’re chomping at the bit and seeking to make up a budget deficit. Don’t let yourself fall victim to poor documentation practices.
Documentation Rules to Follow for Increased Tax Savings
Now you are likely wondering whether or not your own documents are sufficient. Before you set in motion a transformation of your record keeping, let’s go over the four main rules to keep in mind for documentation purposes.
- Keep documents for six years. If you’ve reported bad debts or worthless securities, make that seven years.
- You must have receipts for expenses over $75. Unless of course it’s for meals and lodging as anyone can over report those expenses.
- Your documents can be electronic as long as they are readable. Toss the paper receipts.
- Documentation should be adequate, meaning, it shows the amount, date, place, and “essential characteristic” of the expense.
Remember those four rules and you can develop a record keeping system that CPAs dream their clients will produce. I also highly encourage you to read this page which provides examples of supporting documentation.
Interestingly, many of my clients keep paper records and digital duplicates. Throw the paper out! Once you have a digital copy that is legible, you'll always be able to support to deductions and subsequent tax savings and you no longer need the paper version. The IRS enacted these rules years ago (thank goodness) once they realized their beloved taxpayers were moving to virtual document management systems.
Speaking of document management systems…
What does yours look like?
If we were to video chat right now, and I asked you to share your screen and walk me through your documentation system, will you be proud or embarrassed?
If embarrassed, don’t feel too bad about it. Many people keep poor records and it’s my job to help you get to develop a better, and more efficient, system.
Generally speaking, you will first want a cloud based system that has security settings meeting your risk tolerance. This can be Dropbox, box, Sharefile, etc. At my firm we use Sharefile as they are super secure in everything they do.
Balancing security with accessibility is important. If you can’t access your cloud based document solution via cell phone, how often do you really think you will use it? Make sure there’s an app for your solution, otherwise you’ll quickly find it too encumbering to use.
An added perk, though not required, is a solution that has a built in scanner. I like my receipts to look as if they were professionally scanned rather than be a grainy picture. I previously used Scannable for this.
While folder hierarchy is going to be a discussion for a different post, it’s extremely important that your organize your folders in a way that is relevant to your business. You should be able to access a specific receipt relatively quickly. This may mean labeling “parent” folders as entities or properties and having the “child” folders be months or specific functions of your business.
At least make sure to capture all necessary receipts
At the very least, grab an app like Expensify and capture all of your receipts digitally. While simply compiling all records via an app isn’t ideal, it will allow us to have full access to tax deductions and subsequent tax savings that you deserve as a real estate investor or business owner.
If all you do is take photos of your receipts, at least we have something to support our deductions. Yes, you will pay your CPA extra to sift through all of your documents, but at the end of the day you will have a deduction that you wouldn’t have had otherwise.
Even I sometimes fail to scan in receipts of incidentals like coffee. Maybe I should listen to my own advice.