How Long Do You Need to Keep Records?
I haven’t thought about my 2008 tax return since April 15th. I probably would have continued to ignore it, except for the fact that last week I received a revised 1099 from one of my clients. It turns out that the form that they send me for my tax records was way off from what they had actually paid me, a fact that they hadn’t caught until just now. To make matters even more complicated, I haven’t actually worked with this client since May, 2008. I had to go dig out records from more than a year ago to figure out just how much trouble I was in.
The Problem With Paperwork
Issues like my amended 1099 can illustrate the importance of holding on to your records long after the point that they seem relevant. In my filing cabinet, I had my last tax return, as well as check stubs from my client and hard copies of my accounts receivables from last year. I could quickly tell that I had actually paid my taxes based on my records, rather than the incorrect 1099 I had received.
But how long do I need to keep these files around? And is hard copy the only option?
It depends, to a certain extent. The typical recommendation for U.S. taxpayers is to keep tax returns and related paperwork for three years — as long as you don’t owe extra money, actually filed a return and there won’t be any problems in your future. In most cases, the IRS has a three-year statue of limitations for conducting audits, which is where that number comes from. However, depending on the situation, the IRS can come back to check on your paperwork up to ten years later. And the IRS actually recommends that anyone not filing a tax return or filing a fraudulent return hold on to all records indefinitely.
Many businesses retain detailed business records for five years. After that, it’s best to keep the broader documents, like a tax return, but it’s probably okay to get rid of your internal records. It’s also important to make sure that your insurance doesn’t require you to hold on to receipts for large purchases or other documentation indefinitely. If you’re based outside of the U.S, the rules governing audits may differ.
Hard Copy & Beyond
It’s not actually necessary to have all of your paperwork on paper. Especially for freelancers, who have a tendency to be more mobile, keeping hard copies isn’t really practical. As long as you have your records backed up in a couple of different places, you’ll be okay with computerized records in most situations. There are a few occasions when the IRS or another authority could ask for an original, but those are becoming less common. If you’re concerned that you might be facing such an issue, you’ll probably want to check in with a tax professional.
You do have to be confident that you can restore your records easily in the event of an emergency if you don’t keep any hard copy. An offsite backup is probably the minimum precaution necessary, although that’s true of most record-keeping if you’re a freelancer, even without bringing the IRS into it.
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I purchased a document scanner a couple of years back and it was one of the best investments I have ever made. Except for a few key business documents, everything is stored electronically. I also asked my accountant to send PDF copies of my tax returns to me instead of the traditional paper copies. With OCR on these documents, it is very easy to search for information contained in the documents.
Make sure that you backup everything to a couple of different locations. My computer is backed up to a file server which is then backed up automatically to an off-site server with a 30 day archive.
Now I am more concerned about my required paper documents than I am my electronic documents.
Good advice, but how could you not know what you charged a client in a given year?
At the end of every year I send all of my clients my W-9 and a year-end total of all invoices paid. If there’s a discrepancy we can catch and fix it before they even send the 1099 out.
Isn’t there a way to manage your taxes digitally, digital invoices and such?
If you live in the UK then Crunch will certainly do what you need Agustin.
Basically you use a web-app to send invoices digitally to clients, the system records EVERYTHING (including all the different taxes, rates, etc.) and then an accountant checks everything and submits your tax return just like an old-fashioned accountant would.
Crunch even connects directly to the HMRC so quarterly VAT returns are automatically calculated and sent… all you need to do is invoice and enter expenses… the system does the rest, and all the data is safe in the cloud so you don’t need to keep anything expect paper receipts.
http://www.crunch.co.uk
In Australia and NZ the requirement is to hold records for 7 years – they don’t have to be paper though. About the only paper I get these days are bank statements and I am about to stop those too. Everything I do is electronic – every invoice is electronic – getting a cheque is rare – and I haven’t owned a check book myself for years. All cash in/out is electronic transfer so its dead easy to find the transactions if you need to. I send all the spreadsheets to the tax agent -she sends me a pdf of the draft return, I print it out sign, scan it and return it The return is filed electronically and the refund goes straight to my bank account.
In fact I think I am about to get rid of the filing cabinet – running a business has seen the actual “paper work” go to zero!
Nice post.
Even though it is not exciting, taxes are a very important part of freelancing. Having different versions of your paperwork, digital files and backups are key in times such as this.
Doing your own books is one of the most important things you do as a freelancer. You are your own boss and you are responsible for your own money and taxes.
Thanks for this great post.
I have a question, if I am about to start freelancing, what business license should I obtain?? I am still in college and have debated this for quite some time, the choice of LLC and Sole-Propriotorship seems to be my battle! This blog post on IRS and filing brings up more questions. How would a student learn more information to make an informed decision, I am researching but I’m not finding any good valid information, or should I wait to file for a business license until I get a few steady jobs first??
Thanks for the tips, Thursday!
I’ve only been freelancing less than 2 years, so I still have everything. And I do intend to keep at least a digital copy of all my home biz documents. Just because I’m like that.
Lexi
I have a general tax question that kind of stems from this article. Good article by the way, i’m one of those people that keeps all of his receipts and all invoices and things like that in a box for many years..i’m bad at throwing things away. I’m 19 and have had my bank account for 3 years and I still have receipts from when I was 16
My question is, when freelancing (I haven’t started fully yet, I just do side projects here and there for people I know) how do you go about reporting to the tax people? I notice mention of a 1099 here. I understand that the client in which you work for is supposed to send you a 1099 of the amount they paid you but is there anything the freelancer is supposed to do? Do we have to send a form to the client or is it just the client’s job? If the client’s job, what if at the end of the year we don’t receive a 1099…will I get in trouble or will just the client get in trouble?
@Brett, you’re supposed to pay quarterly taxes on your income using IRS Form 1040-ES. In a nutshell, you estimate how much money you think you’re going to make during the year. Then, you use the IRS form to calculate the tax on your expected income. Estimated taxes are due on the 15th of every April, June, September, and January. (It’s the same process when you’re employed full-time, only your payroll department does all that work for you.)
Depending on your freelancing income and any taxes withheld from an employer, you could face a penalty if you don’t pay enough estimated taxes during the year.
You probably won’t receive a 1099-MISC from any client who didn’t pay you at least $600 during the year (because the IRS doesn’t require them to), but the IRS still expects you to pay taxes on that income. If the client owes you a 1099, it’s their job to send it to you. Make sure you’ve provided a Form W-9 so the client has record of your tax ID number. Then, when you get your 1099, compare the amount to your records to make sure it’s the same.
Thanks for the great information! I figured there would be something more I would need to do. I asked my parents but they had no idea since they’ve both always worked for someone. Appreciate the input!
I think having hard-copies of your tax paper work etc, is still quite important even if you do have all the information digitally stored. If your computer or hard-drive backups fail, then you have something to fall back on.
Nice article
It’s worth noting that these rules apply even if you’ve gone out of business, though you’re not keeping any new records obviously.
Thanks for the tips!
That’s useful information for a newbie!
//Melissa