Tax and Employment Records: What Must be Kept?

April 26, 2006 — 1,807 views  
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Which Tax Records Can You Throw Out Now?

Maybe it's a good thing that the April tax filing deadline and the urge to spring clean coincide. But before you head to the trash can, make sure you're not disposing of tax records you might need.

In general, you must keep records that support items shown on your individual tax return until the statute of limitations runs out — generally three years from the due date of the return, or the date you filed, whichever is later. In most cases, the IRS can audit your return for three years. You can also file an amended return on Form 1040X during this time period if you missed a deduction, overlooked a credit or misreported your income.

So, does that mean you're safe from an audit after three years? Not necessarily. There are exceptions:

  • If the IRS has reason to believe your income was understated by 25 percent or more, the statute of limitations for an audit increases to six years.
  • If there is suspicion of fraud or you don't file a tax return at all, there is no time limit for the IRS.

How Long to Keep Documents?

Like anything involving the IRS or other government agencies, there's no easy answer to that question. But here are some basic guidelines to follow for individuals (guidelines for businesses are in the right-hand chart below):

Completed tax returns. Many tax advisers recommend holding onto copies of finished tax returns forever. Why? So you can prove to the IRS that you actually filed. Even if you don't keep the returns indefinitely, you should hang onto them for at least six years after they are due or filed, whichever is later.

Backup records. Written evidence that supports figures on your tax return, such as receipts, expense logs, bank notices and sales records, should generally be kept for at least three years.

Exceptions. There are some cases when taxpayers get more than the usual three years to file amended returns. You have up to seven years to take deductions for bad debts or worthless securities, so don't toss out related records.

Real estate records. Keep these for as long as you own the property, plus three years after you dispose of it and report the transaction on your tax return. Throughout ownership, keep records of the purchase, as well as receipts for home improvements, relevant insurance claims, and documents relating to refinancing. These help prove your adjusted basis in the home, which is needed to figure the taxable gain at the time of sale, or to support calculations for rental property or home office deductions.

Securities. To accurately report taxable events involving stocks and bonds, you must maintain detailed records of purchases and sales. These records should include dates, quantities, prices, dividend reinvestment, and investment expenses, such as broker fees. Keep them for as long as you own the investments, plus the statute of limitations on the relevant tax returns.

Individual Retirement Accounts (IRAs). The IRS requires you to keep copies of Forms 8606, 5498 and 1099-R until all the money is withdrawn from your IRA accounts. With the introduction of Roth IRAs, it's more important than ever to hold onto all IRA records pertaining to contributions and withdrawals in case you're ever questioned.

If an account is closed, treat IRA records with the same rules as securities. Don't dispose of any ownership documentation until the statute of limitations expires.

Multi-year issues. Records that support figures affecting multiple years, such as carryovers of charitable deductions, net operating loss carrybacks or carryforwards or casualty losses, need to be saved until the deductions no longer have effect, plus seven years, per IRS instructions.

Burden of Proof

The burden of proof, or the responsibility to substantiate items on your tax return, at one time rested entirely on the taxpayer. Since the passage of the Internal Revenue Service Restructuring and Reform Act of 1998, the burden has shifted to the IRS in the event of a courtroom proceeding, but only if you meet the requirements to retain proper records and make them available for inspection. So while the law now takes some heat off taxpayers, it only applies if you diligently maintain records and cooperate with reasonable IRS requests.

Important: Before tossing out financial documents, shred them thoroughly. Identity theft wreaks havoc in victims' lives after information is stolen and used for fraudulent purposes. One way identity thieves obtain confidential data is by rummaging through trash.

Rea & Associates, Inc.