Once again, the tax filing season is behind most Americans, leaving in its wake another batch of paper and electronic records for taxpayers to add to what may already be a large collection of old tax papers and files. So, how long should you keep these files, and what documents should be saved in the archives?
Some taxpayers keep everything. Others prefer to only keep records for a minimum required period, like “three years,” “four years,” or “ten years.” Unfortunately, there is no “bright-line” answer on how long to keep tax records or how much to keep. Instead, the answer largely depends on how comfortable the taxpayer is with the accuracy of his or her returns, whether the return will end up in audit, and the confidence the taxpayer has in the taxing authority receiving and processing the returns correctly.
Many experts recommend keeping tax returns and supporting documentation during the period in which the taxing authority can audit or contest the return. Others suggest a seven-year retention period, which is consistent with most banks, financial institutions, and large employers. While these recommendations may be helpful in many situations, taxpayers should be careful before throwing out their old tax records.
While the Internal Revenue Code requires every person, who is liable for any tax, to keep records,[1] it fails to provide the answer of how long the records must be kept. The only guidance found in the thousands of pages of tax regulations is that a taxpayer should keep returns and records for “so long as the contents thereof may become material in the administration of any internal revenue law,”[2] and that records should be kept for “at least four years after the due date of such tax for the return period to which the records relate, or the date such tax is paid, whichever is the later.”[3] While the regulations do not provide perfect clarity, they do provide a starting point, or a minimum retention period.
There are many reasons a taxpayer may want to keep records beyond the suggested four-year minimum period. First, although the general statute of limitations or period of time in which the IRS can audit your return is three years from the date of filing, that period of time can be extended under certain circumstances. For example, if a taxpayer fails to report income, equal to an amount greater than 25% of the income shown on the return, then the applicable statute of limitations extends out to six years. There is an unlimited period of time for the IRS to audit your return if they suspect fraud or if the taxpayer fails to file a return. These exceptions, extending the period of time the IRS, can audit a return can create exposure for a taxpayer beyond the minimum four-year retention period.
Second, tax records from one year may be necessary to establish a tax position in a subsequent year. One example is establishing the tax basis (original cost) of an asset for depreciation or determining the gain or loss on disposition of the asset in a subsequent year. The IRS recommends keeping records that establish the tax basis of an asset for as long as you own the asset and then for four years following the disposition of such asset.
For state income tax returns, the typical starting point for determining personal income tax liability is a taxpayer’s federal adjusted gross income. This means holding on to your federal returns and records is crucial in addressing future state tax assessments.
Retention of tax records no longer requires massive amounts of paper and storage space, as most returns are now filed electronically. But tax returns are only part of the tax records that must be retained for each tax year. Supporting documentation, like 1099s, W-2’s, purchase receipts, invoices, etc., can be scanned and stored electronically with the tax returns. The IRS allows hardcopies of returns and supporting documentation to be stored electronically so long as the records can be indexed, preserved, retrieved, and reproduced with a high degree of legibility and readability.[4] A taxpayer with an appropriate electronic storage system is relieved of retaining original hardcopies.
So, think twice before throwing out your old tax records, and make sure you have reliable electronic storage of scanned documents – you never know when you may need them down the road.
[1] I.R.C. § 6001.
[2] Treas. Reg. § 1.6001-1(e).
[3] Treas. Reg. § 31.6001-1(e)(2).
[4] Rev. Proc. 97-22, 1997-1 C.B. 652.
By Chad D. Hansen.
