How Many Years Should You Keep Tax Returns?
Understand the critical considerations for retaining tax records to meet regulatory requirements and manage your financial history effectively.
Tax record-keeping is essential for financial management and tax compliance. These documents help substantiate information reported on returns and are crucial for responding to inquiries from tax authorities. Well-organized records also simplify tax preparation and are invaluable if a return is selected for examination.
Standard Retention Periods
The time tax records should be kept generally aligns with the statute of limitations, the period during which the IRS can assess additional tax or a taxpayer can claim a refund. For most income tax returns, the standard retention period is three years from the date the original return was filed or the due date, whichever is later. This rule applies unless specific conditions necessitate a longer retention.
An extended retention period applies if there is a substantial understatement of income. If gross income is underreported by more than 25% of the amount shown on the return, the statute of limitations extends to six years. This six-year period also applies if over $5,000 of unreported income is attributable to foreign financial assets. Additionally, records supporting a claim for a loss from worthless securities or a bad debt deduction should be kept for seven years.
Indefinite Retention Scenarios
Some situations require tax records to be kept indefinitely. If a fraudulent return was filed, there is no statute of limitations, meaning the IRS can assess tax at any time, requiring indefinite retention of all related records. Similarly, if no return was filed for a given tax year, those records should be kept indefinitely.
Records related to the basis of property, such as a home, investments, or other assets, should be kept until the period of limitations expires for the year in which the property is sold or disposed of. These records establish the original cost of an asset and any adjustments, like improvements or depreciation. For example, if a home is sold, its basis records should be kept for at least three years after the tax return reporting the sale is filed.
Key Documents to Retain
Various documents should be retained to support information reported on a tax return. Income documentation includes W-2 forms from employers and 1099 forms for interest (1099-INT), dividends (1099-DIV), government payments (1099-G), and non-employee compensation (1099-NEC). Bank and brokerage statements are also important for verifying reported income and investment activity.
For deductions and credits, keep all supporting documentation. This includes receipts for charitable contributions, medical expenses, and business expenses. Canceled checks, credit card statements, and invoices can also prove payment for deductible expenses. Records for major purchases or sales, especially those impacting property basis, such as real estate closing statements or investment purchase confirmations, are also essential.
Managing Your Tax Records
Effective management of tax records involves systematic organization, secure storage, and proper disposal. Organizing documents by tax year and then by category, such as income, deductions, and property records, can significantly streamline the process. This approach ensures that specific documents can be easily located if needed for future tax preparation or an IRS inquiry.
Both physical and digital storage options are viable. Physical documents can be kept in secure, fire-resistant filing cabinets or off-site storage. For digital records, create scanned copies of paper documents and back them up in multiple locations, such as an external hard drive and cloud storage, for redundancy and protection against loss. When the retention period has passed, secure disposal, like shredding, is important to protect personal information.