Internal Revenue Code 6001: The General Record Rule

The Internal Revenue Code (IRC) establishes a legal duty for every taxpayer to maintain records of their financial activities. This requirement is the basis for substantiating all figures reported on a tax return, as undocumented figures have no verifiable basis. This obligation allows the Internal Revenue Service (IRS) to verify the accuracy of filed returns and gives taxpayers the means to prove their financial standing. The structure of tax reporting is built upon the records that taxpayers are required to create and preserve.

Understanding the General Record Keeping Rule

At the heart of tax compliance is Internal Revenue Code Section 6001, which contains the general rule for record keeping. This section mandates that every person liable for any tax must keep records sufficient to show whether they are liable. The records must be complete enough for both the taxpayer and the IRS to determine the correct tax liability. The responsibility for creating and maintaining these records falls entirely on the taxpayer.

This obligation is further detailed in Treasury Regulation 1.6001-1, which clarifies that taxpayers must keep permanent books of account or records. These records must be sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown on any tax return. For wage earners, the requirement is simplified, stating they must keep records that will enable the determination of the correct amount of income subject to tax.

What Tax Records You Must Keep

To comply with the general rule, taxpayers must retain a variety of documents that serve as evidence for the figures on their tax returns. The specific documents depend on the individual’s financial activities, but they generally fall into several key categories.

Proof of Income

All documents that show income received are fundamental records. This includes:

• Form W-2 from employers, which details wages and taxes withheld.
• Form 1099 series for other income, such as 1099-NEC for independent contractors, 1099-MISC for miscellaneous income, 1099-INT for interest, and 1099-DIV for dividends.
• Schedule K-1 for partners or shareholders in S corporations.
• Records of all gross receipts, including bank deposit slips and invoices, for business owners.

Records for Expenses and Deductions

To claim any deduction or credit, you must have proof. This means keeping receipts, canceled checks, and bank or credit card statements that itemize the expenses. For business expenses, invoices and proof of payment are necessary. If you claim deductions for vehicle use, a contemporaneous mileage log detailing the date, purpose, and mileage of each trip is required. Without this specific documentation, the IRS can disallow the claimed deductions.

Records for Property

When you own property, such as a home or other real estate, record keeping is an ongoing process. Keep the closing statements from the purchase and sale of the property. These documents establish the property’s basis, which is needed to calculate any gain or loss upon its sale. Records of any significant improvements made to the property should also be retained, as these can be added to the basis, potentially reducing future tax liability.

Records for Investments

For those with investments like stocks or mutual funds, brokerage statements are indispensable. These statements document purchase and sale transactions, including dates and amounts, which are needed to calculate capital gains or losses. They also show any reinvested dividends or capital gains distributions, which increase the basis of your investment and prevent you from being taxed twice on the same income.

Record Format

The IRS permits taxpayers to keep their records in either paper or electronic format. If you choose to maintain electronic records, they must meet certain standards. The system used must be able to produce legible, hard copies of all records if requested by the IRS. The electronic records must also be securely stored and easily retrievable to be considered valid.

How Long to Retain Your Records

The length of time you must keep your tax records depends on the specific circumstances and the type of transaction reported. The IRS has established several “periods of limitation,” which are the timeframes during which you can amend your return or the IRS can assess additional tax. Once this period expires, the records associated with that return may be discarded.

The most common rule is the three-year period of limitation. You should keep your records for three years from the date you filed your tax return or the due date of the return, whichever is later. This three-year window covers the vast majority of tax situations for the average taxpayer.

A longer retention period applies in cases of significant error. If a taxpayer underreports their gross income by more than 25%, the period of limitation extends to six years. This gives the IRS additional time to detect and assess tax on the substantial omission of income.

Certain financial events trigger even longer retention requirements. For claims related to a loss from worthless securities or a bad debt deduction, you must keep records for seven years. In some cases, records must be kept indefinitely. Documents that establish the basis of property you own, like a house or stocks, should be kept for as long as you own the property, plus the standard period after you sell it and report the transaction. Employers must keep employment tax records for at least four years after the date the tax becomes due or is paid, whichever is later.

Consequences of Inadequate Record Keeping

Failing to maintain adequate records can lead to significant financial consequences. The most direct outcome is the disallowance of any deductions or credits that cannot be substantiated. During an audit, if a taxpayer cannot produce a receipt for a claimed business expense or a log for vehicle mileage, the IRS examiner has the authority to deny that deduction entirely, resulting in a higher tax bill.

Beyond the loss of deductions, the IRS can impose penalties. An accuracy-related penalty, typically 20% of the underpayment of tax, can be assessed for negligence or disregard of the rules and regulations. A failure to keep proper records is often viewed as negligence. This penalty is in addition to any back taxes and interest that may be owed, compounding the financial impact.