In the immortal words of Reverend Lovejoy, “short answer, yes with an if. Long answer, no with a but.” This is going to be one of those articles.
How long should you keep your tax records? Forever. That’s the safe answer. Never throw out a 1040 and you’ll be just fine. Your additional records, such as receipts and W-2s, those you can toss after seven years. Never get rid of the return itself, however.
How should you store those tax records? Keep one paper file and one digital version. Print out a copy of each year’s tax returns and put it wherever you keep your other vital hard copy documents. Then save the PDF version and put it wherever you keep your backed up digital files.
These are small files. They won’t take up much space, and they might just save your bacon in case of an audit.
Okay, for those who are interested (or just a little bit masochistic), now let’s get to the complicated stuff.
What Does the IRS Say About Keeping Tax Records?
Here’s the IRS’ advice on the subject of record retention, from its web page on the subject written for small businesses and the self-employed. This applies equally to individual income taxes, however this guidance is more thorough than the one written for individuals.
The IRS says:
The length of time you should keep a document depends on the action, expense, or event which the document records. Generally, you must keep your records that support an item of income, deduction or credit shown on your tax return until the period of limitations for that tax return runs out.
The period of limitations is the period of time in which you can amend your tax return to claim a credit or refund, or the IRS can assess additional tax.
In other words, the touchstone on this issue is whether your previous tax bill could be retroactively adjusted either up or down. You will need to keep your documents until any previous liabilities, deductions or credits expire.
How Long Are the Limitation Windows?
There are five general limitation windows you should be aware of:
1. Forever
We’ll start with the biggest issue. If you have not filed a return, if you have filed a fraudulent return or if you have intentionally understated your income (which is generally an act of fraud,) you must retain all records indefinitely.
There is no expiration date for audits on taxes not filed or taxes filed fraudulently. You will need every single document if and when the IRS catches up with you. You will also most probably need a very good lawyer.
2. Three Years
Most taxpayers only actually have to hang on to their records for three years.
In an ordinary income tax situation, the IRS has three years to decide whether to audit you or to claim miscalculation and additional taxes owed. You also have three years to file a claim for additional deductions or credits that can reduce any taxes that you filed.
Most taxpayers don’t know that if you discover overpayment after the fact you can actually file with the IRS for a refund. In fact, if you think you may have done your taxes wrong in a previous year, take them to an accountant for recalculation. Just make sure to do so within the three year window or you may lose the opportunity.
3. …Plus Another Two Years
If you do file for a credit, deduction or refund after the fact, make sure to hang on to your taxes for two additional years after the filing.
The same goes if you have to pay additional taxes. If the IRS sends you a notice of miscalculation, keep your records for two additional years from when you make that payment.
For example, Sandra filed her taxes in 2017 and plans to retain those documents until 2020 (against our advice of retaining them forever). In 2019 she discovers that she overpaid, so files with the IRS for a refund. She should now retain all of those relevant documents at least until 2021.
4. Six Years
If you under-report your taxable income, and if that under-reported income is more than 25% of the gross income reported on your tax return, you will need to keep your records for six years.
In cases where the IRS believes that a taxpayer has claimed significantly less income than he or she actually earned it gets additional time to conduct an investigation and audit. The three-year window is doubled, and you will need your records to back up any claims you made on your filings.
Note that this is not the same as tax fraud. If the IRS believes that you filed a fraudulent return it has no statute of limitations on an audit, as discussed above.
5. Seven Years
This is the maximum ordinary amount of time a taxpayer must keep their records.
This applies if you filed for a capital gains loss under “worthless security” or bad debt. Generally, this means you lost money in the stock market or extended a formal loan which was not paid off. In both cases you can write off those losses on your tax returns but need to retain the records for seven years.
The statute of limitations is extended in the case of securities losses given the high potential for fraud in this field. Simply put, it would be very easy for a tax payer to try and claim a $10,000 deduction on a loan he never actually made.
Why Keep Your Tax Records Forever?
With all that said, why not just keep your records for three years?
It’s simple: The statute of limitations on an audit is based on the investigation.
Let’s say you accurately report your income every April, and so dispose of each tax return after three years. Now let’s further suppose that the IRS makes a mistake and believes that you substantially underreported your income five years ago.
It launches an investigation because the statute of limitations on this claim has not yet expired.
Since you cycled out your paperwork from 2013, you have no records with which to show income and receipts. You’ll be stuck trying to gather old W-2s and investment records in an effort to fight off an erroneous but entirely legal investigation.
Or take it even further back. For reasons unknown, but not unrealistic, the IRS has looked for your 2008 tax return and can’t find it. They have sent you a letter asking for a copy of this return otherwise they’ll assume that you never filed one.
This request is based on an unfiled return. Even though the error is on the part of the IRS, if they think a tax return is missing they can ask for it at absolutely any time. Without that 1040 you’ll be struggling to prove your tax status from back when people were still asking, “whatever happened to that nice Hootie and his blowfish?”
The statute of limitations is based on the claim, not the taxpayer. Keep your records forever.
Why Keep Your Tax Records at All?
There are two reasons to keep your tax records.
1. To Prove a Filing
If the IRS requests a copy of your tax records, typically to prove that you actually did file for the year in question, you will need to provide a copy of your 1040. In this case, they typically just want to see the form to prove that you did file your taxes.
2. To Prove a Claim
In the case of an audit, miscalculation or refund claim, you will need all of your relevant tax records to prove the necessary information.
If you try to claim overpayment, you will need the supporting information to show both that you are entitled to the relevant credit or deduction and that you did not take it. If the IRS believes that you did not file an accurate tax return, you may need all relevant information to back up the claims you made when you filed.
What Tax Records to Keep?
This is the hassle part.
Keeping a 1040 around is not a big problem. For most taxpayers it’s little more than a few sheets of paper stapled together and stacked on top of their birth certificate and social security card.
However, for the bare minimum three-year window of a potential audit, you will need to retain much more than that. Essentially you should keep every document that proves a claim you made on your tax return. If you listed a source of income, keep the document which indicates where that income originated. If you list a deduction or expense, keep the receipt which proves you spent this money.
For each assertion on your tax return you should have a document which proves its validity. Keep that document. Here are some examples to get you started:
Income Documents
• W-2 Forms
• Invoices Paid In
• 1099 Forms
• Investment Income Statements
• Significant Cashed Checks
• Sales Receipts
• Contracts For Work or Sale
Expense Documents
• Spending Receipts
• Charitable Donation Receipts/Confirmation
• Student Loan Statements
• Investment Loss or Income Statements
• Gambling Loss Receipts
• Checks Cashed Against Your Account
• Invoices Paid Out
It’s important to understand that this is just a small representative sampling. You should, for example, also keep all records relating to your home if you take a mortgage interest deduction. Small business owners need to track their expenses with particularity. The simple answer is, if you put it on your tax return you should keep the documentation.
State Income Tax Returns
Finally, readers should note that every state will have its own rules about the statute of limitations on an audit. Some states expand the window to four or even five years. If you plan on throwing out your old income statements and receipts, be certain to look up your state’s individual rules on the subject so that you don’t find yourself subject to an unanticipated investigation.
