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KEEPING PERSONAL RECORDS

 

        Keeping Personal Records         

Each year as we deliver our clients' tax return copies and filing information to them, we inevitably get asked the age-old question:  "How long do I need to keep this stuff?" 

 

Usually the question is accompanied by a look of slight frustration as their mind wanders over the already bulging records files they have from years past.  We have addressed this issue with business records in past articles, but not personal records. 

The IRS has three years after the filing date in which to audit your return.

 

Personal Tax Returns and Records

The IRS has three years after the filing date in which to audit your return, so as a general rule, you should keep copies of the return as well as all supporting documents (W-2's, receipts, mileage records, etc) for at least that long.

However, if the IRS finds that you have understated your income by more than 25%, the statute of limitations stretches out to six years.

Also, in instances of fraud (intentionally under-reporting your income) or failing to file a return, the statute of limitations is nonexistent.  Basically, you will be at risk for the remainder of your life.  

Therefore, it is generally in your best interest to permanently maintain all records for any year that you fail to file a return because you didn't earn enough income to warrant filing one or if you have questionable deductions that may prompt the IRS to later allege fraud on your part.

Its important to bear in mind that the three year statute of limitations begins running when you actually file the return and NOT on the return's due date.  So, if you extend the filing of your return from April 15th all the way to October 15th, the statute of limitations will not expire until October 15th three years later. 

Why is this important?  In most cases, it isn't.  However, if you have questionable items on your return that you would rather not have subjected to an audit, it is generally better to file your return by April 15th to get the statute running as quickly as possible.

Carryover Deductions

If you have losses or deductions that cannot be expensed in the year that they are incurred, you should keep all records of those expenses not only until all carryovers have been used, but until the statute of limitations has expired as well.  

Examples of carryover deductions would be excess charitable contributions, passive loss limitations, home-office expenses in excess of net income, etc.  In the event of a future audit, it can be extremely difficult to prove the amount of a carryover deduction taken if you do not have the underlying records from prior years.

Home Improvements

Many of our clients think its no longer necessary to maintain receipts for home improvement costs given the new home-sale exemption of $500,000 ($250,000 single).  However, we still advise our clients to keep a receipt for at least the major improvements you make on your home.  

You may not think they are necessary now, but in the event of a fire, flood or other catastrophe, they can prove invaluable for insurance purposes (provided of course that your records survive the catastrophe).

Even the home-sale exemption may be compromised in the future if you ever decide to convert all or a portion of your home to business use by renting it or using it as a deductible home office.  Since no one really knows what their future may hold, we just consider it wise policy to always maintain home improvement records.

Investments

So long as you still own an investment (stocks, bonds, mutual funds, etc), you should keep all records pertaining to it.  You will need those brokerage statements and records in order to determine your cost basis upon disposition.  Gains or losses on mutual funds in particular can be nightmarish (and cost you a fortune in accounting fees) if you have not maintained adequate records.

After you have sold an investment, then the standard statute of limitations comes into play.  You will need to maintain all of those records for verification in the event of an audit.

Retirement Accounts

The IRS requires that you keep all copies of Forms 8606, 5498, 1099-R and any tax returns associated with an IRA account.  Since most IRA accounts are with you for life, we basically recommend that you maintain all retirement records dealing with withdrawals and contributions on a permanent basis.

Personal Businesses

If you maintain a personal business as a sideline activity and incur losses, it is best to keep the records validating those losses for several more years than the typical statute of limitations.  

As we stated above, the statute stretches out to six years if the IRS finds that you have understated your income by more than 25%.  The risk you run with losses in a sideline business is that the IRS can claim you were involved in a hobby rather than a business. 

Your sideline operation is automatically presumed to be a legitimate business if it was profitable in at least three of five consecutive years (or two of seven if you raise horses).  If the IRS disallows your losses, you may well be at risk for the 25% underreporting limitation.  

Please bear in mind that you can still prove that you had a profit-motivated intent even if you don't pass the profitability test above, but you will need all your records in order to do so.

We hope this article has cleared up some of the misconceptions you may have had for record-keeping.  If you have questions regarding other personal or business records not addressed here, please feel free to call our office.  We will be more than happy to assist you.

 

 
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