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
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.
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.
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.
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
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.
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.
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.
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
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.