As we have noted in prior editions of the Tax Accounting Review, a good time to review your tax record-keeping responsibilities is right after you have filed your tax return. Retaining and storing your income tax records is a crucial final step in fulfilling your tax filing responsibilities. Consequently, this is a refresher on the rules for maintaining your tax records, along with some information on storage options.
When determining how long to retain most of your income tax records, it is important to look at the time frame over which the IRS (and other taxing authorities) can audit a return and assess a tax deficiency, or over which you can file an amended return to secure a refund. For most taxpayers, this period is three years from the original due date of the return or the date the return is filed, if later. For example, if you filed your 2006 Form 1040 on or before April 17, 2007 (disregarding the extended Northeast "storm" due date), the IRS has until April 17, 2010, to audit the return and assess a deficiency. The statute of limitations is extended to six years, however, if a return includes a substantial understatement of income (which is defined as omitting income exceeding 25% of the amount reported on the return). There is no statute of limitations period when a taxpayer fails to file a tax return or commits fraud. A taxpayer is considered to have committed fraud if the return is false or if there is a willful attempt to evade tax.
An arguably good rule of thumb for keeping tax records is to add a year to the IRS statute of limitations period. Using this approach, you would retain your income tax records for a minimum of four years (three-year general statute of limitations period plus one year), but it may be more prudent to retain them for seven years, which is what the IRS generally, yet informally, recommends.
State tax rules should also be considered, but holding records long enough to satisfy IRS purposes will usually suffice for state tax purposes, assuming the federal and state returns were filed at the same time.
Keep in mind, however, that certain tax records should be kept much longer than described above and some, indefinitely. For example, records substantiating the purchase price of property that could eventually be sold, such as investment property, business fixed assets and your principal residence, should be retained based on the record retention period for the year of sale. In addition, it is important to keep records of contributions to your IRA and other retirement accounts. If you make nondeductible IRA contributions, the IRS requires that you keep records until all of the money has been distributed from the tax-deferred accounts, plus a minimum of three years. Tax returns, IRS and state audit reports, and business ledgers and financial statements are examples of the types of records you should normally retain indefinitely.
To muddy the waters even further, there may be non-tax reasons to keep certain tax records beyond the time needed for tax purposes. This might include documents such as insurance policies, leases, real estate closing statements, employment records and other legal documents. Feel free to contact us for additional guidance in this area.
Finally, the IRS permits taxpayers to store certain tax documents electronically. Although the electronic storage rules are aimed primarily at businesses and sole proprietors, they presumably apply to individuals as well. These rules permit taxpayers to convert paper documents to electronic images, destroy the paper documents and maintain only the electronic files. Certain requirements must be met to take advantage of an electronic storage system (e.g., the electronic storage system must ensure that an accurate and complete transfer of the hard copy information is achieved and that an efficient retrieval of the information is possible, among other requirements), so contact us if you would like more details.
We hope this overview helps you understand the income tax record retention rules. Remember, the burden is on you to prove the accuracy of your tax return, and with adequate records this burden is not onerous. If you have any questions regarding your specific situation or if you would like to discuss these rules in more detail, please do not hesitate to contact us.
For additional information regarding this topic, please contact Michael Gillen at 215-979-1635 or one of the other members of the Tax Accounting Group of Duane Morris LLP with whom you are regularly in contact.
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