Tax Day is today. Hope you are ready!
If you have already filed, there is one more piece of tax business you can attend to before you run off into your summer. Time to shred some old tax returns and documents.
IRS Rule For How Long to Keep Taxes
The general rule for how long you have to keep your tax returns and other tax records is three years. HOWEVER, this is the IRS we are talking about, so there are some exceptions, and sub-rules to the general rule.
First, you need to know when to count from. The 3-year rule counts three years from the date you FILED them. So, if you filed early, you don’t technically have to wait until April 15 (I always do. Better safe than sorry.) On the other hand, if you filed late, whether with an extension or not, you need to keep them for three years from that date. Also, the IRS says you should keep your returns for two years after you paid the tax, so if you ended up paying late, or on some sort of payment plan, be sure to keep them for two years after that tax bill has been completely paid.
What Tax Documents to Keep Longer
If you claim a loss from worthless securities, or a bad debt, you have to keep those records (including the return itself) for 7 years.
You need to keep employment records for 4 years after the tax is due.
Any records that are tied to property you need to keep until you are done depreciating that property. With the larger 179 Deduction these days, this doesn’t apply to as many small businesses as it once did, but if you are depreciating something over 11 years, then you need all 11 years of records, should the IRS come calling.
Health records if you have an HSA. Health Savings Accounts are a great way to deduct health care expenses by first contributing the money into an HSA before paying your expenses. However, because there can theoretically be years between contributions and expenses, and you can technically wait as long as you want to claim those expenses (even years later), there is a good chance that you might end up needing more than three years’ worth of medical expenses should the IRS every come calling about your HSA. You should keep your medical records indefinitely for now, which means you’ll need to go through your taxes and pull them out or keep them separately from the beginning. Using some sort of electronic records is a good strategy as well.
Fraud and Failure to File
Did you think you were in the clear after three years? Not so fast. Note that all of these limitations start from the DATE YOU FILE. That means if you didn’t file a return, the clock never starts. Technically speaking, you should keep your records forever if you didn’t file.
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The same applies for a fraudulent return. In other words, if you claim $50,000 in non-existent security losses, you won’t be able to hide behind the record limitations as an excuse to not have proof of your losses.
When To Destroy Tax Records
Most of the exceptions to keeping your tax records for three years involve improper or illegal filings. For example, you have to keep records for income you do not report (you’re supposed to report all income), you have to keep records indefinitely if you don’t file a return at all, or if you file a fraudulent return. What is that all about, really?
The idea is that while you can destroy tax documents after three years if you file normally, you don’t get to use the three-year rule as cover for improper filing. So, assuming that isn’t you, let’s move on.
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The other exception is that you must keep records for deducting worthless securities, or for a bad debt for seven years instead of the usual three, and employment records should be kept for four years.
The final exception is if you paid your taxes late, then you have to keep your documents for three years from when you filed, or two years from when you made final payment, whichever is later. This mostly applies to taxpayers who end up on payment plans for large tax bills. You basically have to keep your records longer if it takes you more than 12 months after filing to finish paying your taxes.
Tax Audits and Records
Now, just because you destroy your tax records doesn’t mean that the IRS can’t, or won’t, come asking about taxes older than three years, but here is the big difference.
During the three years, you are required to have supporting documents, or proof, of various tax situations, mainly for deductions you take. If, for whatever reason, you do not have those records during that first three years, then the IRS is allowed by law to assume that the deduction is invalid because you do not have the documentation to prove it.
After those three years, however, the rules change. If you get audited in year four, for example, and you do not have a receipt or donation letter from a non-profit, the IRS must actually assume that you did have the proof and that your documentation was valid. But there are two catches. If you (or your accountant — ALERT, ALERT!) DO STILL HAVE those documents, then you must provide them to the IRS, and the IRS can use those documents to validate — or invalidate — your deductions. So, it is to your advantage to not have them after year three.
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The other catch is that just because your proof is deemed to be valid, doesn’t necessarily make the deduction valid. For example, if you claimed your wife’s Valentine’s Day gift as a tax deduction four years ago and get audited, the IRS will assume that you did have a valid receipt for the gift. However, that doesn’t make the deduction valid, because receipt or no, you cannot deduct a gift to your spouse from your taxes.
Basically, the short, non-legal, way to understand your tax record storage requirements is that if you do not have your supporting documentation during the first three years, the IRS gets to assume you are lying. After three years, they have to assume you are telling the truth.
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By Brian Nelson – Brian is a former Certified Financial Planner and financial advisor. He writes for the Finance Gourmet and other financial publications. The material provided on this website is for informational use only and is not intended for financial or investment advice. Please note that some material is not updated regularly and some of information may not be current. Consult with your own financial professional when making decisions regarding your financial or investment options.