how long to keep tax returns

How Long Should I Keep Tax Returns?

Now that you’ve gotten past tax day, you may be wondering what to do with the leftover paperwork and how long to keep your tax returns. Retaining your tax return records is important, especially for larger transactions, such as a home. Tax records should always be stored immediately after filing, but how long does a person really need to keep them?

Statute of Limitations on Tax Records

The amount of time that you should keep your tax records depends on what type of record it is and the type of transaction that it is.  The IRS recommends that you keep your tax records until at least the period of limitations for the tax return ends.  The statute of limitations is the allowed period of time to review, analyze, and resolve IRS tax-related issues.  In general, the IRS typically has 3 years after you file your tax return to do so.  That said, there are some exceptions to the rule.  

If you file your taxes early, the statute runs for three years after the due date, not the filing date. On the other hand, if you file late without an extension, the 3 years statute starts once the taxes are filed, not the due date.

Note that although the general statute of limitations is 3 years, it can be extended.  If the tax collector can show that there is a “substantial understatement” of your liability, then 3 years can turn into 6 years.  It is considered a “substantial understatement of income” if you omitted more than 25 percent of your gross income.  For example, if you earned $500,000, but only reported $350,000, the IRS can audit you for up to 6 years.  It is also possible to be audited for 6 years for basis overstatements.  

Example:

If you sell your house for $4 million, but you claimed that you invested $2 million into the property.  If you, in fact, only invested $500,000, that means that you only paid taxes on the $2 million gain, rather than $3.5 million.

Extending the Statue

The IRS will usually follow the 3-year rule when it comes to reviewing a tax return unless an individual falls into the categories stated above.  Nonetheless, there is also the possibility that the IRS will contact you requesting to extend the statute of limitations. They do so when they need more time to review your case and tax records.  If the IRS contacts you regarding a statute extension, make sure to consult your financial advisor to consider the situation and discuss if it’s a good option to approve the extension.

How Long to Really Keep Tax Returns

Due to the IRS’ typical 3-year rule, many people suggest that you only need to keep your records for this amount of time.  However, there are loopholes to the rule. It’s actually a  good idea to keep records a little longer.  A recent Forbes article told the tale of a Pennsylvania citizen who got caught in a sticky situation as a result of not keeping his tax records.  

This individual paid his 2015 local income tax but received a notice in 2019 demanding $2,000 in taxes and penalties from 2015.  He was confused by this notice because he believed that there was a 3-year limit on tax audits; he also couldn’t locate the receipt from 4 years prior.  Ultimately, this individual will most likely be responsible for paying these taxes because he doesn’t have proper records to prove that he isn’t responsible for the penalty costs.  This reinforces the fact that 3 years of tax documents is not always sufficient. Important tax records should be kept on hand, either physically or in the cloud, for life. 

The Benefit of a Financial Advisor 

In the case of any skepticism from the IRS, it’s recommended to keep your tax records for longer than 3 years.  In the case that the IRS were to want further explanation, a financial advisor can be hugely helpful in navigating any potential tax issues. Keeping tax records not only ensures you have a full record of your taxes in the case of an audit but also are great records for a new financial advisor to reference when creating your holistic financial plan. 

Disclosure: These videos are not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accounting, tax, legal or financial advisors. The observations of industry trends should not be read as recommendations for stocks or sectors.

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