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May, 2008 Tax Tip

Tax Record Retention


In the week or so since the tax filing season ended I have already received three calls from clients wanting to know how long they should hold on to their tax returns and supporting documents.  I thought that I would be a bit lazy this month and merely rehash this topic, which was the very first Tax Tip I wrote around eight years ago.  This Tax Tip will only cover record retention for individual returns and their documents to support their contents.


At the outset, I am assuming that everyone wants to get rid of useless clutter piling up in his or her home or garage.  Well, Doctor, heal thyself, as I tend to be a pack rat.  But even I must soon address this problem.


First things first - after you adhere to the advice I’m about to give, I should not have to tell you that when you dispose of any documents SHRED THEM!!.  It is infinitely better to rent a storage space than to have your identity stolen.


The answer to the retention question depends upon what is in the records.  I always recommend that you keep copies of tax returns indefinitely (they really don’t take up that much space).  In addition, the assessment period doesn’t begin to run until a return is filed.  Therefore, if IRS claims that you never filed a return for a particular year, it can assess tax for that year at any time unless you can prove that you did file. Proving that you filed would, of course, be impossible if you have discarded your returns.


You should retain supporting documents for six years, although four years (which includes an additional year for some states, including Arizona and California) will, in nearly all cases, suffice.  In general, except in cases of fraud or substantial understatement of income, IRS can only assess tax for a given year within three years after the return for that year was filed (or, if later, three years after the return was due.  For example, if you filed your 2007 return by its original due date of April 15, 2008, IRS would have until April, 15, 2011 to assess a tax deficiency against you.


A problem with the three-year rule, and why I often recommend keeping supporting records for six years is that the assessment period is extended to six years if more than 25% of gross income has been omitted from a return (whether or not intentionally). 


While we cannot be completely certain that IRS will not at some point seek to assess tax, retaining tax returns indefinitely and supporting records for six years after the return is filed should, as a practical matter be adequate.


Are there any records that should be maintained for longer than six years (as mentioned previously, four years should normally suffice)?  The answer is possibly.  Records relating to business assets and property which is still owned may have to be kept longer to prove what you originally paid for them.  For example, if you sell real estate that you bought many years ago and since its purchase you added improvements, you should keep records of both the purchase and the improvements for at least six years after you file the return for the year of sale.


Another example is when new property takes the place of older property, such as a vehicle trade-in.  The tax basis (cost) of the new car is determined in part by the basis of the car that was traded in.  Accordingly records pertaining to the old car should be kept for six years after you sell the new car.


Similar considerations apply to property such as stocks, bonds, and other investments.   If you reinvest dividends to purchase additional shares of stock over a lengthy time period, remember that each reinvestment is a separate purchase of stock, and the records of each reinvestment should be kept for at lease six years after the return is filed for the year in which the stock was sold.



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