June, 2008 Tax Tip
Retaining Tax Records for Businesses
Last month I stated that retaining tax returns indefinitely and important tax return related records for six years (see note in next paragraph) after the return is filed should generally be adequate. This month’s Tax Tip will cover record retention for businesses. It does not matter what form you operate your business in, as the discussion covers all types of business entities, including sole proprietorships.
Records relating to businesses and their related property may have to be kept longer. The tax consequences of many types of transactions that occur in one year may depend on events that happened in earlier years. The period for which you need to retain records must be measured from the year in which the tax consequences actually occur. This may be significant, for example, if you sell property, such as real estate, that you bought years earlier and later added improvements. The records pertaining to both the purchase and the improvements should be kept for at least six years after you file the return for the year of sale. Note: Last month I stated it is recommended that you 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. The reason for the additional two 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).
When new property takes the basis of old property (such as a trade-in), records relating to the old property should be kept for six years after the sale of the new property is reported. For example, suppose you purchased a car for business use in 2005 and traded it in on a new car for business use in 2008. If you sell the new car in 2010, your basis in the new car will determine whether you have a tax gain or a tax loss on the sale. The basis in the new car is determined, at least in part, by your basis in the car you traded in '2008. Accordingly, records relating to your old car should be kept until 2016 (i.e., for six years after your 2010 return is filed).
Similar considerations apply to other property which is likely to be purchased and sold such as stock in a corporation or mutual fund, bonds, etc. In particular, remember that if you reinvest dividends to purchase additional shares of stock, each reinvestment is a separate purchase of stock, and the records of each reinvestment should be kept for at least six years after the return is filed for the year in which the stock is sold.
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