Income Tax Records - How Long to Keep Them and Why
Tax season is a great time to examine the contents of your old filing cabinet and desk drawers, reduce the clutter, and shred any documents you no longer need. Many clients ask for guidance on how long you should retain your personal income tax and other financial records. You may have to produce those records if the IRS (or a state or local taxing authority) audits your return or seeks to assess or collect a tax. In addition, lenders, co-op boards, or other private parties may require that you produce copies of your tax returns as a condition to lending money, approving a purchase, or otherwise doing business with you.
The general rule is to keep the tax return forms indefinitely and retain the supporting records of each tax form for six years. In general, except in cases of fraud or substantial understatements of income, the IRS can only assess tax for a 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 file your 2021 individual income tax return by its original due date of April 18, 2022, the IRS will have until April 18, 2025, to assess a tax deficiency against you. If you file your return late, the IRS generally will have three years from the date you filed the return to assess a deficiency. However, the three-year rule isn't ironclad. The assessment period is extended to six years if more than 25% of your gross income is omitted from a return. In addition, where no return was filed for a tax year, IRS can assess tax at any time (even beyond three or six years) if IRS claims that you never filed a return for a particular year. That is why keeping a copy of the tax return form indefinitely will help you to prove that you did.
While it's impossible to be completely sure that the IRS won't at some point seek to assess tax, retaining tax returns indefinitely and important records for six years after the return is filed should, as a practical matter, be adequate. If you file a return electronically, the company that prepared and/or filed your return is required to provide you with paper copy of the return. Be sure to get and retain that copy.
Records relating to property may have to be kept longer. The tax consequences of a transaction that occurs this year, such as a sale of property, may depend on events that happened years ago. The period for which you should retain records must be measured from the year in which the tax consequences actually occur.
For example, suppose you bought your home in 2006 for $200,000, made $20,000 of capital improvements in 2013, and sell it this year. To determine the tax consequences of the sale, you must know your basis in the home -- your original cost plus later capital improvements. If your return for the year of sale is audited, you may have to produce records relating to the purchase in 2006 and the capital improvement in 2013 to prove what your basis is. Therefore, those records should be kept until at least six years after you file your return for the year of sale.
You should retain all records relating to home purchases and improvements even if you expect your gain to be covered by the current home-sale exclusion, which can be as much as $500,000 for joint return filers. You will still need to prove the amount of your basis should IRS ask about it. In addition, there's no telling how much the home will be worth when it's sold, and there's no guarantee that the home-sale exclusion will still be available when the future sale takes place.
If separation or divorce becomes a possibility, be sure you have access to any tax records affecting you that are kept by your spouse. Or better still, make copies of the tax records since relations may become strained, and access to the records may be difficult. Copies of all joint returns filed and supporting records are important since both spouses are liable for tax on a joint return, and a deficiency may be asserted against either spouse.
Your records should include a copy of the divorce decree or agreement of separate maintenance, which may be needed to substantiate alimony payments (which, for pre-2019 divorces, are deductible by the payor spouse and included in the payee's income) and distinguish them from child support or a property settlement. Your records should also include agreements or decrees over custody of children and any agreements about who is entitled to claim them as dependents.
Retain records of the cost of all jointly-owned property. Also, get records as to the cost or other basis of all property your spouse or former spouse transferred to you during your marriage or as a result of the divorce because your basis in that property is the same as your spouse's or former spouse's basis in it was.
Paying for long term care costs might also require you to retain financial records for five (5) years. In the event that you are no longer able to pay for your own long term care costs, the Medicaid program is available for those that meet the medical and financial requirements. However, to receive Medicaid, you will need to supply them with up to five (5) years of monthly statements for each financial account that you have had during that time period.
The format in which you retain your records is up to you. You may keep your records in electronic form instead of or in addition to keeping paper copies. The periods for which the records should be kept are the same as for paper records. If your tax records are stored on your computer's hard drive, you should back it up to an external storage device or on paper.
Protect your records against loss or destruction. To safeguard your records against loss from theft, fire, or other disaster, you should consider keeping your most important records in a safe deposit box or other safe place outside your home. In addition, consider keeping copies of the most important records in a single, easily accessible location so that you can grab them if you have to leave your home in an emergency.
If, in spite of your precautions, records are lost or destroyed, it may be possible to reconstruct some of them. For example, a paid tax return preparer is required by law to retain, for a period of three years, copies of tax returns or a list of taxpayers for whom returns were prepared. Most preparers comply with this rule by retaining copies (sometimes for a longer period than the legally required three years) and can furnish a copy if yours is not available. Similarly, other professionals who assisted you in a transaction may retain records relating to the transaction. For example, a stockbroker through whom you bought securities may be able to help you to determine the basis of the securities, and an attorney who represented you in the purchase of your home may retain records relating to the closing. Nonetheless, because you can never be sure whether third parties will actually have the records you need, the safest course of action is to keep them yourself, in as safe a place as possible.