Retention of Tax Records - Keep or Toss

Keep or Toss – And When?

Record Retention

By Teri Kaye, CPA

As a Certified Public Accountant, I work with my clients’ banking and business records all the time. As a mom, I handle my own family’s banking, credit card and other financial records. In both capacities, I have learned how important it is to safely retain financial records. If you have ever applied for a loan or been through a tax examination, you also know the need to have adequate records. But what are adequate records and how long do you need to keep them?

In general, except in cases of fraud or substantial understatements of income, the IRS can only assess additional tax for three years from the date the return was filed, (or, if later, three years after the return was due). For example, if you filed your 2005 personal tax return by its original due date of April 17, 2006, the IRS would have until April 15, 2009 to assess a tax deficiency against you. If you filed your return late, the IRS generally would have three years from the date you filed the return to assess a deficiency.

However, the assessment period is extended to six years if the IRS asserts that more than 25% of gross income is omitted and is indefinite if the IRS asserts fraud on a return. In addition, the assessment period doesn't begin to run until a return is filed. Therefore, if the IRS claims that you never filed a return for a particular year, it can assess tax for that year at any time (even beyond three or six years), unless you can prove that you did file. Proving that you filed would entail providing a copy of the return and proof of mailing (such as the green “return receipt” from the U.S. Postal Service.

Retaining tax returns (along with their proof of mailing) indefinitely and important records (bank statements, check registers, receipts, expense logs, sales invoices, computer backups, W-2s and 1099s, etc.) for six years after the return is filed should, as a practical matter, be adequate. If you file your returns electronically, be sure to get copies from the company that prepared and/or filed your return; it is required to provide you with a paper copy of the return.

The six year retention rule is extended for assets and transactions that affect more than one tax year. For instance, if you buying real property, or other investments, or obtaining or making loans, the records for the purchase or origination should be kept for six years after the ultimate sale or payoff. In addition, documentation on any improvements or other costs required to be capitalized should also be kept until six years after the sale.

For any business with an employee, keep complete and accurate record of hours worked and hours paid for. Have a written payroll policy that states how employees are to record their time and that they must submit the information to the employer. Include rules for overtime (i.e., does it need to be approved in writing in advance by a supervisor). Keep all these records for three years after the employee has been terminated. For all employment records, including tax returns and timecards, keep these records for at least four years.

In the event you have a transaction generating a loss carry-forward, such as the sale of an investment at a loss, you should keep the records relating to the underlying transaction as proof of the loss, until six years after the loss has been fully utilized or expired. In particular, remember that if you reinvest dividends to buy 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.

For Individual Retirement Accounts (IRAs) you should keep records of contributions and distributions, Forms 8606, 5498 and 1099-R until all the money is withdrawn from all the accounts and an additional three years has passed.

When new property takes the basis of old property, records relating to the old property should be kept until six years after the sale of the new property is reported. For example, suppose you bought a car for business use in 1998 and you traded it in on a new car for business use in 2001. If you sold the new car in 2006, your basis in the new car will determine whether you have a tax gain or a tax loss on the sale, and your basis in the new car is determined, at least in part, by your basis in the car you traded in 2001. Accordingly, records relating to your old car should be kept until 2013 (i.e., for six years after your 2006 return is filed in 2007).

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 in such situations, relations may become strained and access to the records difficult.

As many of us have learned this year with the various hurricanes, and other disasters, the calculation of the casualty and theft loss deduction is determined in part by your basis in the damaged or stolen property. You need to have records to support that basis, until six years after you file the return claiming the loss deduction.

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 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. Similarly, other professionals who assisted you in a transaction may retain records relating to the transaction. Consider contacting, your banker, investment broker, realtor and attorney for records.

Your state may have different rules so consult your State taxing authority to request information regarding their record retention rules.

Today, with the prevalence of computer scanning equipment and software, it is easier than ever to maintain complete records for years. My firm invested in state of the art scanning, storage and retrieval technology and now instead of having a filling room, we scan our files and clients’ records and store them electronically. This not only satisfies the retention requirements, but also allows easy access. No more looking in cabinet after cabinet or boxes in storage.

Whether you keep hard copies of tax returns, proof of filing and other financial records, or scanned copies, it is important to set a policy about what you will keep, how you will keep it and when you will destroy it (by shredding so your identify and information are protected).

Teri Kaye, Certified Public Accountant , is a Principal with Friedman Cohen Taubman & Co, LLC, a public accounting firm in Plantation, Florida, http://www.fctcpa.com/. Teri is also on the leadership panel for Mommy Mentors’ Mom’s Business Mastermind Group, http://www.mommymentors.com/. Mommy Mentors is a resource for all mothers to find support, inspiration and information, both in business and life. Teri can be reached at terik@fctcpa.com

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By Teri Kaye