How Long to Keep Tax Records

The fear of being audited might lead many people to stash an unnecessary amount of paperwork. Keeping accurate tax records helps to ensure compliance and provides evidence in case of an audit. 

Here are some things to consider when deciding what tax documents to keep. And remember, it's always best to refer to official IRS guidelines when in doubt or to verify that your record-keeping plan is correct.

 

How Long to Keep Tax Returns

Sending off your tax payment does not mean the end of your responsibility for that year’s tax paperwork. Should the IRS or state tax authorities raise questions about deductions or reported losses after you file your return, having access to your tax return and documents like W-2s can help you prove the accuracy of your filings. The general recommendation is to keep your returns and any supporting documents for three years after you file or the tax return due date, whichever is later. 

 

Digitize Your Financial and Tax Records

The IRS accepts electronic records, so there's typically no reason to hang on to a statement or other piece of paper just because it was issued by your bank or other financial institution. Scan the originals to a digital format or consider going paperless by getting your statements electronically.

Make sure you backup your data and consider keeping a copy off-site, either in physical form (such as on an external hard drive) or encrypted in the cloud. 

 

What Tax Documents to Keep

If your biggest worry is that you'll shred something you'll need later, take heart. Most documents can be re-created. Banks and brokerages keep electronic versions of your statements for at least six years and sometimes more, though they may charge you to get new copies. This makes it easier to report income or credit or refund amounts on future income tax returns. 

Your biggest risk of being audited is in the first three years after you file a tax return, although that limit can be extended to six years if you under-report your income by 25% or more.

You may hear some tax experts say to keep records for seven years. What they mean is seven years from the relevant tax year. So, if you file your 2023 return on April 17, 2024, you'll want to keep those records until April 2031— seven years from 2023.

If you'd like to be extra cautious, keeping all relevant documents for seven years might be the right option for you. This will help ensure that you comply with IRS guidelines and support any claims of income tax paid or refundable on your gross income. 

If you're looking for specifics, keep reading to learn more.

Three Years

For three years after the tax-filing deadline, hold onto documents that validate any income, deductions or tax credits reported on your return for that tax year.

These documents include:

• W-2 forms reporting income from employers.
• 1099 forms showing income such as self-employment, interest, dividends and capital gains.
• 1098 forms for mortgage interest deductions.
• Receipts and canceled checks for charitable contributions, if you itemize deductions.
• Documentation of eligible expenses from health savings accounts and 529 college savings plans.
• Contributions to tax-deductible retirement savings plans, like a traditional IRA.

If you don't itemize deductions, you may not have to hold onto specific documents. For instance, unless you're taking charitable deductions, there's no need to keep donation receipts.

Six Years

As mentioned above, the IRS reserves the right to audit your tax returns up to six years back if you've omitted 25% or more of your income.

Documents to keep include:

• 1099 forms and receipts for business expenses for those who are self-employed.
• Keep all relevant records if you haven't reported at least $5,000 of income from foreign assets.

Seven Years

Documentation should be kept for at least seven years for bad investments or loans that haven't been repaid, as this period allows you to claim deductions for losses from worthless securities or bad debt. It’s important to remember that loans considered to be gifts (if repayment was uncertain) are not deductible.

Indefinitely

There's no statute of limitations for tax fraud investigations.

Therefore, keep tax records indefinitely if:

• You've filed a fraudulent return and have been accused of tax fraud.
• You have justification for not filing your tax return in a particular year, such as insufficient income due to personal circumstances.
• You have estate tax returns reported on Form 706. This form tracks the transfer of assets and might be needed to address legal or tax matters that can arise years later. 
• When it comes to gifting money to children or others, Form 709 provides a record of gifts that exceed the annual exclusion limit. This scenario can impact potential future estate taxes and serve as a reference for long-term financial planning. 

What Documents to Keep Forever in Paper Form

We're still not a paperless society, and it can be a hassle to get certain documents re-created if needed. That's why it's important to keep physical copies of certain records that might be used for tax and other financial purposes.

Important documents you should keep safely in paper form include:

• Birth certificates.
• Marriage certificates.
• Death certificates.
• Title certificates.
• Social Security cards.
• Military service records.
• Divorce decrees.

Keep these secured in a home safe or safe deposit box and consider making digital copies as a backup. 

Retirement Accounts

Handling paperwork for retirement accounts like IRAs, 401(k)s and similar plans can be easier than you think. Unlike regular investment accounts, retirement accounts are not subject to capital gains tax rules. 

Retirement account records you should keep include:

• Form 8606: Form 8606 tracks nondeductible contributions made to your IRAs and helps avoid being taxed again when you withdraw the funds. This form is also required when dealing with a Roth conversion as it will inform the IRA that you’ve converted your account come tax filing time. 
• Form 5498: Sent by your IRA custodian, Form 5498 summarizes your contributions (including rollovers and conversions) for the year. It's a record of your account's growth and contributions.
• Rollover Documentation: Any paperwork associated with the transfer or rollover of accounts, such as moving a 401(k) to a new employer's plan or changing IRA custodians, should be retained. These documents keep track of the history and movements of your retirement funds.
• 403(b) Statements (pre-1987 contributions): If you contributed to a 403(b) account before 1987, keep those statements indefinitely. These contributions are unique because they allow for a later withdrawal age of 75, differing from other retirement funds which may require earlier withdrawals.

Documents you do not have to keep include:

• Investment Tracking Records: For capital gains tax, there's no need to keep a detailed log of buy/sell actions within these accounts. Since retirement accounts are typically tax-deferred, gains or losses within the account do not impact your tax situation year-to-year.

Tax Records for Investments & Property

For investments and property, maintaining accurate records is helpful for document management and tax purposes.

Here's what you need to know:

• Roth IRA Contributions: Keep documentation of your contributions for three years after the account has been fully withdrawn. These records prove that taxes were already paid on contributions, ensuring they are not taxed again upon withdrawal.
• Investment Transaction Records: Transaction records for stock, bond, mutual fund and other investment purchases in taxable accounts.

Keep these records for up to three years after selling the investments to establish the cost basis. The cost basis includes the purchase price and any additional acquisition costs, determining the taxable gain or loss when you sell. Even with brokers reporting the cost basis, having your own copies is wise for accuracy and backup.

Different Categories of Property:

• Inherited Property: Keep records of the property's fair market value on the date of the original owner's death.
• Gifted property: Maintain documentation of the donor's basis, which is usually the fair market value at the time you received the gift.

Save these records for at least three years after selling the property, as sales are taxable if sold for more than your basis.

Home Sales & Improvements:

Receipts and documents related to home sales and improvements should be retained for three years after selling the home.

This is important even though you may not owe capital gains tax on home sale profits (up to $250,000 for single filers and $500,000 for joint filers), provided that the home was your primary residence for two of the five years prior to the sale. Receipts for home improvements can be used to adjust the home's cost basis, potentially reducing taxable gains.

How Many Years Can the IRS Go Back to Audit?

The IRS typically has a three-year window from when you submit your tax return to decide if they'll audit it. In cases where significant discrepancies are discovered, this period can be extended, but it rarely surpasses six years.  

Complete information about audits can be found on the IRS website.

 

Exemptions to the Audit Rule

While the standard IRS audit window is three years from the date the tax return was filed, some exceptions allow the IRS to extend this period. Here are some common scenarios under which the audit timeline may extend beyond the typical three years:

• Retirement Accounts: Mistakes or discrepancies in reporting on retirement account contributions, distributions and rollovers can prompt the IRS to look beyond the standard audit period. This includes issues with traditional and Roth IRAs, 401(k)s and other tax-advantaged retirement accounts.
• Bad Debt Deduction: If you claimed a deduction for a bad debt or a worthless security, the IRS has up to seven years to question this deduction. 
• Substantial Understatement of Income: For individuals who underreport their income by more than 25%, the IRS can audit returns up to six years back. This rule is in place to combat tax evasion and ensure accurate reporting of income. Implementing effective tax planning strategies for high-income earners can help individuals minimize their tax liability while staying compliant. 
• Worthless Securities: Similar to bad debt deductions, if you are filing a claim for a loss from worthless securities, the IRS extends its audit period to seven years. This involves investments that have become completely without value within the tax year.
• Foreign Income and Assets: The audit period extends to six years for taxpayers who fail to report more than $5,000 of income related to foreign financial assets. 

When and What to Shred

Managing and discarding unnecessary financial documents can help keep your personal information safe and your filing system clutter-free. Here's what to shred and when:

• Trade Confirmations: Shred paper trade confirmations after comparing them with your brokerage statement. Discard monthly brokerage statements once the comprehensive year-end statement is received and reviewed.
• Pay Stubs: Shred pay stubs after receiving your W-2 and ensuring that the information matches your year-end pay stub summary.
• ATM Receipts and Deposit Slips: Shred these documents after verifying they match your bank statements.
• Credit and Debit Card Receipts: Once reconciled with your statements, keep only those receipts necessary for tax purposes or documenting significant purchases. For less important receipts, consider a quarterly filing system. Keep these receipts for six months before safely discarding them, allowing for any discrepancies or returns to be handled.

 

How Long Should You Keep Tax Statements in California?

Unlike the federal standard, California operates under a four-year statute of limitations for tax documents. This means the California Franchise Tax Board (FTB) has the authority to audit your tax returns up to four years after they are filed.

To align with California's statute of limitations, residents should retain their tax returns and all supporting documentation for at least four years. This time frame provides adequate coverage in case of a state audit. Types of documents to keep include, but are not limited to, your annual tax returns, W-2s, 1099s, receipts for deductible expenses and records related to property or investment transactions.

 If you have more questions about your finances, contact our wealth planners today.