Thursday, April 14, 2022 -      written by Timothy Perry        

Surprisingly, there is not a clear-cut answer to this common quandary. If you are as fanatical as the O.C.D. plagued Howard Hughes then the answer is likely forever. If you are conservatively cautious and somebody who buys a 2 million dollar insurance policy when a 1 million dollar policy might suffice, then 6 years is probably more compatible with your risk tolerance. If you are a gambler who puts half your monthly paycheck on red number 7 in Vegas, then 3 years might work… but only most of the time. Don’t worry, the following best practices will add clarity so that you don’t finish this article while still scratching your head.

1.   Save completed tax returns for at least 10 years

2.   Save each return’s supporting documents for at least 6 years

Follow these two simple rules and if you are ever audited, you’ll be happy you did.

Because a small percentage of audits are selected at random it means anyone can become the target of an IRS audit. However, if you do everything right the odds of an audit are extremely low. If you become one of the unfortunate few who goes through this sometimes excruciating process, having detailed records will make the audit process much less torturous. Retaining sufficient supporting documentation and records can help ensure you don’t pay taxes, penalties, and interest on what should continue to be legitimate deductions simply because you can no longer document them.

The 3-year audit window

The IRS can initiate an audit within 3 years from the date you file your tax return. Hence our recommended bare-bones retention period of 3 years for tax records. So why potentially hang on to things 6 years or longer? A few reasons. During the audit process, the IRS can expand the scope of the audit to 6 years if the examiner finds evidence that your income was underreported by at least 25%. Unnervingly, there is no limit on how far back an IRS audit can go when the IRS suspects fraud. This could make an audit significantly more problematic and exponentially more challenging and costly to deal with.

Save These Tax Documents For 6 Years

A minimum 6 year retention period is recommended for the following documents:

Income Reporting Forms: forms or other documents reporting wages, dividends, interest, and capital gains or losses

• W-2 forms
• 1099 forms (Contractor income, miscellaneous income)

Receipts for expenses claimed as tax deductions

Note: You need actual receipts, not credit card statements to back up your deducted expenses.

• Business travel and meals
• Home office expenses
• Medical expenses
• Professional memberships, subscriptions, and classes
• Automobile expenses or mileage logs

Receipts for charitable contributions

• For donated items with stated values over $5,000, save a professional valuation document or risk the value being reduced

Gift letters for tax-exempt gifts

• 2021 tax year annual gift tax exclusion - $15,000
• 2022 tax year annual gift tax exclusion - $16,000

1098 & 1098-C, E, or T forms

• Form 1098: Mortgage interest paid
• Form 1098-E: Interest paid on qualified student loans
• Form 1098-C: Donations of automobiles, boats, and airplanes to charitable organizations
• Form 1098-T: Post-secondary tuition and related fees. Used to calculate education-related tax deductions, scholarships and grants received that may reduce the taxpayer’s allowable deductions

Health insurance records

• Alternatively, keep exempt status records

Business owners: Keep these additional documents

Businesses potentially have additional types of audits to contend with. Payroll, and sales & use tax audits will go smoother if you retain the following documents for 3 to 6 years.

• Inventory logs
• Sales journals
• General ledgers
• Sales tax exemption certificates
• Payroll records

Save these records for more than 6 Years

Inherited or gifted asset records should be kept for 10 plus years

• Stocks, cryptocurrency, and other investments
• Records should show the original purchase price and purchase date, as well as the date you received the investment
• Section 1202 - Qualified small business stock gain exclusion. These rules are complex. Work with a professional and keep good records

Real Estate Purchase records

• Closing Disclosure statements (formerly HUD 1 statement)

Investment purchase records

• Stocks, mutual funds, cryptocurrency, and other investments
• These records should include the purchase price (cost basis) and date of purchase

Birth certificates

• Both your’s and your children’s – Keep for a lifetime

Adoption records

• Your children

Divorce decrees

• Keep your entire lifetime

For most of us that don’t live in a 500-square-foot NYC apartment, keeping a couple of banker boxes or fireproof boxes of tax documents is not going to cramp our home’s feng shui, so just do it. Proper preparation and organization coupled with a prudent retention plan for tax records will make life infinitely better should you ever be audited. These very same things can potentially lower your tax bill each year and greatly reduce the odds of an IRS audit. Another great reason to get your (tax) act together.