Thursday, April 14, 2022 - 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
Receipts for expenses claimed as tax deductions
Note: You need actual receipts, not credit card statements to back up your deducted expenses.
Receipts for charitable contributions
Gift letters for tax-exempt gifts
1098 & 1098-C, E, or T forms
Health insurance 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.
Save these records for more than 6 Years
Inherited or gifted asset records should be kept for 10 plus years
Real Estate Purchase records
Investment purchase records
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.