Your tax return is filed. All of the statements, receipts, and forms you needed to determine your income, deductions, and credits are now ready to be put away.
What documents do you need to keep in the event the tax authorities want some verification of the items claimed on your return? And for how long? Here are some answers.
In general, the IRS can only assess tax for a given year within three years after the return for that year was filed (or, if later, three years after the return was due). If you file your return late, the IRS generally has three years from the date you filed the return to assess a tax deficiency.
Example: Andy filed his 2006 individual income-tax return by its original due date of April 17, 2007. The IRS will have until April 17, 2010, to assess a tax deficiency against him.
The tax assessment period is extended to six years if more than 25% of gross income is omitted from a return. Moreover, 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 filed. So, you'd need a copy of your return to help prove you did file (other proof showing that you actually sent in the return might also be required).
While you're never sure that the IRS won't later seek to assess tax, retaining tax returns indefinitely and important records for six years after the return is filed should be adequate. If you file your return electronically, be sure to get a copy from the tax professional who prepared and/or filed your return. (Note: We always provide our clients with a paper copy of an electronically filed return.)
Some Records to Keep Longer
Be aware that the tax consequences of a transaction that occurs in one year may depend on what happened in earlier years. Therefore, the period for which you should retain records must be measured from the year in which the tax consequences actually occur. This is true, for instance, where you sell property that you bought years earlier.
Example: Maria bought her home in 1987 for $90,000 and made an additional $20,000 of capital improvements in 1995. If she sells her home in 2007, Maria will need to know her tax basis (i.e., the original cost plus later capital improvements) to determine the tax consequences of the sale. So, she may have to produce records relating to the purchase in 1987 and the capital improvements in 1995. Therefore, those records should be kept for at least six years after Maria's 2007 return is filed instead of just six years after the transactions occurred.
Although as much as $250,000 of home-sale gain can escape tax – up to $500,000 for joint-return filers – you should still retain all records relating to home purchases and improvements. You cannot know now how much the home will be worth when it's sold. Plus you cannot be certain that the home-sale exclusion will still be available when your future sale takes place.
Similar issues apply to other property that is likely to be bought and sold – for example, shares in a corporation or in a mutual fund, bonds (or other debt securities), etc. Keep in mind 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.
Another example: The calculation of the casualty and theft loss deduction is determined in part by your basis in the damaged or stolen property. Therefore, you'll need to keep records to support your basis until six years after you file the return claiming the loss deduction.
What If You Lose Records?
Safeguard your records against loss from theft, fire, or other disaster. Consider keeping your most important records in a safe deposit box or other safe place outside your home. Moreover, consider keeping copies of the most important records in an easily accessible location so that you can quickly take them with you if you have to leave your home in an emergency.
If your records are lost or destroyed, don't despair. It may be possible to reconstruct some of them. For instance, your stockbroker may be able to help determine the tax basis of securities you sold, and an attorney who represented you in the purchase of your home may retain records relating to the closing. Still, since you can never be sure whether those persons will actually have the records you need, the safest course of action is to retain them yourself, in as safe a place as possible.
We're Ready to Help
If you need more information about safekeeping your tax records, or any tax-related matter, please consult with us. We're always happy to help