Retention of Tax Records

Keep returns indefinitely and the supporting records usually for 6 Years - In general, except in cases of fraud or substantial understatements of income, the Internal Revenue Service can only assess tax with respect to a year within three years after the return was filed for such year (or, if later, three years after the return was due). For example, if you filed your 2004 individual income tax return on or before its unextended due date of April 17, 2005, IRS could assess tax until April 17, 2008. If you filed your return late, it has three years from the date you filed.

The problem with the three-year rule is that the assessment period is extended to six years if more than 25% of gross income is omitted from a return. Neither period begins to run until a return is filed. Therefore, if the Service 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, of course, be impossible after you have discarded your returns.

While it is therefore impossible to be completely sure that the Service will not at some point seek to assess tax, retaining tax returns indefinitely and important records for six years after the return is filed should, as a practical matter, be adequate.

Records relating to property may have to be kept longer than other records - Keep in mind that the tax consequences of a transaction that occurs in one year may depend on things that happened in earlier years--and that the period for which you should retain records must be measured from the year in which the tax consequences actually occur. This may be significant, for example, where you sell property that you bought years earlier.

for example, suppose you bought your home in 1995 for $200,000 and made an additional $20,000 of capital improvements in 1998. You then sell your home in a taxable transaction in 2005. In order to determine the tax consequences of the sale, it's necessary to know your basis, which depends on the earlier transactions. If your 2005 return is audited, you may have to produce records relating to the purchase in 1995 and the capital improvement in 1998 in order to substantiate your basis. In effect, therefore, such records should be kept until six years after the 2005 return has been filed--even though they relate to years long past.

Similar considerations apply to other property which is likely to be purchased and sold such as stocks, bonds and other securities.

And, because the calculation of the casualty and theft loss deduction is affected by your basis in the property, you'll need to have records to support that basis, until six years after you file the return containing the loss deduction.

In case of separation or divorce - 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.

Your records should include a copy of the divorce decree or agreement of separate maintenance, which may be needed to substantiate alimony payments and distinguish them from child support or a property settlement. Copies of all joint returns filed and supporting records are important, since the liability for tax on a joint return is joint and several and a deficiency may be asserted against either spouse. Your records should also include agreements or decrees over custody of children and any agreements of who should claim an exemption for them. Retain records of the cost of all jointly-owned property. And get from your spouse or former spouse records of the cost or other basis of all property transferred to you by him or her during your marriage or as a result of the divorce, because your basis in this property is the same as your spouse's or former spouse's was.

Loss or destruction of records - To safeguard your records against loss from theft, fire or other disaster, you might wish to consider keeping your most important records in a safe deposit box or other safe place outside your home. In addition, you may want to keep 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, despite your precautions, 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. Most preparers comply with this rule by retaining copies (sometimes for a longer period than the legally required three years) and can furnish a copy if yours is not available. Similarly, other professionals who assisted you in a transaction may retain records relating to the transaction--for example, a stockbroker through whom you bought securities may be able to help you to determine the basis of the securities, and an attorney who represented you in the purchase of your home may retain records relating to the closing. Nonetheless, because you can never be sure whether those persons will actually have the records you need, the safest course of action is to keep them yourself, in as safe a place as possible.

Click here to view a Records Retention Schedule.

Source: Research Institute of America

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