Past tax returns, statements, and financial records have a life; you should keep them as long as needed to substantiate your filings. On the other hand, there is a moment when you can let the past go and relieve yourself of expired records.
The general rule of thumb is seven years, but there are some additional details to consider, I go through those below. Please remember that this post is informational only: if you want specific advice please set up a time to talk with one of us here.
The accounting records that you should keep
This is an overview of record-keeping, not a comprehensive list. I cover the general rules below, but your specific situation may have different requirements. Use this information as a general guide.
Keep records to substantiate the tax returns that you have submitted to the IRS
You’ve filed and feel confident that you can prove the legitimacy of your return. You mail it and forget it. In a year, or two, or three, the IRS comes back to you and asks to verify your details.
Having your records available at the time of an audit will be a life saver!
What records you should keep to support your tax returns
Copies of your tax return
This may seem like a no-brainer but, you’d be surprised how easy it is to forget the big picture when you’ve been focusing on the details. Also, many people rely on their tax filing software to keep records: you should keep a printed or electronic version of your tax returns. It won’t just help you deal with the IRS; it will also help you file future returns if you lose access to the software.
In addition to the return itself there are a few other documents that you should keep:
Proof of income
- Earned Income: W2, 1099, pay stubs, bank statements.
- Unearned Income: Social Security, annuities, pensions, court-ordered payments, unemployment benefits, Workers Compensation statements.
Proof of expenses if you run a business or have deductible expenses.
- Mortgage interest, medical expenses, real estate tax records.
- Business expenses.
- Property expenses – closing statements (of course refinance documents), insurance records, purchase records, improvement expenses.
- Investment and IRA statements.
To substantiate these expenses, the IRS also requires proof of payment
Proof of payment is a receipt that documents the transaction itself. You should obtain and keep a record of every transaction between a buyer and a seller. Should the IRS come back to you, you will want to have them at your fingertips.
Proof of payment includes:
- Canceled checks.
- Cash register receipts.
- Statements: banks and credit cards.
- Mortgage interest statement.
All of these will serve the purpose of cross-referencing your financial reports and tax returns.
Records for special situations
Some situations do require specific records that you should keep for tax and legal reasons. These include (and this is not an exhaustive list):
If you pay or receive alimony, keep a copy of your written separation agreement or divorce, separate maintenance, or support decree.
Business use of your home
This is a very common deduction and one that can require significant substantiation. Keep clear records of what part of your home you use for business and the expenses related to that use.
A common home business use is child care. If you provide child care in your home, keep track of business hours and hours spent preparing and cleaning up.
Keep detailed records of your winnings and losses. The information that the IRS requires includes:
- Date and type of gambling activity.
- Gambling establishment name and the contact information for any people with you.
- The amount you won or lost.
Unfortunately, each tax credit includes special recordkeeping requirements. Examples include (and this is not an exhaustive list):
- Child and Dependent Care Credit requires the provider’s name, address, and taxpayer ID number.
- Credit for the Elderly or the Disabled requires a physician’s certification.
- Educational credits require school records.
If you are claiming a tax credit, be sure to identify and retain the necessary documentation.
If you use your car for business, medical transport, or qualifying volunteer work, you will need to keep clear and accurate records of all business trips and related vehicle expenses. Read our post that explores vehicle expense deductions in more depth here.
Another big reason to keep documents is to establish a basis
Beyond tax, every property owner should know about “basis.” It’s the amount of your capital investment in a property for tax purposes: the higher your basis, the lower your capital gain when you sell a property. Therefore you should document the investment you’ve made to reduce your tax obligation.
There are three elements of basis:
- Original Cost of Property – Simple; what did you pay for it? (include all the costs and fees up to closing).
- Capital Improvements – What work did you do to the property to add value, energy savings, anything to increase the useful life of the property (additions, updated plumbing, wiring, roofs, kitchen, driveway, etc.)?
- Other Adjustments – Look into insurance reimbursements, deferred gains, and depreciation claims in past years.
Keep all of these records until you sell. Keeping these records will reduce the capital gains on the sale and reduce the tax you will owe.
How long should you keep your records?
The short answer is: it depends.
The general rule of thumb is that you should keep tax records for seven years and basis records until you sell your property. The IRS says that you must keep records for as long as the IRS may need them to administer any provision of the Internal Revenue Code.
This means that you must keep them until the statute of limitations expires.
Assuming you file on time and your tax filings are legitimate, the IRS can audit you without reason for up to three years, so you will need to keep your records for at least three years.
However, if the IRS decides that you omitted more than 25% of your gross income, the statute of limitations increases to six years.
If you file a claim for a loss from worthless securities, then the statute of limitations on an audit increases to seven years.
There is no statute of limitations on fraudulent returns or not filing returns: in this case, the IRS can require tax records for an indefinite period. So, if you are filing fraudulent returns, keep your records forever. Better yet, don’t file fraudulent returns; it is not worth it.
What about electronic records?
Luckily for everyone, the IRS acknowledges electronic records as the same as paper. Original papers can damage over time, so an electronic scan or copy is a safe bet, but only if you back it up.
Good record-keeping matters just as much in an electronic world as in a paper world. Are you, for example, still using the same laptop from seven years ago? Probably not. Be sure to keep your records safe by backing up to external hard drives, or better yet, to a cloud service.
The same rules of retention apply to electronic records as hard copy ones.
One last thought about electronic records; don’t assume an institution (like your bank or investment firm) will have your documents in seven years should you need them. Check to see what their policies dictate.
The best place to keep your records is in your computer, your drive, your cloud, or your file cabinet. Don’t rely on anyone else to retain these records for you.
Keep, Categorize, Copy, and Clean Out
In short, keep everything that substantiates your tax returns. Categorize all of your records for ease of reference. Copy everything as a backup.
Also clean out the records you no longer need. Those tax records from twenty years ago you can probably let go (though you may want to check with a professional first, this advice is informational only.)
Unless, of course, they spark joy, in which case even Marie Kondo would encourage you to keep them.
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