For most taxpayers, getting your return prepared and filed is the end of a long road. Yet what happens after you've filed your tax return can be equally important. By making sure that you hold onto your tax records as long as you need to, you'll avoid what can become major problems down the road. Let's take a closer look at what you'll need to handle a potential audit and to help you prepare future tax returns.
The general rule for tax records
Typically, the IRS has three years to audit your tax return. The clock starts when you file your tax return, or on the due date for the return if you file it before the deadline. For instance, if you file your 2016 tax return on May 15, 2017, then the government will have until May 15, 2020 to go after you. However, if you file on March 31, 2017, then the time to audit extends just over three years to the mid-April tax deadline for the 2016 return.
One key exception to this rule involves situations in which you pay taxes after you file your tax return but then make a claim to get some of those taxes back. In that case, if you paid your taxes within the first year after filing your return, then the regular three-year rule applies. However, if you paid your taxes after a year had passed, then you should hold onto your records for two additional years beyond when you paid the tax. That will result in keeping your records slightly longer, acknowledging the ability of the IRS to get more time in that situation.
When you need to hold onto your tax records longer
There are several other situations in which the IRS has longer than three years to audit your return, and most of them involve bad behavior on your part. If you haven't reported income that you should have reported, and the amount by which you underreported your income is more than 25% of the gross income shown on your return, then the IRS gets double the normal amount of time to look into your return. That means you should keep your records for six years beyond your filing date or return due date if you think that's a possibility.
If you never file a return, then the IRS has no time limit on coming after you. In that event, you should keep your tax records forever. In addition, if the IRS determines that you've filed a return fraudulently, then the same no-limit rule applies, making it necessary for you to retain your tax documents to address a potential audit at any time in the future.
A special situation applies when you've claimed a loss due to having worthless securities. The IRS has seven years to audit a return making a worthless securities claim, so you should keep documentation of your position for at least that long.
Keeping tax records you haven't used yet
The rules above apply to records related to returns that you've already filed. However, in many cases, you'll get records that you won't need until you file future returns. For instance, the brokerage statements that document purchases of investments will be useful when you sell those investments in order to prove your tax basis and consequent capital gain or loss. Therefore, you need to hold onto such documents for as long as you own the securities. Then the three-year rule applies once you report the sale on your tax return.
In addition, in some cases, the IRS will allow you to do a tax-free exchange in which the tax basis of newly acquired property is based on the tax basis of property that you exchanged away to another party. That means you'll need to hold onto records establishing the old property's tax basis, even though you no longer own it.
Keep what you'll want later
Finally, keep in mind that even if you can get rid of old tax records, you might not want to throw them away. Even once you no longer need old records for tax purposes, keeping them as a record of your taxable income and how you handled your finances in the past can be useful for things you do in the future. Keeping a full set of tax records can be inconvenient, but at least retaining copies of filed tax returns will give you a starting point for looking back at your financial history if the occasion arises.