Pop quiz: How long should you hold on to your tax returns? If you guessed at least three years beyond the due date of the return, then you’re not alone. That is the standard answer that the vast majority of taxpayers give. Most taxpayers have also learned that if they were able to obtain an extension for filing their original return, that the three-year period would run from the actual filing date as opposed to the normal filing date of April 15.
The reason for the three-year answer is that the IRS has up to three years to audit you and assess additional taxes. Incidentally, that’s also the time limit for you to file an amended return.
While the standard answer is an acceptable starting point to work from, regretfully it does not end there. Just when you thought it was safe to rely on a bright-line rule, the IRS has thrown a wrench in the works. This wrench takes the form of exceptions that broaden the three-year rule on retaining tax records.
Below is a list of exceptions that all but swallow up the rule:
- The assessment period is extended to six years if a taxpayer underreports more than 25% of his or her gross income from the tax return.
- The IRS can assess additional taxes well into time and memorial when a taxpayer has been “naughty.” This means that the statute of limitations for assessing taxes is suspended indefinitely, giving the IRS license to assess stiff penalties for tax years that might go back as far as the ice age. In other words, there is no statute of limitations. The following circumstances are par for the course: (a) the taxpayer doesn’t file an income tax return, (b) the taxpayer files a false or fraudulent return with the intention to evade taxes, or © the taxpayer deliberately tries to evade tax in any other manner. With respect to (a), the three-year statute of limitations is triggered only when you file an income tax return. If you never filed a return, then you can’t raise the statute of limitations as a defense because the clock never started to run. After submitting your tax return, be sure to confirm that the IRS has received it. As a vast bureaucracy that dwarfs the governments of many small nations, the IRS has been known to misplace returns. This may explain why the very first thing the IRS asks for when auditing a taxpayer is a copy of the original tax return. More often than not, it comes down to convenience. It’s easier to ask the taxpayer for a copy of the return instead of having to dig for it in the catacombs of the IRS’s storage vault. The tragedy in this is that if you don’t have a copy of your return, the IRS will assume that you never filed one. This is why you can never be too careful when dealing with the IRS and I dare say, may even want to retain proof of having filed the return. That would mean a signed certified mail receipt if you filed by mail or the confirmation email or web page print-out from an electronic filing.
- The IRS has unlimited time to assess additional tax when a taxpayer files an unsigned return.
If none of these exceptions apply to you, then you can breathe a sigh of relief and take comfort in the fact that you need not turn your living room into a mini junk warehouse with piles of returns dating back to the twentieth century covering the entire floor from one wall to another. Before breaking out the champagne for a celebratory toast, there is a caveat that you should be aware of that may necessitate adding a year or more onto the three-year retention period, even if none of the exceptions apply to you. And this caveat applies to those taxpayers who live in a state that has a longer statute of limitations than the IRS’s.
Below is a quick and dirty example of the mechanics of what has been discussed thus far:
Suppose that Jack filed his 2014 tax return before the April 15, 2015 deadline. He can safely discard his 2014 return after April 15, 2018.
Contrast the above example with this one: Suppose that Jennifer filed her 2014 tax return on June 1, 2015. She must keep her tax records until at least June 1, 2018, even though June 1, 2018 is more than three years past the normal filing deadline of April 15, 2015. This is because Jennifer received an extension for filing her return and when extensions are granted, the statute of limitations does not begin to run until the actual date that the return is filed. Because Jennifer did not file her 2014 return until June 1, 2015, the IRS has until June 1, 2018 to audit her and assess additional taxes. Thus, she must keep her tax records until at least that date.
In each case, both taxpayers should retain their records a year or more beyond the dates listed above if the state taxing authority of the states in which they live have statutes of limitations on assessment that extend beyond three years.
With all the fuss about retaining tax records, this is as good a time as any to define what is meant by “tax records.” By tax records, we’re talking narrowly about the returns themselves and not the records backing up your tax returns (good gracious if we were). The latter need not be retained beyond three years.
Although you can dispose of your backup records, there are certain tax records above and beyond your tax return that I would encourage keeping for longer than three years:
- Stock acquisition data. If you own stock in a corporation, keep the purchase records for at least 4 years after selling the stock. The purchase data is needed to prove the amount of profit (or loss) that you had on the sale.
- Statements for stocks and mutual funds with reinvested dividends. Many taxpayers use the dividends that they receive from a stock or mutual fund to buy more shares of the same stock or fund. These reinvested amounts contribute to the basis of the property and reduce the gain when it is eventually sold. A good practice is to retain these statements for a minimum of four years beyond the date of final sale.
- Tangible property purchase and improvement records. It is a good practice to keep records of home, investment, rental-property or business-property acquisitions, as well as all related capital improvements, for a minimum of four years beyond the date that the underlying property is sold.
If you have misplaced a copy of a prior year’s return, do not fret. You can always order an account transcript from the IRS. Account transcripts contain valuable information such as a summary of the return information and includes adjusted gross income. This service is free and is available for the most current tax year once the IRS has processed the return. These transcripts are also available for the past six years’ returns.
When ordering a transcript, keep in mind that the IRS is not especially known for its speed and efficiency. If FedEx’s slogan is “The world on time,” then the IRS’s slogan ought to be, “See you in September.” For example, it is not unusual for ten days or more to pass before receiving your account transcript, even if you ordered it online or over the phone. If you’re old school and mail a written request for your transcript to the IRS, it can take up to 30 days before you receive your transcript (75 days for full tax returns).
There are the three ways in which you can order a transcript. They are:
- Online Using Get Transcript. Use Get Transcript Online on IRS.gov to view, print or download a copy for any of the transcript types. Users must authenticate their identities using the Secure Accessprocess. Taxpayers who are unable to register or who prefer not to use Get Transcript Online may use Get Transcript by Mail to order a tax return or account transcript.
- By phone. The number is 800–908–9946.
- By mail. Taxpayers can complete and send either Form 4506-T or Form 4506T-EZ to the IRS to receive a transcript by mail.
When it comes to obtaining a copy of an original tax return, the IRS will be happy to furnish you with one, albeit at a price. The fee is $50 per copy. In the same way that account transcripts are available for the current tax year as well as for the last six tax years, so too are copies of the original tax returns. Simply fill out Form 4506 and mail it to the appropriate IRS office, which is listed on the form.
While the odds of the IRS asking about a years-old tax return are slim to none, you may just be holding the lucky ticket (or better said, “unlucky ticket”). In that case, you’ll be happy that you put up with the hassle of keeping those old returns.