Travis H. Long, CPA, Inc. Blog

Originally published in the Cedar Street Times

May 3, 2013

It is time to do some spring cleaning!  Do not miss your opportunity as summer is coming quickly, at which point you will be required to keep everything for another year.  Perhaps you will find that old pair of muddy tennis shoes in the garage – now the home to three indignant spiders as you turn their palace upside down.  Or maybe you will find that half-used bottle of hotel shampoo under the sink – a small, but satisfying entitlement for a $300 room charge.  Ah, and then there are those tax returns you filed way back in April – is it time to get rid of those too?!

You can do whatever you want, but my advice is to keep them.  In fact, I would say you may want to keep every tax return (and the supporting documents) you have ever filed – I know I have.  Record retention is always an interesting debate and you hear a lot of people say three, five, or seven years as a rule of thumb for many types of documents.  Regarding tax returns, the real answer is unique to each person depending on his or her tax circumstances and risk tolerance.

Someone that works a W-2 job, has no other sources of income, no investments, contributes to no retirement plans, and files the returns correctly would have little risk if discarding the returns after four years.  If you do make retirement plan contributions, depreciate any assets, have an installment sale agreement, or a host of other things, it would not really be wise to discard the returns in accordance with a rule of thumb.

The IRS generally has three years from the later of the due date (or extended due date) or the date you file to audit your returns.  The California FTB has four years from the later of the non-extended original due date or the date you file in order to audit.  You should never throw out returns or source documents until you are outside of these statutes of limitation.  If you have understated your gross income by more than 25 percent (even if by accident), then the IRS has six years to audit you.  People can get tripped up on this pretty easily if they fail to report stock sales.  I have seen this before with people preparing their own tax returns that ignore the 1099-B issued year-after-year because they did not really understand it.  If you filed a false tax return or there was any kind of fraud, there is no statute of limitations.

Even if you are outside the statute of limitations, however, you may still need prior tax returns to support positions you are taking on current tax returns that are inside the statute of limitations.  Think about someone that has been contributing to an IRA for many years and was unable to take deductions due to income limitations.  Each of these nondeductible contributions would have created basis in the IRA which would lower the taxable amount of distributions while in retirement.  If the IRS audited your returns in retirement and questioned your basis, having all the past tax returns showing the nondeductible contributions would be a saving grace.

People that have rental properties or home offices may find tax returns from twenty-five years ago helpful in proving the basis in the property when it is eventually sells due to depreciation deductions taken on each past return.  I have also had situations where clients had no idea what their cost basis was for a stock sale, and we were able to help recreate and substantiate the cost basis by reinvested dividends reported on tax returns stretching back several decades.

The safest thing to do is just keep them, or at least scan them and maintain the electronic files through the years.

One other pointer – be sure you do not throw out purchase records, refinance documents, or receipts of improvements to any type of property you own as you will likely need this information if you ever sell it.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.