April 18, 2018

Don't Toss Those Tax Records Yet!

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Article Highlights:

Reasons to Keep Records
Statute of Limitations
Maintaining Record of Asset Basis

Even though the 2021 tax due date has come and gone, and even though you have filed your 2021 tax return, you may still need to keep your 2021 tax records. Generally, tax records are retained for two reasons: (1) in case the IRS or a state agency decides to question the information on your tax returns or (2) to keep track of the tax basis of your capital assets so that you can minimize your tax liability when you dispose of those assets.

If you are like most taxpayers, you have records from years ago that you are afraid to throw away. With certain exceptions, the statute for assessing additional taxes is three years from the return’s due date or its filling date, whichever is later. However, the statute of limitations in many states is one year longer than that of federal law. In addition, the federal assessment period is extended to six years if more than 25% of a taxpayer’s gross income is omitted from a tax return. The three-year period doesn’t begin elapsing until a return has been filed. There is no statute of limitations for the filing of false or fraudulent returns to evade tax payments.

If none of the above exceptions applies to you, then for federal purposes, you can probably discard most of your tax records that are more than three years old; you will want to add a year to that time period if you live in a state with a longer statute.

Examples – Sue filed her 2018 tax return before the due date of April 15, 2019. She will be able to safely dispose of most of her 2018 records after April 15, 2022. On the other hand, Don filed his 2018 return on June 2, 2019. He needs to keep his records at least until June 2, 2022. In both cases, the taxpayers should keep their records for a year or two longer if their states have statutes of limitations longer than three years. Note: If a due date falls on a Saturday, Sunday, or holiday, the actual due date is the next business day.

The problem with discarding all the records for a particular year once the statute of limitations has expired is that many taxpayers combine their normal tax records with the records that substantiate the basis of their capital assets. The basis records need to be separated and should not be discarded until after the statute has expired for the year when a given asset was disposed of. Thus, it makes more sense to keep separate records for each asset. The following are examples of records that fall into the basis category:

Stock-acquisition data – If you own stock in a corporation, keep the purchase records until at least four years after the year when you sell the stock. This data is necessary for proving the amount of profit (or loss) from the sale. While brokers generally will have provided the purchase information on Form 1099-B for the year you sold the stock, keeping a copy of the purchase confirmation or statement from the broker for the month of the purchase is still advised. As the taxpayer, you are the one ultimately responsible for substantiating the basis in case of an audit. The information can be saved on paper or as a PDF file. If your sales for a given year result in a net loss of more than $3,000, you may need to keep your purchase and sale records for an even longer period. This is because $3,000 is the maximum capital loss that can be deducted in any one year, so the excess loss must be carried over to the following year(s) until it is used up. If the IRS audits a return that includes a carryover loss, it will ask to see the records from the original purchase even if it was more than three years in the past. Thus, don’t dispose of such records until the statute of limitations has passed for the last year when you claimed a carryover loss.
Stock and mutual fund statements (if you reinvest dividends) – Many taxpayers use the dividends that they receive from stocks or mutual funds to buy more shares of the same stock or fund. These reinvested amounts add to the basis of the property and reduce the gain when it is eventually sold. Keep all such dividend statements for at least four years after the final sale.
Tangible property purchase and improvement records – Keep records of home, investment, rental property, or business-property acquisitions, of the related capital improvements, and of the final settlement statements from the sale for at least four years after the underlying property is sold.

For example, when Congress instituted the large $250,000 home-sale-gain exclusion (which is $500,000 for married couples filing jointly) many years ago, homeowners began to be more lax in maintaining their home-improvement records, thinking that the large exclusions would cover any potential appreciation in their homes’ value. Now, that exclusion may not always be enough to cover the gains from a sale, particularly for markets where property values have steadily risen; thus, keeping records of all such home improvements is vital.

What about the tax returns themselves? Although the backup documents that you use to prepare your returns can usually be disposed of after the statutory period has expired, you may want to consider indefinitely keeping a copy of the tax returns themselves (the 1040, the attached schedules/statements, and the state return). If you just don’t have room to keep copies of your paper returns, digitizing them is an option. For more recent years, PDF versions of the tax returns may have been provided by your return preparer.

If you have questions about whether to retain certain records, give this office a call; before discarding any records, it is a good idea to make sure that they will not be needed down the road.

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Don't Toss Those Tax Records Yet!

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