Are Your Papers in Order?
After going through the annual chore of filing tax returns, most people want to put the ordeal behind them. But before banishing the experience from memory, there’s one more important task to complete, and that’s properly saving the supporting documents used with your annual return. Here are tips from accountants and personal-finance experts about what to save, what to throw away, how long to keep tax return-related materials, and how best to store these important documents.
The Three-Year Minimum
As a general rule, most financial professionals recommend hanging on to documentation supporting your annual tax return for at least three years. Why three years specifically? “The IRS can audit your tax returns for up to three years after the tax filing deadline,” explains Logan Allec, certified public accountant and owner of personal finance blog Money Done Right. For businesses or the self-employed in particular, the IRS suggests hanging onto records that “support an item of income, deduction or credit shown on your tax return.”
The Six-Year Rule
Did you fail to disclose all income on a tax return? If the answer is yes (shame on you), then plan to hold onto important financial documentation for even longer than three years. “If you underreported income by more than 25%, the IRS can audit your tax return six years later,” says Allec of Money Done Right. More specifically, the IRS website states that “if you do not report income that you should report, and it is more than 25% of the gross income shown on your return,” you should maintain related records for six years. Allec suggests maintaining any documents that verify your income, deductions, or credits earned.
Did You Skip Filing a Return Altogether?
If for some reason you opted to forgo filing a tax return in a given year, the IRS website recommends keeping all financial records and documents related to the year in question indefinitely. You’ll also want to keep records forever if you filed a fraudulent return, according to the IRS website. Also, we probably shouldn’t even have to say this, but here goes: Filing a fraudulent return is a really, really bad idea.
What to Save
Aside from worrying about how long to save supporting documents and paperwork, you also need to think about what exactly must be saved. Beth Logan, a tax professional and enrolled agent with Massachusetts-based Kozlog Enterprises, says you should keep everything that ‘proves’ what’s on your tax return. “Important items include W-2s, proof of the purchase price of the assets on your return, proof of the losses, business books with receipts or proof of payments,” Logan said. “If you take the standard deduction, then you can throw away your donation receipts and medical receipts because you did not claim these deductions.”
Documentation related to property ownership should also be maintained for an extended period of time. The IRS website explains that it’s a good idea to keep “records relating to property until the period of limitations expires for the year in which you dispose of the property.” These records must be maintained in order to determine any depreciation, amortization, or depletion deduction. Such documentation is also needed to help calculate gains or losses when you sell or dispose of the property.
Save Important Documents Electronically
While you can obviously save hard copies of your important tax-related documents, some experts suggest it’s an even better idea to store these items electronically. “Electronic format is the best way to keep your records … especially since the ink on paper and receipts wears off,” said accountant Thomas Williams, co-founder of Deducting the Right Way. “You can either use a scanner or a mobile device to take pictures of the documents. Store them on an external hard drive or cloud-based platform. Make sure you have clear images before destroying the originals.”
Organization and Storage Strategies for Hard Copies
If you eschew electronic document storage, then consider keeping your financial documents and tax returns in a locked file cabinet or a fireproof safe, suggests Ben Watson, a CPA and CFO of DollarSprout.com. “Paper copies should be kept in a locked cabinet or drawer to prevent thieves from stealing sensitive personal information such as your full name, Social Security number, or banking information,” Watson said. “A fireproof safe can protect these and other important documents in the event you experience a disaster.” You should also consider saving your paperwork chronologically by year, Watson adds. “Consider each year a chapter in a book that you’re compiling telling the financial story of your life,” he explained.
Paperwork You Can Ditch
While it’s important to maintain things like W-2s and receipts for expenses, you don’t have to hang onto everything from a given year, says Allec of Money Done Right. “Generally, you can get rid of your pay stubs after you have double-checked them with your W-2s and ensured that they’re all equal,” Allec said. “ATM and deposit receipts can be shredded after you’ve double-checked them with your monthly bank statements.” There’s also no need to hang onto bills after you’ve paid them, except when they support a tax deduction or credit that you received, Allec says.
Determining When it’s Safe to Shred
While it sounds obvious, the three- or six-year period for maintaining supporting documentation for a tax return starts from the due date of the return, or from the date you filed the return if you filed it late, says Tim Yoder, tax and accounting analyst for FitSmallBusiness.com. “In other words, if a taxpayer extends his or her 2019 return until October 15, 2020, he or she must retain [their] records until October 15, 2026.”
Even When You Think It’s Safe to Toss It….
Even after the IRS statute of limitations has elapsed with regard to audits, you still might not be able to throw that documentation in the garbage bin or put it through the shredded yet. The IRS advises that “when your records are no longer needed for tax purposes, do not discard them until you check to see if you have to keep them longer for other purposes. For example, your insurance company or creditors may require you to keep them longer than the IRS does.” Let’s all share a collective sigh together now.