Keeping track of financial records is crucial for any business owner or entrepreneur looking to maximize income and forge strategic partnerships. How Long Should You Keep Your Income Tax Returns? Generally, you should keep records that support an item of income, deduction, or credit shown on your tax return until the period of limitations for that tax return runs out, but let’s break that down into details so you know what to do.
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1. Understanding the Basic Retention Rule for Income Tax Returns
The bedrock of responsible tax management is knowing how long to hold onto your tax documents.
1.1 What’s the 3-Year Rule?
Generally, the IRS requires you to keep records for three years from the date you filed your original return or two years from the date you paid the tax, whichever is later, if you file a claim for credit or refund after you file your return. This applies if situations involving worthless securities, bad debt deductions, unreported income exceeding 25% of gross income, failure to file, or fraudulent returns do not apply to you.
1.2 Why Three Years?
This period aligns with the IRS’s ability to audit your return or for you to amend it. Keeping your records organized during this period ensures that you can substantiate any claims made on your return if the IRS comes knocking.
2. Exceptions to the 3-Year Rule
While the three-year rule is a good starting point, it’s not a one-size-fits-all solution. Here’s when you need to hold onto your records for longer.
2.1 Claiming a Loss from Worthless Securities or Bad Debt Deduction
If you file a claim for a loss from worthless securities or a bad debt deduction, you’ll need to keep records for seven years. This is because these types of claims often require more extensive documentation and may be subject to closer scrutiny by the IRS.
2.2 Substantial Omission of Income
If you fail to report income that you should report, and it is more than 25% of the gross income shown on your return, the IRS gets six years to assess additional tax. So, keep your records accordingly.
2.3 No Return Filed
Did you forget to file a return? If you don’t file a return, you need to keep records indefinitely. There is no statute of limitations on unfiled returns, so the IRS can assess tax at any time.
2.4 Filing a Fraudulent Return
This is a big one. If you file a fraudulent return, you must keep records indefinitely. The IRS can pursue a fraudulent return at any time, so it’s best to keep all related documentation indefinitely.
3. Special Cases: Property Records
When it comes to property, the rules change slightly.
3.1 How Long to Keep Property Records
Generally, you should keep records relating to property until the period of limitations expires for the year in which you dispose of the property. These records are essential for calculating depreciation, amortization, or depletion deductions and for determining the gain or loss when you sell or otherwise dispose of the property.
3.2 Nontaxable Exchanges
If you received property in a nontaxable exchange, your basis in that property is the same as the basis of the property you gave up, increased by any money you paid. Keep records on the old property, as well as on the new property, until the period of limitations expires for the year in which you dispose of the new property.
