Spring Cleaning: When Can You Purge Your Old Financial Records?

Apr 17, 2017Business, Business Tax

Are you feeling the urge to purge? Before you clear your filing cabinets of old financial records, it is crucial to make sure you won’t be caught empty-handed if an IRS auditor contacts you.

For Individuals

In general, you must keep records supporting items shown on your tax return until the statute of limitations runs out — generally, three years from the due date of the return or the date you filed, whichever is later. That means that now you can usually throw out records for the 2016 tax year, for which you filed a return in 2017.

In most cases, the IRS can audit your return for three years. You can also file an amended return on Form 1040X during this time if you missed a deduction, overlooked a credit or misreported income.

So, does that mean you are safe from an audit after three years? Not necessarily. There are some exceptions. For example, if the IRS has reason to believe your income was understated by 25 percent or more, the statute of limitations for an audit increases to six years. Or, if there is suspicion of fraud or you do not file a tax return at all, there is no time limit for the IRS to launch an inquiry.

Here are some basic guidelines for individuals:

  • Completed tax returns. Many tax advisors recommend you hold onto copies of your finished tax returns forever. Why? So you can prove to the IRS you filed. Even if you do not keep the returns indefinitely, you should hang onto them for at least six years after they are due or filed, whichever is later.
  • Backup records. Any written evidence supporting figures on your tax return, such as receipts, expense logs, bank notices, and sales records, should generally be kept for at least three years. Important note: There are some cases when taxpayers get more than the usual three years to file an amended return. You have up to seven years to take deductions for bad debts or worthless securities, so do not toss out records that could result in refund claims for those items.
  • Real estate records. Keep these for as long as you own the property, plus three years after you dispose of it and report the transaction on your tax return. Throughout ownership, keep records of the purchase, as well as receipts for home improvements, relevant insurance claims, and documents relating to refinancing. These help prove your adjusted basis in the home, which is needed to figure the taxable gain at the time of sale, or to support calculations for a rental property or home office deductions.
  • Securities. To accurately report taxable events involving stocks and bonds, you must maintain detailed records of purchases and sales. These records should include dates, quantities, prices, dividend reinvestment, and investment expenses, such as broker fees. Keep these records for as long as you own the investments, plus the statute of limitations on the relevant tax returns.
  • IRAs. The IRS requires you to keep copies of Forms 8606, 5498 and 1099-R until all the money is withdrawn from your IRAs. With the introduction of Roth IRAs, it’s more important than ever to hold onto all IRA records about contributions and withdrawals in case you are questioned. If an account is closed, treat IRA records with the same rules as securities. Do not dispose of any ownership documentation until the statute of limitations expires.

Issues affecting more than one year. Records supporting figures influencing multiple years, such as carryovers of charitable deductions, net operating loss carrybacks or carryforwards, or casualty losses, need to be saved until the deductions no longer affect, plus seven years, according to IRS instructions.

For Businesses

The record-retention guidelines are slightly different for businesses. Here are the basics:

  • Employee records. Keep personnel records for three years after an employee has been terminated. Also, maintain records that support employee earnings for at least four years. This timeframe should cover various state and federal requirements. However, do not throw away records that might involve unclaimed property, such as a final paycheck not claimed by a former employee. Timecards specifically must be kept for at least three years if your business engages in interstate commerce and is subject to the Fair Labor Standards Act. However, it’s a best practice for all companies to keep the files for several years in case questions arise.
  • Employment tax records. Keep four years from the date the tax was due or the date it was paid, whichever is longer.
  • Travel and entertainment records. For travel and transportation expenses supported by mileage logs and other receipts, keep supporting documents for the three-year statute of limitations.
  • Sales tax returns. State regulations vary. For example, New York generally requires sales tax records to be retained for three years, while California requires four years, and Arkansas, six. Your Smith Schafer professional can help you identify the rules for your state.
  • Business property. Records used to substantiate the cost and deductions (such as depreciation, amortization, and depletion) associated with business property must be maintained to determine the basis and gain (or loss) on the sale. Keep these for as long as you own the asset, plus seven years, according to IRS guidelines.

Proper Disposal Protocol

Regardless of whether you are tossing out personal or business financial documents, always shred them thoroughly first. Also, use proper disposal protocol for any computers and other electronic equipment (such as printers and copiers) that may contain financial data. Simply deleting files using File Manager is not enough. Unless you use proper disposal protocol, tech-savvy hackers may be able to recreate sensitive data from the device’s hard drive when it was thrown out, donated to a charity, or returned to the lessor after the lease term expired.

If you have any questions regarding financial records retention, click here to contact us. We look forward to speaking with you soon.

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