Tax Tips
Record Retention Policy - May 2002
Richard Scrivanich - Partner
Many clients ask how long they should keep their records. The following is a general guideline for you to use. If you have specific situations not discussed here, you should consult with us regarding that situation. Records may have to be produced if the Internal Revenue Service (or a state or local taxing authority) were to audit your return or seek to assess or collect a tax. In addition, lenders or other private parties may require that you produce copies of your tax returns as a condition to lending money, approving a purchase, or otherwise doing business with you.
Keep returns indefinitely and the supporting records usually for six years.
In general, except in cases of fraud or substantial understatements of income, the IRS can only assess tax for a year within three years after the return for that year was filed (or, if later, three years after the return was due). For example, if you filed your 1999 individual income tax return by its original due date of April 15, 2000, IRS would have until April 15, 2003 to assess a tax deficiency against you. If you filed your return late, IRS generally would have three years from the date you filed the return to assess a deficiency.
The problem with the three-year rule is that the assessment period is extended to six years if more than 25% of gross income is omitted from a return. In addition, the assessment period does not begin to run until a return if filed. Therefore, if the IRS claims that you never filed a return for a particular year, it can assess tax for that year at any time (even beyond three or six years), unless you can prove that you did file. Proving that you filed would, of course, be impossible after you have discarded your returns. You should also keep your certified receipts or other proof-of-mailings.
While it's impossible to be completely sure that the IRS will not at some point seek to assess tax, retaining tax returns indefinitely and important records for six years after the return is filed should, as practical matter, be adequate.
Records relating to property may have to be kept longer.
Keep in mind that the tax consequences of a transaction that occurs in one year may depend on things that happened in earlier years-and that the period for which you should retain records must be measured from the year in which the tax consequences actually occur. This may be significant, for example, where you sell property that you bought years earlier.
For example, suppose you bought your home in 1980 for $100,000 and made an additional $20,000 of capital improvements in 1988. To determine the tax consequences of the sale, it's necessary to know your basis (i.e., original cost plus later capital improvements). For example, if you sell your home in 2002, and your return for that year is audited, you may have to produce records relating to the purchase in 1980 and the capital improvement in 1988 to be able to show what your basis is. Therefore, those records should be kept for at least six years after your 2002 return has been filed instead of just six years after the transactions they related occurred. (Even though as much as $250,000 of home sale gain can now escape tax (up to $500,000 for joint return filers), you should still retain all records relating to home purchases and improvements. There's no telling how much the home will be worth when it's sold, and there's no guarantee that the home sale exclusion will still be available when the future sale takes place.
When new property takes the basis of old property, records relating to the old property should be kept until six years after the sale of the new property is reported. For example, suppose you purchased a car for business use in 1999 and you traded it in on a new car for business use in 2002. If you sell the new car in 2003, your basis in the new car will determine whether you have a tax gain or a tax loss on the sale, and your basis in the new car is determined, at least in part, by your basis in the car you traded in during 2002. Accordingly, records relating to your old car should be kept until 2010 (i.e., for six years after you 2003 return is filed).
Similar considerations apply to other property which is likely to be purchased and sold-for example, stock in a business corporation or in a mutual fund, bonds (or other debt securities), etc. In particular, remember that if you reinvest dividends to purchase additional shares of stock, each reinvestment is a separate purchase of stock, and the records of each reinvestment should be kept for at least six years after the return is filed for the year in which the stock is sold.
Because the calculation of the casualty and theft loss deduction is determined in part by your basis in the damaged or stolen property, you'll need to have records to support that basis, until six years after you file the return claiming the loss deduction.
If you have any questions concerning record retention, or any other tax, accounting, or business matter that you would like to discuss, please give me a call at (562) 698-9891.
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