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The Ultimate Guide to Keeping Tax Records

Most of us are too worried to throw away our tax records but also too frustrated to keep them. Let’s face it – cupboards full of dusty documents you can’t make head or tail of can’t really come in handy! But you still have to keep at least some of these documents, so how do you go about handling all this?

In this article, we will discuss the following:

  1. How Long Should You Keep Tax Records?
  2. Which Documents Should You Keep Track of?
  3. How to Organize Your Tax Records
  4. How to Get Rid of Unnecessary Tax Records

If you have any questions about how to keep tax records, you’ll find the answers here.

How Long Should You Keep Tax Records?

In general, you must keep documenting proofs of your income, credit, or debit on your tax return until the limitation period for that tax return expires. Wondering what that means?

The period of limitation brackets the period in which you are allowed to amend your tax return to claim an extra credit or refund. It also happens to be the same period the IRS takes to assess your tax return. Keeping copies of your filed tax returns often helps in planning future tax returns or in case you go about amending your filed return.

Dealing with tax-related documents on your own can be a serious pain in the neck thanks to the complications it brings along. Here’s a list of services that can help with your taxes in the US:

  1. H&R Block
  2. Tax Group Center
  3. LibertyTax
  4. TaxAct
  5. com
  6. E-file.com
  7. FreeTaxUSA
  8. Visor
  9. com
  10. TaxSlayer

If you are in Canada, consider using TurboTax Canada or H&R Block Canada, Inc.

Going by the IRS modus operandi, if you’ve filed your tax return every year without a miss, and have reported all your income correctly, keeping tax records for as long as three years is good enough. But let’s look into this in more detail.

Period of Limitations on Income Tax Returns
  1. As per the IRS, you should keep records for 3 years if you:
    1. haven’t reported incorrect income and the correct income information records more than 25% of the gross income shown on your return.
    2. don’t file for returns
    3. file a fraudulent return
  2. If you file a claim for credit or return after filing annual returns, it’s necessary to show records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later.
  3. Keeping records for 7 years is a must if you file a claim for a loss from worthless securities or bad debt deduction.
  4. You must keep records for 6 years in case you have reported any erroneous income, and in actuality, your income is more than 25% of the gross income shown on your return.
  5. You have to keep records indefinitely if you don’t file a return.
  6. You have to keep records indefinitely if you file a fallacious return.
  7. You have to keep your employment tax records for a minimum of 4 years after the date that the tax is paid or becomes due, whichever is later.

The points above state the periods of limitations that apply to income tax returns as specified by the IRS. Unless stated otherwise, the time period refers to the time frame after the tax return was filed. For ease in calculations, the IRS adjusts the returns filed before the due date as filed on the due date.

Tax Records Regarding Property

To avoid any dispute or issues during an IRS audit, you should keep property-related records until the end of the period of limitations applicable from the year in which you dispose of the property. Disposing of the property means scraping off or decommissioning the asset due to ageing, performance or value changes, or changes in requirement capacity.

Keeping records will aid in figuring out any change in the initial cost of the property from the date you bought it. Any depreciation (reduction in the value over time), amortization (process of writing off the initial cost gradually), or any other gain or loss calculation when you sell the property is accounted for through this. In case you acquire property in a non-taxable exchange, you should always keep records on the old property as well as the new one until the limitation period exhausts for the year when you dispose of the new property.

Which Documents Should You Keep Track of?

Generally, you don’t have to keep every single piece of stamped paper for your records since you get an annual notice summarizing all the essential information. This is called the W-2. It is an annual consolidation of your paychecks. The IRS suggests that you should keep all the income proofs and the supporting documents showing credits or deductions you claim. The table below will give you a quick rundown of the tax records you should keep for a minimum of 3 years, given that you have been avoiding fraudulency and filing your returns every year.

Items Records
Income Form(s) W-2,

Form(s) 1099

Form(s) K-1

Expenses Purchase slips

Invoices

Receipts

Cancelled checks or other proof of payment

Annual bank statements

Property Closing statements

Purchase and sales invoices

Proof of payment

Insurance records

Investments Annual brokerage statements

Form(s) 1099

Form(s) 2439

Retirement accounts

 

Form 5498, Roth and traditional IRA contributions

Form 8606, nondeductible IRA contributions

Annual statements

401(k) and other company-sponsored plan statements

Form 1099-R distribution records

Health insurance

 

Form 1095-A, Health Insurance Marketplace Statement

Form 1095-B, Health Coverage

Form 1095-C, Employer-Provided Health Insurance Offer and Coverage

Time limit exceptions

 

If the IRS finds an error on your tax return, or perhaps you find an error, in either case, you will need your records to file an amended return. Sometimes you might even need the previous year’s tax record to fill out the current year’s. In case of a review, the IRS makes it a point to examine your accounts and bank statements to determine everything is reported correctly. But while doing so, the IRS asks for the proofs from the taxpayer. Having your records in place is the only way you can dodge complications in such a scenario.

How to Organize Your Tax Records

It really doesn’t matter how you organize your tax records, as long as you are able to find out the right piece of information when required. Going by the IRS, it suggests that taxpayers should sequentially arrange their records and make it a point to keep them in a safe enough place.

If you are looking for a rather step-by-step approach, we suggest that you make a tax file with multiple pockets in it and organize the documents in it by year. Don’t worry about further categorizing them, if you do, then that’s even better. Once you have the documents for each year, enclose them in envelopes and label them, such as the 2017 envelope has all the tax documents pertinent to the year, the 2018 envelope will have all the tax documents for 2018, and so on. Now, keep these labeled envelopes in your tax file sequentially.

For backup, make sure that you take a digital copy of all the tax documents and arrange it in a similar fashion (year on year) on your computer. It is always advisable to save the digital files to avoid risks of getting lost or stolen.

If you are an entrepreneur, we recommend you to use cloud accounting software or hire professional help to maintain clean records. One major advantage of having a clean accounting system or legitimate expense tracker is that you get to save a lot of money on your taxes. Downloading bank statements, utility bills, and uploading them in your drive/cloud is also a very helpful practice.

Also, you can use FreeTaxUSA to file your taxes digitally. This will automatically provide you with e-receipts. Until now FreeTaxUSA has filed 43 million tax returns with the IRS. As they say, do it right, do it free! And also have your records saved digitally.

How to Get Rid of Unnecessary Tax Records

Tax records contain sensitive data, such as your Social Security number/ ITIN, address, bank account numbers, property details, etc. And this vital information can be misused for innumerable purposes. That’s why disposing of your tax documents carefully is very important. Always use a paper shredder before trashing them in a dustbin. It is in your best interest to ensure that you don’t keep these documents open to public view.

Tips: The three-year statute of limitations applies under several terms and conditions. There have been many instances where the IRS called up people for more than 3-year-old returns. If the IRS doesn’t have a copy of your return, they are simply going to assume you didn’t file one. Post that, it’s your responsibility to produce all the documents proving you have filed one. Our suggestion – In today’s digital age, it won’t hurt us if we save tax records every year and corner it in a folder in our blue screens. Doing so can save us a lot of unwanted attention from the IRS.