Clients are always asking me how many years should they keep their tax records. This is a really great question and an important one that everyone should be aware of. There is much confusion about the rule and it’s because the rule is somewhat confusing. The general rule about how long to keep tax records is that it depends. No this isn’t just another lawyer answer, it really does depend. It depends on things like what type of record we are talking about. It also depends on your personal tax situation – are you aggressive on your return or are you conservative on your tax return? Maybe you fall somewhere in between.
Generally, one should keep their day-to-day tax records for at least 3 years. Day-to-day tax records include things like DMV vehicle registration, annual medical expenses, annual mortgage interest payments, W-2 and 1099 statements, etc.
However, a client should keep records related to capital assets for the life of the asset. For example, if you own a home and make improvements to it, and have the house for 30 years before you sell it, you should keep records of the improvements, purchase agreement, closing agreement, for at least 33 years! That’s right, you need to keep those records for the entire time you owned the home plus at least 3 years after you disposed of it.
There are some more complicated rules that could apply if you take aggressive positions on your tax return. For example, the IRS can audit you up to 6 years after you filed your tax return if you failed to report 25% of your gross income, which would constitute a “gross omission.” Also, if you are really aggressive the IRS could assert you committed fraud which would mean there is no time period limitation for the IRS to audit your tax return. In which case the IRS could go back forever to audit your return.
In a recent case, the IRS applied the 6 year limitation period against an individual who failed to disclose income. In this case, the individual did not disclose to the IRS a distribution he received from his employee stock ownership plan (ESOP), and so a six-year statute of limitations applied with regard to a deficiency notice sent more than three years, but less than six years, after the taxpayer filed his return. I have several clients who have ESOPs, which is sometimes used as a tax saving tool for people who have too much income.
In the recent case, the ESOP distributed its assets to its participants’ individual retirement accounts (IRAs). The ESOP did not timely file a Form 5500, Annual Return/Report of Employee Benefit Plan, for any of the relevant years, and the taxpayer did not include the distribution in income on his return for the year he received it.