I've been trying to find some extra space in my house lately, so this seems like a good time to think about which tax records I can safely dispose of and which ones I ought to keep around in case the IRS wants to ask me some questions about my tax returns.
At a minimum, I've always been told to save everything for three years. That statement sounds innocuous enough, but what constitutes "everything" and when do I start counting to determine "three years?"
Three years means three years from the date on which you filed your tax return, or April 15, whichever is later. So if you filed your 1997 tax return on March 18, 1998, you should hold on to the related receipts until April 15, 2001. If you filed after April 15, on July 10, for example, save your receipts until July 10, 2001.
The reason you wait for three years before you begin weeding out the excess paper in your desk drawers is that the IRS has three years to make a decision about examining your tax return. If you haven't heard from them after three years has passed, it probably means you won't hear from them at all. The exception to this rule occurs if you filed a fraudulent return or made some intentional errors or omissions. If you did this and the IRS catches on, they can call you in for an audit even after the three years has passed. So if you plan to play Russian Roulette with the IRS, hang on to your receipts forever.
The records that should be saved for three years include all receipts that support the numbers in your tax return. This includes W-2 forms, 1099 forms for interest and dividend income, K-1s, receipts for charitable deductions, year-end mortgage statement, and anything else that you think will help convince the IRS that the amounts you claim as income and expenses on your tax return are legitimate.
I save bank statements and cancelled checks for three years, as well as any year-end pay stubs that support the amounts recorded on a W-2 form (even though that may be redundant). In addition, as a self-employed person, I keep an income statement summarizing my business income and expenses for the year, support for any deductions I've claimed in my business, and the 1099 forms provided by the kind people who pay me.
If you own rental property, you will want to keep records of the rents received (bank deposit slips and bank statements are excellent supporting documents for this type of income), as well as receipts for the expenses you incurred.
People who deal with stock brokers or who own shares in mutual funds should keep their year-end broker statements, as well as any statements you received during the year that show purchases and sales of stocks or shares in mutual funds.
Three years isn't enough
Sometimes you should hold on to your receipts for longer than three years. If there is any deduction that is being carried forward into your tax return from years gone by, you will want to hang on to the receipts that support that deduction.
For example, if you took a beating in the stock market in 1987 and are still carrying forward the loss (because you are limited to a deduction of $3,000 net capital loss per year), you should keep the receipts that generated that loss until three years after the last year in which the loss appears on your tax return. If you use up the last of that loss on your 1998 tax return, keep the receipts that show how much you lost until 2002.
If you own the house you live in, you should hang on to the original purchase documents for that house at least until three years after you sell the house. Even though the tax law has relaxed considerably with regard to the tax treatment on the sale of a personal residence, there are situations when you may need to reproduce the closing statement from the purchase of the house (as well as the subsequent sale).
For example, if at some point you begin doing business from your home and want to take a depreciation deduction on a home office, you will need support for the cost of the house. And some gains from house sales are still taxable, even under the new law.
Some Records Keep Playing Forever
Long after I've discarded the receipts that support my old tax returns, I still keep copies of the actual tax returns I filed from years gone by. Partly to provide historical perspective on how my financial life has changed over the years, and partly out of inertia (and because I don't seem to need the space in that particular drawer yet), I continue to save tax returns going back to my college days.
Sometimes it's hard to part with old documents, the first W-2 form I ever received might be an interesting item to frame, or at least a worthy addition to my scrap book. But I think it's time to discard the boxes of cancelled checks from 1983. I need to make room for the next century