Should Clients Ditch or Keep Tax Return Records?

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By Ken Berry

Now that the tax return season is over – at least for those filers who didn't request extensions – invariably, some of your clients will ask you this question: How long do I need to keep copies of my tax return? The answer: A minimum of three years, but maybe longer, especially if you're risk-aversive.

"Because the statute of limitations is three years, you have to keep tax records at least that long", says James Wood, CPA, a sole practitioner in Hillsborough, New Jersey. "However, if there is fraud, or an allegation of fraud, there is no statute of limitations."  

This means that the IRS has three years to review the situation and assess any tax deficiencies. Once the three years are up, the taxpayer is generally in the clear, so there's usually no pressing need to hold on to the records longer. But the three-year period is extended to six years if gross income is understated by more than 25 percent. And, for tax cheats, returns can be challenged at any time.

If your clients are hoping to remove some of the clutter around the house, they can dump their cumbersome tax records once the statute of limitation lapses. But human nature being what it is, many clients will be inclined to hold on to them longer. Wood says ten years is normal.

Although most tax return preparers now file returns electronically on behalf of clients, the new technology isn't much of a factor, according to Wood. He notes that the IRS doesn't keep images of tax returns, so it's better for clients to rely on their independent records in case of inquiries. Also, he says it saves time and hassle for clients to use their own records.

If a client asks Wood for a digital copy of a return, he can meet the request, within limits. "The tax software only allows you to retain ten years of active files", he claims. "As a practical matter, we hang on to ten years of data." 

Of course, clients should be encouraged to sift through their tax-related documents and shred paperwork that's no longer needed, like W-2s and 1099s from days of yore. But they might want to keep other documents – for example, records showing basis adjustments in a home – that remain relevant.  And even though basis reporting rules for investments now require financial institutions to provide the vital information for new acquisitions, clients should continue to retain the necessary records for older investments.

The bottom line: The length of time you should hold on to tax records depends on the individual. "Five years is a reasonable time for most clients", says Wood. "But if you're superconservative, you might hold them forever."

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