Tax Records: What to Keep and for How Long?

Paying taxes, one of the joys of adulthood, can seem harrowing at first, but once you organize yourself, it becomes simpler. Learning what financial and tax records to keep and for how long helps you make the following year’s taxes easier to prepare and makes it a breeze if you get audited.

It also provides you an opportunity to examine your finances and determine how well your career or business has performed in juxtaposition to prior years. Your financial records review can provide you with an opportunity to cull papers you do not need, reduce clutter, and either pat yourself on the back for doing better or determine that you need to use new financial methods for better fiscal management and wealth building. There is nothing like the feeling of determining that you moved from one tax bracket into the next higher tax bracket.

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Choose an Organizational Method

Getting organized means choosing a tax management method and sticking to it. While you could color code file folders or use binders, the important thing is to stick with one method and use it to get organized and stay that way.

• You need to organize it by tax year.

• You also need to organize by form type within each year.

• Create a file for the current year first. Within that you need a file or section for tax filings, W-2 forms, 1099 forms if applicable, brokerage account statements, banking statements, etc.

• Also, consider folders or sections for business travel, charity donations, or major purchases you would use as deductions.

Keep the Forms for How Long?

You may have heard the edict that you should hold onto financial records for seven years. That is not a magical number. It only applies to certain records. You will have some financial and tax records that you keep for life, some for seven years, some for one or more years, and some for one year or less.

Unless you want to take up a significant amount of space in your home, you should obtain a safe deposit box for the paperwork kept in perpetuity and a small storage unit for the other papers. This lets you save things as you need to and make the Internal Revenue Service (IRS) happy if you get audited. The IRS likes paper.

Don’t laugh. They really do.

You probably thought, hey, I do not need a storage unit. I will simply scan every document and store it in the cloud or on a thumb drive. Um, no. No, you will not.

You want the IRS to be nice to you. If you get chosen for an audit, you need to make the examiner happy. This is not done with bribes or even fabulous herbal teas. (My favorite T-man, now retired, loves herbal tea.) You must make them happy with your files, filing system, and how obscenely honest you are. They like to see, touch, and feel receipts. If you deducted it, they want hard copy evidence. Always get a clearly printed receipt. Print out emailed receipts if you will deduct it.

Now that you know, let’s get to the fun stuff. Starting with the records you keep forever, here are your categories of records to keep:

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Perpetuity Tax Records

These items you place in a safe deposit box. Gather together your birth certificate and those of your immediate family, Social Security cards, and if applicable the death certificates of any of your immediate family, your marriage license, divorce decree, and military discharge paperwork. You should also store in the safe deposit box your insurance papers including defined-benefit plan documentation, your estate plan, last will and testament, life insurance policies as well as an inventory of the documents you store in the safe deposit box.

Seven Year Term Tax Records

The IRS and each state have a term of seven years in which to file for an audit. You need to maintain all of your tax records for at least seven years.

That does not mean you literally only keep your form 1040 or 1040EZ, etc. Nope. It means you keep a copy of the form and every schedule you completed plus every receipt, deposit form, brokerage account statement, bank statement, etc. that you used to file out the form. If you claimed it on the taxes, you need to keep the document that proves the deduction. Now, based upon this alone, you understand why I said you want a small storage unit.

If you just started working and you can file a 1040EZ form, you can just keep a folder in a drawer at your house. For any person reading this who has been out on their own for about a decade and has progressed in their career, or who owns their own business, you get it. Printed out, you file 1040 with numerous schedules. Your taxes by themselves take between 20 to 50 pages to print. Then you have the documentation. Gasp. One year could take up an entire file drawer once printed out.

At Least a One Year Term Tax Records

You need to keep all bonds, stocks, and mutual fund purchase confirmations. When you sell, you need to retain your sales confirmation. These documents help establish both the cost basis and the holding period.

Loan documents also need to remain in your files for the duration of the loan. That typically will have a longer duration of more than one year. Until you make that last payment, keep the loan paperwork. If you own a vehicle, keep the title until you sell the vehicle.

Keep for Less Than One Year Tax Records

Think of this as your rotating file. Your monthly statements go in this file as do your ATM slips, bank-deposit slips, and credit card receipts. You can either throw them away after shredding them or store them in long-term storage once you have reconciled them with the monthly statements. Also, keep insurance policies and investment statements until the updated documents arrive.

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Exceptions to the Length of File Retention

That all sounds pretty straightforward, doesn’t it? Some records you keep seven years, others more than one, but less than seven, some less than one. A very few records you keep forever.

You know, the IRS has to have its exceptions. No need to laugh. I am serious.

These exceptions apply in very specific circumstances and result in you keeping the records for three years, six years, seven years, or indefinitely. Ah. Here goes…

Three Years

This applies if you claim a refund or a credit when you file your federal income tax return. From the date you file the original (not amended) return or you paid the tax due, whichever is later, you keep all tax records including the tax returns. This means if you file a tax extension you need to save the extension form, too.

Six Years

I can hear people laughing as they read this, but this category exists because the IRS catches so many people trying to cheat on their taxes. You know how the US government took down one of the baddest assed criminals of modern times, Al Capone, right? Tax evasion prosecution.

That’s right. The guy who ran the Chicago Outfit as that city’s branch of the Italian mafia was called went down due to not paying his taxes. He supplied the liquor during Prohibition for one-third of the US or more. He and his siblings ran, not just Chicago, but the entire central US. No speakeasy (an illegal bar for those who aren’t history buffs) served booze in the early 1900s unless they got it from the Capone brothers.

One of the toughest to catch ever went down because the IRS prosecuted him successfully. It also went down in history as the first time the IRS and Federal Bureau of Investigation worked together on a case.

With that preface, here is the list of things to keep. If you do not report income that you should have reported, you need to keep the records for it as long as it would result in more than 25 percent of the gross income you did report on your return.

Seven Years

This applies if you file a claim for a loss for one of two reasons – a bad debt deduction or worthless securities.

Indefinitely/Perpetuity

If you do not file a tax return or you fraudulently file a tax return, knowingly, keep your records in your safe deposit box in the forever file. You might question the need to keep these files since you might not have reported taxes at all. You need them because the IRS can investigate you for tax evasion and you need to prove why you did not file taxes. The only reason to not file is you did not make enough money to require filing taxes. You have to prove this. If you defrauded the IRS on purpose, you need receipts to show that you could have reported expenses that could count as the deductions to show you did not really defraud them.

Besides the files you keep in perpetuity in a safe deposit box, you also need to keep the at-home files in a safe place. If you have few records to store, choose a fireproof safe or password-protected lockbox. If you have a large number of files, choose a fireproof file cabinet. Store everything that does not go in the permanent storage of the safe deposit box. You can store electronic files on a thumb drive in the file cabinet, then print them as needed, if you ever have to go in for an audit. Backup those files to an encrypted cloud service, so you can have an extra copy that you could access from anywhere.

Tax Tips: Where to Find More Specific Information

You can visit the IRS website for more specific information. This is a great idea to do at least annually. When you file your income tax returns, check the web site. The IRS updates its rules every year. That means that as I write this on November 8, 2020, the rules for what to keep and for how long to keep it could change in a few months or by the time we all file taxes again in April of 2021. It is a smart idea to keep on top of these updates to the law by visiting the rulemaking site.

After seven years, it is a great idea to scan the documents and move them to a cloud server or thumb drive. While you do not have to keep your tax records forever and ever, you may find it helpful when applying for loans or presenting to venture capitalists or angel investors. The electronic files will take up very little space and provide important information for you.