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Federal
and State Tax Records Retention
How Long Is Long Enough?
By
Larry Tunnell, Cindy Seipel, and Ed Scribner
APRIL
2008 - Many taxpayers feel a sense of information—and paper—overload.
E-mail, junk mail, regular mail, voicemail, faxes, text messages,
and other communications make managing the information flow more
difficult. When
it comes to the records required to substantiate the information
submitted on income tax returns, identifying what to keep and how
long to keep it becomes a problem. If anything, record-keeping requirements
seem to be growing, as evidenced by the recently expanded requirements
for receipts supporting charitable contributions. Records of stock
transactions, retirement plan distributions, charitable contributions,
childcare expenses, partnership K-1s, and similar materials must
typically be kept for as long as taxpayers might need to produce
them to support tax return disclosures. While
many businesses opt to digitize documents and keep them indefinitely,
for many taxpayers this is impractical. All taxpayers, however,
would benefit from knowing the required holding periods, because
it would keep their tax records under control by indicating which
documents they can safely discard. The problem is that information
about these holding periods lies buried in various statutes and
is not easy to find, even when contacting the local tax office.
This article provides simple tables, based on federal and state
statutes, as guidance for retention of evidence supporting income
tax returns, both federal and state.
Federal
Income Tax Returns
With respect
to federal income tax returns, most taxpayers can safely keep
supporting records for five years. Assessment of federal income
tax by the IRS must generally occur within three years of the
later of the date that the return was actually filed or the unextended
due date of the return. This assessment period, combined with
the portion of the year that the taxpayer held the document prior
to the date the return was filed, would equal no more than five
years in most cases, even when a possible extension is included.
Suppose,
for example, that the taxpayer receives a fax on January 1, 2008,
that contains information necessary to support amounts on 2008
Form 1040, filed on March 9, 2009. The IRS would have until April
16, 2012 (April 15, 2012, falls on a Sunday), to audit the return.
If the taxpayer filed a six-month extension and did not file the
return until October 15, 2009, the IRS would have until October
15, 2012, to complete an audit. Under these circumstances, the
taxpayer would need to keep the fax for at least four years, nine
months, and 15 days to be sure it was available to support the
related item on the federal return.
Rather than
calculating the precise holding period, a more practical and convenient
approach is to have a general rule that is easy to remember and
easy to follow. In this case, it would be to discard every document
five years after it was issued. (Of course, evidence supporting
the tax basis of property should be retained until the statute
of limitations has run out on the return that reports the sale
of that property.) Then it would be necessary only to look at
the date on the document and determine if was generated more than
five years ago when deciding whether to dispose of the document.
If the IRS
cannot complete the audit by the deadline, it might ask the taxpayer
to grant an extension of the statute of limitations. Although
taxpayers are not required to grant such an extension, doing so
might be in their best interest because the IRS might otherwise
immediately assess a deficiency, in which case the taxpayer would
have to either settle or pay the tax. To obtain relief, the taxpayer
would then have to either take the case to the Tax Court or file
a claim for a refund.
A Form 1040
might be subject to audit for even longer periods under certain
circumstances. For example, if a taxpayer underreports gross income
by more than 25%, the statute of limitations extends to six years
from the date the tax return is filed. For filers of fraudulent
returns and for nonfilers, the statute of limitations runs indefinitely.
Exhibit
1 outlines the different statutory holding periods for federal
individual income tax returns with different characteristics.
It also indicates a possible general rule to be used with respect
to documents relating to each type of return. A general rule might
be more useful than the specific statute of limitations because
of the following:
- The ending
of the limitations period might differ for each taxable year
if the return was filed after the original due date;
- A general
rule (e.g., five years after receipt) is generally easier to
remember than the statute of limitations; and
- A general
rule can be easier to implement than calculating where a particular
document falls within the statute of limitations period.
State
Income Tax Returns
Unfortunately,
the rules in Exhibit 1 do not take into account all income tax–related
reasons for maintaining records. Most states have an income tax,
and many states have statutes of limitations that differ significantly
from the federal statute. Therefore, the authors searched the
statutes of the 50 states and the District of Columbia to compile
a summary of holding periods for various jurisdictions. Exhibit
2 outlines the applicable requirements.
Exhibit
2 indicates that the end of the limitations period for state
income tax purposes can vary by as much as two years from the
end of the period for federal income tax purposes. In fact, some
of the more populous states, such as California, Michigan, and
Ohio, have statutes of limitations that exceed the federal statute
by a full year. In addition to extending the period for such factors
as underreporting of income or filing a fraudulent return, most
states also extend the limitations period by one to two years
if there are changes to the federal return, either because of
an amended federal return or adjustments resulting from an IRS
audit.
Whatever
the underlying causes of the longer state limitation periods,
they underscore the need for taxpayers to use a more generous
rule when determining when to discard records, rather than adhering
strictly to the federal income tax statute of limitations.
Larry
Tunnell, PhD, CPA, is an associate professor of accounting
and head of the department of accounting and information systems;
Cindy Seipel, PhD, CPA, CFE, is an associate professor
of accounting; and
Ed Scribner, PhD, CPA, is a professor of accounting, all
at New Mexico State University, Las Cruces, N.M.
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