Tax record keeping tips and the statute of limitations on IRS audits

May 16, 2012

I can't watch Hoarders.

First, those people are scary. And their houses are gross.

But I also avoid the show because I am a bit of a pack rat and I don't want to be reminded of what could happen if I go over the "it could be useful one day" edge.

That said, when it comes to taxes there are some documents you need to keep.

Stacks of documents from Hoaders A&E TV

Some only need to be stored for just a few years. A few, however, you should hang onto forever.

Determining which tax material falls into what category is today's Weekly Tax Tip.

Atop the list of tax record-keeping tips is to hold onto substantiating material until the chance of audit passes.

That generally is three years.

  If you …

Then the limitation period is …

1

Owe additional tax and instances 2, 3 and 4 below do not apply to you

Three (3) years

2

Do not report income that you should and it is more than 25 percent of the gross income shown on your return

Six (6) years

3 File a fraudulent return

No Limit

4 Do not file a return

No Limit

5

File a claim for credit or refund after you filed your return

The later of
three (3) years or two (2) years after tax was paid
6

File a claim for a loss from worthless securities

Seven (7) years

Source: IRS Publication 552, Recordkeeping for Individuals

High Court concurs: In fact, the U.S. Supreme Court ruled in April that the Internal Revenue Service took too much time to try to collect back taxes from a business, Home Concrete, in a tax shelter case.

The decision, say tax watchers, has a wider impact for dozens of related cases.

The IRS had wanted to use the extended, six-year statute of limitations period that's allowed because, argued the tax agency, the Home Concrete had understated its adjusted gross income by more than 25 percent.

But the High Court, in a 5-to-4 ruling, said that Home Concrete's gain from the sale of an asset was shown on the firm's tax return, so the six-year period wasn't triggered.

The Home Concrete case dealt with a specific tax shelter, Son of Boss, an acronym for bond and option sales strategies, that were created in the late 1990s and which soon became an IRS target.

Obviously others who employed this strategy and who are facing IRS investigation are the prime beneficiaries of the Supreme Court ruling.

But in a larger view, the decision is huge, reinforcing that the standard three-year statute of limitations for IRS assessments is plenty of time to act.

Be ready if IRS asks: If, however, the IRS does have some questions about your filing within the three-year window (or later if other circumstances apply), here are some ways via documentation to be ready.

For income verification purposes, keep copies of W-2 forms, alimony payments received, all types of 1099s (MISC, DIV, INT), gambling winnings, bank statements, brokerage statements and K-1 forms.

When it comes to expenses and deductions, hang onto receipts, sales slips, invoices, canceled checks, credit card statements, alimony payments made, gambling losses and written statements from charities.

You should keep residential records for as long as you own the property. These include closing statements, purchase and sales invoices, proof of payment, insurance records, property tax assessments and payments, receipts and documents related to casualty and/or theft losses and receipts for improvement costs.

Similarly, hold onto investment documentation until you sell the asset, including brokerage statements, mutual fund statements, 1099 and 2439 forms.

And keep forever a copy of each year's tax return that you file. You can get rid of the back-up material once the statute of limitation passes, but you should always have a copy of every Form 1040 and associated schedules that you file easily accessible.

Remember, you can digitize your tax (and other) records. This will save you a lot of storage space.

Just be sure back up the electronic tax records and keep a separate copy in a safe place in case something happens to the original.

You also might find these items of interest:

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