Out with the old?
Not so fast when it comes to disposing of tax records

During the COVID-19 pandemic, most people have spent a lot of time at home, inspiring many to clear out some of the clutter in their living spaces. If you’ve decided to tackle the boxes, bins or drawers full of paper files that have accumulated over the years, you may be wondering when it’s safe to dispose of tax records.

General rules

Generally, you should keep tax records — at a minimum — until the statute of limitations has expired. During that time, you can amend your return to claim a credit or refund (or correct an error) and the IRS can audit your return and assess additional taxes. In either case, it’s critical to retain all of your tax forms and supporting documentation, including receipts, canceled checks, and bank and brokerage statements.

When does the limitations period expire? As a general rule, it runs for three years from the date you timely file your return or the original due date, whichever is later. So, for example, if you filed your 2020 return on March 1, 2021, the limitations period expires on April 15, 2024. But if you applied for an extension and file your return on September 30, 2021, the limitations period expires on September 30, 2024.

Don’t get out the shredder just yet, though. In some cases, the statute of limitations stretches beyond three years. For example, it doubles to six years if you’ve understated your adjusted gross income by more than 25%, which doesn’t necessarily mean you failed to report items of income.

An understatement can also result if, for example, you overstate the basis of property sold, thereby underreporting your gain. Also, the IRS is never barred from auditing your return and assessing tax if you don’t file a return or if the IRS alleges that your return was fraudulent.

To be safe, it’s advisable to keep tax records for at least six years; indefinitely if you don’t file a return for a particular year or if you’ve taken any aggressive tax positions that the IRS might later characterize as inappropriate.

Exceptions for certain records

Special rules apply to certain types of records. For example, retain:

• Tax returns for at least six years, in case the IRS later claims that you failed to file a return.
• W-2s at least until you start receiving Social Security benefits, in case a question arises about your work record or earnings in a particular year.
• Real estate-related records until the limitations period (three or, preferably, six years) has expired for the tax year in which the property was sold. Original closing documents plus records of capital improvements over the years will help you substantiate your adjusted basis in the property and, therefore, the amount of gain on the sale.
• Investment records until the limitations period has expired for the year in which you disposed of the investments.
• Any relevant records that are related to retirement accounts until the limitations period has expired for the year in which you emptied an account.

Also, the IRS recommends that you retain records for at least seven years if you claim a loss for a bad debt or worthless securities.

Consider going paperless

Scanning original records and storing them on external hard drives, CD-ROMs or in the cloud can be a great way to declutter without destroying records. The IRS permits you to store tax records electronically, so long as they’re accurate and readily produced if needed. Your tax advisor can help you determine whether your electronic storage system meets IRS requirements.

Better safe than sorry

Before you dispose of any tax records, find out whether your state has document retention rules that differ from IRS requirements. And be sure you don’t need the records for non-tax purposes — requirements imposed by your insurance company or lender, for example.