The IRS and most states have a three year statute of limitations for conducting an audit and issuing refunds. Most taxpayers keep records in case they are selected for an audit. But what is considered to be the appropriate length of time for retaining personal records, and which records are essential to keep?
Understanding the statute of limitations for tax returns
Under the three-year statute of limitations, the IRS and state taxing authorities are barred from conducting any audit once the three-year period has elapsed. If a taxpayer files a personal income tax return before the April 15th due date, the statute of limitations period begins on April 15th of that year. For example, if a taxpayer filed a 2011 Form 1040 on February 22, 2012, the statute of limitations began on April 15, 2012 and expires on April 15, 2015. If a taxpayer filed a personal income tax return on extension, the statute of limitations period begins on the date the extended tax return was filed. Thus, taxpayers who filed their 2011 income tax return on the extended due date of October 15, 2012 can still be subjected to an audit since the statute of limitations expires on October 15, 2015.
Amended income tax returns follow the same statute of limitations. For instance, if a taxpayer forgot to deduct real estate taxes for a particular year, an amended Federal income tax return (Form 1040X) can be filed to request a refund as long as the statute of limitations has not expired.
Lastly, there is one very important rule to take note of regarding the statute of limitations. If a taxpayer fails to file a personal income tax return within three years of the due date, they risk forfeiture of any refunds that they may have otherwise been entitled to.
Exceptions to the statute
Exceptions to the three-year limitation do exist. If the IRS determines that gross income in excess of 25% of the gross income reported on a tax return was omitted, the three-year statute of limitations extends to six years. To illustrate, if gross income of $400,000 was reported on a return but the IRS determined that $175,000 of income was omitted, the taxpayer would face a six-year statute of limitations.
In some cases, the statute of limitations does not apply at all. If a taxpayer does not file an income tax return, or if a fraudulent return is filed, there is no statute of limitations.
Keeping records
Every taxpayer should retain bank statements for at least three years after filing their income tax returns. During an audit, the IRS will often request all bank statements to search for unreported income. In addition, any tax documents that relate to the tax return, such as W-2 forms, 1099 forms, Schedule K-1’s, Form 1098 reporting mortgage interest, charitable contribution acknowledgement letters, and real estate tax bills should be retained for at least three years. As a guide, most taxpayers can now discard their records for the years 2010 and earlier if they wish.
There are some tax records that should never be discarded. These include, but are not limited to, prior year tax returns and the closing statements on the purchase of real estate. But many taxpayers do retain records unnecessarily. For example, if an individual did not claim a home office deduction, there is no reason to retain a year’s worth of utility bills. Also, if purchases using a credit card did not factor into a tax deduction, there is no reason to retain the credit card statements.
One man’s trash….
Careful record-keeping should go hand-in-hand with carefully discarding any records that may contain sensitive personal information. In today’s environment, identity theft is rampant. Identity thieves are known to rummage through trash in search of another person’s personal information. Any documents containing social security numbers, credit card numbers, bank statements, PIN numbers, and other personal and financial information should be properly destroyed when they are being discarded.
Neil Becourtney, CPA
CohnReznick LLP
