Think Twice Before Tossing: The Critical Timing for Disposing of Your Tax Records Safely

Think Twice Before Tossing The Critical Timing for Disposing of Your Tax Records SafelyArticle Highlights:

  • Why We Keep Records
    • Audit Defense
    • Amending Returns
    • Claiming Refunds
    • Tax Basis
  • Duration for Keeping Tax Records
    • Federal Statute of Limitations on Tax Refunds
    • Tax Return Omissions
    • Indefinite Retention
    • Financially Disabled
  • The Big Problem!
    • Stock Acquisition Data
    • Stock and Mutual Fund Statements
    • Tangible Property Purchase and Improvement Records
  • The 10-Year Statute of Limitations on Collections

You're undoubtedly wondering what old tax records may be thrown away now that your taxes for the previous year are finished and submitted. Like other taxpayers, you probably have old records that you are reluctant to discard. Knowing why the documents have to be retained in the first place can assist you decide what to do next. We often maintain "tax" records for a number of reasons:

Audit Defense Taxpayers must provide evidence to back up the statements they make on their returns in the case of an IRS audit. It is very difficult to argue against audit modifications without accurate documents.

Amending Returns Having thorough records facilitates the process and guarantees that all adjustments are correct in the event that taxpayers need to alter a return as a result of mistakes or missed deductions.

Refund Claims In order to support a refund claim, particularly one involving overpaid taxes, comprehensive documentation is required.

Tax Basis When capital assets, such as stock, business assets, rentals and other investments are disposed of it is necessary to determine for tax purposes if there was a gain or loss from the transaction. The tax basis is what the asset cost plus or minus adjustments such as the cost of improvements which increase the tax basis, depreciation (reduces basis), casualty losses, or tax credits which decrease the tax basis.

Duration for Keeping Tax Records

Generally speaking, tax records should be kept on file until the applicable tax return's statute of limitations has passed. The statute of limitations is the time frame within which the IRS may levy extra taxes or the taxpayer may modify their tax return to get a credit or refund.

Federal Tax Refund Statute of Limitations: The Internal Revenue Code establishes a series of guidelines known as the statute of limitations on tax refunds, which specify the amount of time a taxpayer has to file a claim for credit or refund for unpaid taxes. There are two major reasons for this statute:

  • It outlines the time frame within which a person must make a claim for a refund or an updated return following the filing of their first return or the payment of their taxes.
  • Based on a few requirements, it places restrictions on the total amount of refund or credit that may be requested.

Some states have longer statutes, typically 4 years, so they have more time to piggyback on any federal audits and adjustments.

Example: Sue filed her 2023 tax return before the due date of April 15, 2024. She will be able to safely dispose of most of her records after April 15, 2027. On the other hand, Don files his 2023 return on June 2, 2024. He needs to keep his records at least until June 2, 2027. In both cases, the taxpayers should keep their records a year or two longer if their states have a statute of limitations longer than three years. Note: If a due date falls on a Saturday, Sunday or holiday, the due date becomes the next business day.

Tax Return Omissions The IRS advises preserving records for six years in some circumstances, such as when a taxpayer fails to declare income that exceeds 25% of the gross income shown on the return.

Naturally, the statute of limitations doesn't start to run until a return is submitted. When a taxpayer submits a fake or fraudulent return in order to avoid paying taxes, there is no time restriction on the assessment period.

Indefinite Retention The IRS advises retaining property-related records for the duration that the property is owned and for a minimum of three years following the filing of the return that details the sale or other dispose of the property. This is essential for computing gains or losses on the property, as well as depreciation and amortization.

Financially DisabledIn addition, taxpayers who qualify as "financially disabled" have their deadlines for filing refund claims postponed. A physical or mental handicap that is medically determinable, anticipated to result in death, or that has lasted or is expected to persist for a continuous period of not less than 12 months renders a taxpayer financially incapacitated if they are unable to handle their financial affairs. Just one spouse must be financially incapacitated for the period to be suspended for a joint income tax return. Nevertheless, a taxpayer is not considered financially incapacitated for the duration of any time that their spouse or another person has the authority to act in their place with regard to financial affairs.

The Big Problem

Once the statue of limitations has passed, it becomes problematic to throw out documents arbitrarily for a specific year since many taxpayers combine their regular tax records with the documentation required to support the basis of capital assets like stocks, bonds, and real estate. Separating these information is necessary, and the basis records shouldn't be destroyed before the statute of limitations for the year the asset is sold ends. Therefore, keeping such data divided by asset makes more sense. Here are some instances of records that fit this description:

Stock Acquisition Information If you hold stock in a company, you should save your purchase documentation for a minimum of four years following the year of the stock's sale. To demonstrate how much profit (or loss) you made on the sale, you will need to provide this data. Additionally, you must retain the purchase and sale records for four years following the filing of the return on which the remaining loss is used up if the result of those sales and the sales of other capital assets results in a loss that you will be carrying forward to future tax returns if the loss exceeds $3,000 ($1,500 if filing as married separately).

Stock and Mutual Fund Statements A lot of taxpayers purchase additional shares of the same stock or fund using the dividends they earn from stocks or mutual funds. When the stock is eventually sold, the profits are offset by the sums reinvested, which increase the property's basis. After the last transaction, save the statements for a minimum of four years.

Purchase and Improvement Records for Tangible Property Maintain records for at least four years following the sale of the underlying property on purchases of residential, commercial, investment, or rental property, as well as any associated capital improvements.

Furthermore, you must retain all of the business's records attesting to income and expenses from the loss year for at least four years following the filing of the return on which the NOL deduction is exhausted if you are the owner of a business with a loss that results in a net operating loss (NOL) that you will be carrying forward to deduct in subsequent years.

The 10-Year Statute of Limitations on Collections

It's a common question, even though it has nothing to do with the article's theme: "How long does the IRS have to collect unpaid tax?" The IRS's ability to pursue the collection of a tax obligation is limited by the tax statute to ten years. The start of this statute of limitations is not the tax year for which the obligation was incurred, but rather the date the tax was assessed. It is essential that taxpayers comprehend this constraint for several reasons:

Collection Activities Tax liens, levies, and wage garnishments are just a few of the collection tools available to the IRS. Nevertheless, the 10-year statute of limitations applies to these actions.

Installment Agreements If a taxpayer has unpaid federal taxes and is unable to pay it all at once, they can work out an installment payment plan with the IRS. The ten-year statute does not expire in this situation. This implies that unless certain circumstances allow for an extension of the original 10-year timeframe, the IRS must collect the whole amount owing.

Do you have doubts about keeping some records? Please call our office before discarding those documents. When throwing away anything that you might need later, it is best to be certain.

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If you have any questions and would like to connect with a team member please call (704) 599-3355 or contact an advisor below.

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