From the Desk of C.G. Johnson & Company:
I subscribe to a few experts that prepare information for us to share with our client base. Their articles are clear, concise and most important, reliable. I get calls all the time from my clients and people just calling for this information. “What do I do with all of the boxes of records that I have, going back some 20 years?”. To lighten up your storage and to better help you with retention issues, I am sharing with you, this article It was originally published this April. Please feel free to reach out to me. I’m here to help!
Statute of Limitations for Tax Records
The “statute of limitations” refers to the period of time when you and the IRS can make changes to
your tax return
Most taxpayers think of the limitation periods as the time frames during which the IRS can audit returns. The periods for change by you and the IRS are laid out in IRS publications, and those
1. Three years if you filed on time or with extensions and did not understate your income by 25 percent
or more and did not file a fraudulent return
2. Six years if you filed on time or with extensions but understated your income by more than 25
· Forever, no limit, if you filed a fraudulent return
· Forever, no limit, if you did not file a return
3. Three years after filing or two years after the tax was paid if you filed an amended return or
other change to your original return, such as a quick claim for refund.
4. · Seven years if you filed a claim for a loss from worthless securities or a bad-debt deduction
5. If you have employees, you must keep your employment tax records for four years after the date the
payroll taxes were paid or due, whichever is later.2
How Long to Keep Records
If your returns are examined, you need tax records that prove your deductions. This means you need to keep your records for longer than you might think.
Assets. Assets such as your car, desk, computer, and office building are relevant to your tax
return during their depreciable class lives.
· If you are depreciating the assets, the depreciation shows up in those returns.
. If you used Section 179 to expense the assets, then you have potential recapture during the depreciable class life.
You buy a $1,500 desk and depreciate it over the seven-year MACRS life (this takes eight years). In year eight, you still have to prove the depreciation. That means you need the original purchase record in year eight. Yo also need the original purchase record in year 11 to meet the
three-year statute of limitations during which this eighth-year deduction is subject to audit.
If you used Section 179 expensing on the desk in the example above, your records requirement is identical to the example. You have recapture exposure during the eight years, and you need to hold on to your proof of purchase for three years beyond that, or 11 years in total.
Make this easy. For any asset that has a life of more than one year, keep the purchase records in a
separate permanent file. With a separate permanent file of asset purchases, you don’t have to think or worry about class lives or limitation periods.
The five-drawer method. To use the five-drawer method, you need to keep your permanent files in
another place (such as a different set of file drawers). Next, you must report your income and file
and pay your taxes on time or with extensions to limit your audit exposure to three years from the
date you filed your return. If you fit this profile, the five-drawer system can simplify your
records retention. It works like this:
· Drawer 1: Accumulation of current year tax return information
· Drawer 2: Last year (tax return filed this year, say on April 15)
· Drawer 3: Two years ago
· Drawer 4: Three years ago
· Drawer 5: Four years ago
At the beginning of each year, the contents of drawer 5 go to the dump and all drawers move down
Employment taxes. If you have employees, you must keep all employment tax records for at least four years after the date the tax becomes due or is paid, whichever is later. Again, simplify. If you have employees, use a six- drawer method. Toss the sixth drawer when your four-year statute of limitation.
Thoughts That Make Keeping Records More Pleasant
Think of your business records in the way you think of golf handicaps and batting averages. The business record should tell you where your business is at and what you need to do to continue improving.
The fact that the tax law requires the records is another incentive to keep them. But really, if no
tax law existed, a businessperson you would want records that show you where you have been and
help you get to where you way to go.
1 IRS Pub. 583, Starting a Business and Keeping Records (Rev. December 2011), Dated Feb. 17,
2012, p 12.