Many small business owners ask: "How long should I keep tax returns and related financial records?" You may hear conflicting advice on this subject. So what do accountants advise?
The short answer: seven years.
The longer answer: as long as you and your financial advisor agree that you need them.
Here, we delve into IRS guidelines and other factors that affect how long you should keep business tax returns.
The IRS sets some basic standards for retaining tax records. You may hear that three years is the finish line for when you can ditch those tax returns. This general guideline hinges on the fact that the IRS can only audit someone up to three years back. The IRS requires that you keep business tax returns and all supporting documentation for three years. Remember, even if you’ve completed your returns flawlessly, the IRS can select your return for audit based on a formula they use.
Three years is not always enough, however. The IRS can actually go back further in response to a significant error. For example, if you fail to report more than 25 percent of your business’ gross income, the IRS can request records going back six years. If you claim a deduction for a bad debt or worthless security, hang onto those records for seven years. In fact, seven years should be the minimum time you retain business tax records.
In the days of digital record keeping, there’s no reason not to keep your business tax returns permanently. It’s good to know you can refer to them if you ever need information for future or amended returns.
While we certainly hope that all our clients have been above board and dutiful in their tax filings, it’s good to know that there is no statute of limitations on fraudulent or unfiled returns. If you have done anything dishonest, or not filed a return at all, the IRS can come knocking at any time in the future.
You should also note that it’s up to you to prove that you did file a return in a past year. If the IRS doesn’t have a copy of a particular tax return from you, and they need to reference it, they will assume you didn’t file it. You should always have your own copies.
If you file electronically, always keep a record of any email confirmation along with the return itself. And, if you sent it via USPS, you could be asked for proof that they actually delivered it. If you mail your tax return, request a signed certified mail receipt.
In the case of an audit or disagreement, the IRS accepts digital copies of documents as long as they’re identical to the originals. So, to save space, many people choose to keep only digital tax records. Keep in mind, however, that computers crash, hard drives fry, and occasionally, hackers hack. To be safe, keep hard copies of tax records--at least for those critical first three years.
When storing digital records, keep them in a secure location protected by a password, and backed up on a separate drive that you guard equally well. A thumb drive stored in a fireproof safe should suffice. When you dispose of the paper versions, make sure you shred them in accordance with good security practices.
Tax returns tend to bring with them a lot of other records and documents. Should you keep these, too? The IRS states, “Generally, you must keep your records that support an item of income, deduction or credit shown on your tax return until the period of limitations for that tax return runs out.”
The period of limitation is the time--counting from the due date or the filing date, whichever was later--in which you could amend your return or in which the IRS might decide to revisit it. As discussed above, this typically lasts no more than seven years. Stick with the full seven years especially if you filed for a deduction for a bad debt or worthless security.
It’s a good idea to keep records of any expenses you deduct for as long as you keep the return. You can scan them electronically to save space. Typically, expenses under $75, or transportation and lodging expenses, do not require a receipt. So, even if you keep these until you file, you can probably shred them once you submit the return.
If you buy or sell property, keep those records until the period of limitations ends for the year of the transaction. These records usually include deeds, titles, and receipts for equipment or vehicles. You need these records to calculate depreciation, amortization, or depletion deduction. If you received property in a nontaxable exchange, keep the records on the old property, as well as on the new property, until the period of limitations expires for the year in which you sell the latter.
Go ahead and keep annual business financial statements, bank statements, and credit card statements for seven years as well, if they’re related to your taxes. If they’re not tax-related, it’s generally safe to dispose of the bank and credit card records after a year.
If you have specific questions about how to manage financial documents for your business, talk to a financial advisor. Here at BAAP CPAs, we want to give you the peace of mind that you’re making the best choices for your unique situation all throughout the year.