Tax ARTICLE - Cleaning Up Tax Records Can Help Fend Off an IRS Audit

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As summer rolled around, Mike and Beverly, a married couple with two young daughters, decided to finally get their house in order — literally. While the daughters set to sorting through their toys and books, and Mike hit the garage, Beverly began organizing the family’s financial records.

Not long into her work, however, Beverly began to get frustrated. Did they really need all these old tax returns? What about these piles of investment records? Before enduring another paper cut, she picked up the phone and called their financial advisor.

The advisor assured her that they could get rid of some of their tax-related documents. But her family would be best off keeping certain records for specified time periods. Knowing what to toss and what to keep is important because, in the event of an IRS audit, Beverly could really improve her chances of fending off the agency’s case by quickly producing the appropriate documentation.

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3 Easy Categories To organize tax-related documents

Beverly’s financial advisor recommended that she organize her tax-related documents into three easy categories:

1. Tax returns and supporting documents. The advisor suggested keeping their returns and supporting documentation (including W-2 forms) for at least seven years after a return was filed. Why? Under the statute of limitations, the IRS can audit their return or assess additional taxes for three years after the original or extended due date, if they filed on time — or, if the couple filed late, three years after the tax return’s filing date (which could be as long as three years and nine and a half months from the end of the tax year).

If they mistakenly understated their adjusted gross income by more than 25%, however, the IRS has six years from the due date of filing the tax return, including extensions, to audit their return and assess additional tax. Again, this period could end up being as long as six years and nine and a half months from the end of the tax year, which is why the recommended time frame for retention is seven years rather than six.

And, of course, if you fail to file a tax return or file a fraudulent one, there’s no statute of limitations.

2. Investment statements. The couple should retain trade confirmations and other investment records for at least three, and preferably seven, years after they file a return for the year in which they sold the stocks or other securities.

3. Property records. The advisor recommended keeping closing documents from a property’s purchase or sale, as well as receipts from any improvements made to the property or reflecting money invested in the property, for three years after the due date or extended due date of the tax return in which the sale or disposition of the property is noted.

They should extend this period to seven years if they ever mistakenly understate their adjusted gross income by more than 25%.

A Well-advised Effort

After speaking with her financial advisor, Beverly had a much clearer idea of how to organize her tax records. Plus, by cleaning them up during the lazy, hazy days of summer, she knew she’d be in much better shape come year end.

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