Once you have gathered your tax-related records and filed the required returns, you may be inclined to dispose of some current and prior year tax information. However, you should be aware of the rules for retaining relevant tax records in the event that the IRS (or another taxing authority) wants you to produce those records during an audit.
Keep at Least Three Years
The following records are commonly used to substantiate a taxpayer’s income and expense items:
- Form(s) W-2
- Form(s) 1099
- Form(s) K-1
- Bank and brokerage statements
- Canceled checks or other proof of payment of deductible expenses
At a minimum, the above tax records should be kept for a three-year period following the date that you file your return (or its due date, if later). However, the IRS has a six-year time limit to initiate an audit on a return where income was grossly understated, yet no fraud was discovered. Therefore, retain the above documents for at least six years to better protect yourself in the event of an audit.
Similarly, you’ll want to keep investment sales records after you liquidate an investment. Documentation that substantiates the gain or loss on an investment should be kept for the period that you retain other tax documents supporting the return on which you report the sale.
Prior Year Tax Returns
It is a good idea to maintain one or more permanent files with important legal and personal documents, including those relating to taxes. Specifically, as a general rule, you should retain copies of your federal and state income tax returns (and any tax payments) indefinitely. For instance, the IRS (or another taxing authority) could claim that you never filed a particular year’s return. If that occurs, the IRS could assess taxes and penalties relating to the return in question. You will need a copy of your return to bolster your position that you actually filed the return.
It is an employer’s responsibility to keep accurate, up-to-date business records. Similar to the concern of an individual taxpayer, businesses—especially small businesses—need to be prepared for the possibility of an audit.
Employment Tax Records
Employment tax records must be maintained for at least four years after the later of the due date of the tax return or the date the tax is paid. The penalties for noncompliance can be harsh. These records should include the following information:
- Employer identification number (EIN)
- Amounts and dates of all wage, annuity and pension payments
- Amounts of tips reported
- The fair market value of in-kind wages paid
- Names, addresses, Social Security numbers and occupations of employees and recipients
- Employee copies of Forms W-2 that were returned as undeliverable
- Dates of employment
- Periods for which employees and recipients were paid while absent due to sickness or injury, and the amount and weekly rate of payments made to them by the employer or third-party payers
- Copies of employees’ and recipients’ income-tax withholding allowance certificates (Forms W-4, W-4P, W-4S, and W-4V)
- Dates and amounts of tax deposits
- Copies of returns filed
- Documentation for allocated tips
- Documentation for fringe benefits provided, including appropriate substantiation.
Pass-through Business Entities
If you are an owner in a subchapter S corporation, LLC, LLP or a limited partnership, you should retain a copy of the annual Form K-1 for as long as you own an interest in the entity plus four additional years. Also keep any paperwork related to the sale or other disposition of your interest for at least four years after the disposition.
Corporate Income Tax Returns
It is highly advisable that you retain copies of all corporate tax returns indefinitely.
Filing your tax returns on time is just one part of properly handling your taxes. Make sure you can defend yourself in the event of an audit by properly retaining your tax records.