Records Retention &
Taxpayer Responsibilities

IRS typically has three years to audit tax returns. But it is six years if IRS suspects that the return understates income by more than 25%. There is no statute of limitations if tax fraud is involved or if the tax return was not filed.

What Tax Records to Keep and For How Long:
The general rule under federal income tax regulations requires you to keep your records so long as they may be material to administration of the income tax law.

Income Tax Returns: Keep all federal and state income tax returns permanently along with copy of and forms W-2 and 1099-MISC for compensation earned.

Income Tax Return Related Items: Keep all federal and state income tax return supporting documents (i.e., those items confirming your income and/or deductions) for a minimum of three years after the return’s filing date. The more prudent route is to keep these returns and documents for six years. Why? The IRS can assess additional taxes within three years of its filing date, but has up to six years in which to make a tax assessment if the IRS determines that a substantial amount of income has been omitted from the return. In certain cases, including when fraud is suspected, the IRS can go back even further.

Property Taxes: The Statute Of Limitations on personal property taxes are fifteen (15) years of more after the due date of the tax. The sale of long-ago forgotten tax liens on personal property you no longer own, or real property you still own can come back to haunt you a decade later unless you have canceled checks and stamp receipted tax bills to prove that you already paid.

Mailing Receipts: Keep with your file copy of each tax return the U.S. Postal Service receipt — i.e., the registered mail receipt –showing the date the return was mailed. If your return is filed electronically, keep a copy of the electronic filing confirmation with a printed copy of the return. In the event the return is misplaced or lost, this documentation will save you from penalties.

Residential Property Records: Keep settlement records from all of your home purchases and sales in a safe place. This will help you determine basis for any future sale and gain determination. In addition, keep records of the amounts that you spend for home improvements with this file. These records will provide documentation of your basis in the house if and when it comes time to compute your taxable gain.

Stock and Bond Records: Keep records of your investment and trading purchases (e.g., stocks, options, futures, mutual funds, and bonds). Besides providing you with a date for determining the type of gain — long term versus short term — these records establish your basis in the investment and help to compute the gain/loss when you sell. In addition, keep records that show a return of capital on your investments.

Depreciation Records: For any rental real estate or depreciable business property that you own, keep records of the property’s cost, the purchase date, the method used to calculate depreciation, and a schedule of all depreciation claimed on the property in previous years. Maintain these records until you sell or dispose of the property. Once you sell the property, keep these records with the tax return on which you report the sale.

Personal Records: Keep a permanent file of personal records — such as divorce agreements, copies of estate and gift tax returns under which you received property, etc. – – since they can provide a basis for determining your tax liability when you dispose of the property.

Other Records: There are other situations in which you will benefit from keeping records. For example, if you have made nondeductible contributions to an IRA or Roth IRA, maintaining records of these contributions will facilitate proving your tax liability when funds are withdrawn from the IRA.

 

 

Copies of tax returns including corrections and amended tax filings – Keep Forever
Tax / Legal correspondence – Keep Forever
Audit Reports – Keep Forever
Contracts and leases – Keep Forever
Real estate records – Keep Forever
Mortgages and Notes – Keep Forever
Corporate minutes and stock records – Keep Forever
General Ledger and Journals – Keep Forever

Bank statements – Six Years
Sales records and supporting journals – Six Years
Personal investment records – Six years after final taxable sales to a 3rd party
IRA and 401(k) records – Six years after final taxable withdrawals

Canceled checks – Three Years
Paid vendor invoices – Three Years
Employee payroll records – Three Years *
Employee expense records – Three Years
Depreciation schedules – Life of asset plus Three Years

* updated 1/31/2011 Recently a client had a former employee sue for back pay. The court wanted to see twelve (12) years of payroll records. The client actually was able to provide all twelve years and was able to use them to prove to the court that there was no unpaid back pay.

 

Keeping Good Records
Preparing to meet your annual income tax obligations is a year-round process. For example, everyone who pays taxes is required to keep accurate, permanent books and records so they can determine the various types of income, expenses, gains, losses, and other items that affect their income tax liability for the year.

Individuals should retain basic records showing the source of all income received including W-2 forms, 1099 and 1098 forms, and year-end comprehensive statements from financial institutions.

For any deductible item, you should retain documents proving the expense itself (a receipt, bill or invoice) and proof that you paid it (a canceled check, credit card slip, or bank statement itemizing your checks and debits).

If you receive or pay alimony, you should keep a copy of the separation agreement or divorce decree.

If you are claiming charitable donations, you need proof of payments plus charity issued receipts or acknowledgements and in some cases certification from the charity and detailed appraisals of property donated.

If you are claiming the child care credit, you should keep records of the name, address, and Social Security number or TIN of each caregiver.

If you have gambling winnings, you should be keeping a diary of your winnings and losses that includes the date, type of activity, and location of the establishment, the names of other people who were present, and the amount you won or lost.

If you are claiming employee business expenses keep in mind that the recordkeeping rules for each type of expense are the same as those that apply to business owners.

Business owners must retain basic records documenting income and disbursements. Special more detailed recordkeeping rules apply to automobile and travel, meals and entertainment, capital assets (fixed assets, long-term assets or investments) and various items that might be considered to provide a benefit the owners such as: health insurance, retirement plans, office in the home, education and so on.

Types of paperless banking records:
Check 21 a/k/a substitute checks.
Once an original paper copy is destroyed it must be available to be reproduced and verified as official documentation when required. Banks only retain these images for several years and they often charge a fee for each image reproduced.

What is a substitute check?
A substitute check is the legal equivalent of the original check if it meets the following requirements:
accurately represents all of the information on the front and back of the original check as of the time the original check was truncated;
represents the MICR line of the original check; and
states that “This is a legal copy of your check. You can use it in the same way you would use the original check.”

Electronic monthly bank statements along with electronic imaged substitute checks.
These must be available to be printed and verified as official documentation when required.
Banks only retain these images for several years. Sometimes there is a charge for each page reproduced.

Electronic online banking, online bill paying services.
These must be available to be printed and verified as official documentation when required.
Monthly statements list your electronic payments. You need to retain additional documentation to verify and support the items listed.

ACH, direct deposits and other electronic debits and credits.
Monthly statements list these. You need to retain additional documentation to verify and support the items listed.

Check 21 means that banks may stop shipping original physical paper drafts (checks) from bank to bank. Rather a bank (or other authorized party) may make a “Check 21” electronic image and digital recording of the check information and then destroy the actual original check. Then this electronic information can be sent around from bank to bank instantly, and when it gets to YOUR bank, they will print it out on paper and mail it to you. That printed paper of the Check 21 IMAGE is a legal substitute for the original check that you wrote.

Electronic monthly bank statements and Electronic monthly brokerage statements are legally allowed if the customer opts in. There are benefits for these including: the bank saves handling, paper and postage. The customer has less paper sitting around his house. The customer may actually prefer to view his statements online from anywhere in the world, rather than look for an envelope that was mailed to his home.

The banks and brokers like this new ability because they save handling, paper and postage by shifting the burden to the customer who can supply his own paper, toner, printer, his time and effort to print the statements himself. If the customer chooses not to print/save the statements, that’s his problem.

To help alleviate “his problem” the bank/broker make the electronic information available online for a couple months to as long as for several years. Beyond those months/years the bank makes a nice fee when the customer realizes he needs paper copies as proof of his banking or broker activities. Example: Bank of America charges $3.00 per check that you need but have not printed during a 65 day window before it is taken off-line.

Caution: Not all copies of a check are substitute checks. For example, pictures of multiple checks printed on a page (also known as an image statement) that is returned to you with your monthly statement are not substitute checks. Online check images and photocopies of original checks are not substitute checks either. You can use image statements and other copies of checks to verify that your bank has paid a check.

If you receive something other than a substitute check, be aware of your rights to resolve errors under other state and federal laws.

 

Why Retain Documents and Records?
Your business records and your personal financial records must be retained for as long as they may be relevant for any tax purpose.

Generally, you will need to keep all records that support items on your tax return for at least four years, since the IRS may challenge your return for three years after its due date. (Even longer in certain cases)

Records for long-term assets, such as real estate, business equipment, and investments, should be maintained as long as you own the assets plus several years afterwards, since you will need them in order to determine your taxable gain or loss upon sale of disposition of the asset, and you may need them to support depreciation or casualty loss deductions along the way. If you rolled over a gain in the asset, as was permitted under the old rollover replacement rule for personal residences, or because you traded some business or investment property in a tax-free exchange, you must keep records of the original asset until you dispose of the asset that took its place.

Be sure to keep copies of your income tax return itself. If you have ever made any nondeductible IRA contributions, you must retain the Forms 8606 from each year you made a contribution or received a distribution from any IRAs. But more generally, if your return is ever challenged for something serious such as fraud or not filing a tax return, the IRS can go back in time to examine your returns for as many years as it thinks necessary. The problem is that the IRS computer system might not have accessible copies of your returns from, say, 10 or 15 years ago. Therefore it is very important that you keep copies of your own tax records indefinitely, and preferably forever.

 

 

 

Guidelines for Paper Records:

Three Years*
Auto mileage logs (three years or life of vehicle)
Bank deposit slips
Cancelled checks
Daily sales records
Entertainment records
Expense reports
Paid vendor invoices
Written acknowledgment from charity for contributions of $250 or more
*From date of filing return or due date of return, whichever is later

Six Years
Bank statements
Contracts (after expiration)

Permanent
Annual financial statements
Corporate stock records
General ledger & journals
Real estate records
Tax returns
Copy of Form W-2
LIFO inventory record
Parking tickets and Motor Vehicle Moving
Violation tickets along with proof of payment

Other
Depreciation schedules (life of asset, plus three years)
Meeting minutes (life of company)
IRA contribution and distribution records (three years after final distribution)

 

 

Organizing your financial records
PDF file from MFS Investment Management
http://www.leonardrea.com/assets/MFS_Organizing_Your_Financial_Records.pdf

State of California’s listing of record keeping requirements
(remember that the CA Statute of Limitations is 4 years, not only 3 years as is the case for the IRS)

After recent audits of personal income tax returns, we recognize that taxpayers and preparers may not be aware of the rules and regulations pertaining to the requirements of record keeping for expenses and deductions.

Who?
Taxpayers need to be prepared to provide documentation that proves why they claimed what they did on the return. The burden of proof is on the taxpayer. Taxpayers must be able to prove (substantiate) certain elements of expenses to deduct them. Deductions are only allowed if they are ordinary and necessary as determined by IRC Section 162(a) and conforming CR&TC Section 17201.

Why keep good records?
Good records help to prepare and support taxpayer tax return information. Whether it is business or personal, good records help when applying for a loan or for supporting an insurance claim.

Poor or no records result in missed deductions and higher taxes. If audited, poor records can result in underreported income and unsupported deductions, which will result in higher taxes and possible penalties.

What are good records?
Good records support the deduction(s) taken on the tax return. Taxpayers have the right to take every deduction the law allows them. However, we have the right to say “Show me.”

What records need to be kept?
Lack of good records show that taxpayers are not following the rules and regulations established by the law (Federal Tax Regulation 1.274-5T). Examples of records needed to support expenses and deductions are:

Payment records – Provide either a canceled check or credit card payment to show that payment was made.
Invoices – Along with the proof of payment, provide the invoice cross referencing the business expense.
Receipts – Provide receipts that itemize the purchases and/or method of payment.
Mileage logs – Keep and provide mileage records during an examination. Federal Tax Regulation 1.274-5T outlines specific requirements for mileage records.
Charitable cash or non-cash contributions – Keep records of your donations. IRC Section 170 allows deductible contributions given to qualified exempt organizations.
Meals and entertainment – Check Federal Tax Regulation 1.274-5T for guidance on what the taxpayer must provide. For example; there is a meeting with a client to discuss sales opportunities at a local restaurant, generally, the receipt must show the meeting time, the reason for the meeting, and who attended the meeting.

Property/Investments
Basic records enable the taxpayer to determine the basis or adjusted basis of their home. If claiming a carryover loss, then the records need to be kept for as long as there is a carryover balance.

How long should I keep records?
Generally, California’s minimum statute of limitations is four years.

The length of time you should keep a document depends on the action, expense, or event. You must keep your records as long as they may be needed to prove the income or deductions on a tax return until the statute of limitations runs out for that return.

Are there requirements on how to keep the records?
No. In general, taxpayers may choose any record keeping system that suits their personal or business needs and that clearly shows their income and expenses. However, if the taxpayer chooses the “shoebox” method, then the taxpayer will be responsible for assembling and reconciling the records to the tax return.

For small businesses, the business checkbook is the main source of entries. We cannot over emphasize the importance of keeping business accounts separate from personal accounts, so business and personal transactions are not commingled. Computerized software packages are available that require little or no experience in bookkeeping and accounting.

FTB’s mission is to collect the proper amount of tax. No more, but no less than your fair share.

References – Internal Revenue Service Publications
Publication 552 – Recordkeeping for Individuals.
Publication 583 – Starting a Business and Keeping Records.
Publication 463 – Travel, Entertainment, Gifts and Car Expenses.

http://www.ftb.ca.gov/professionals/taxnews/2009/0109/0109_5.shtml

 

FAQ: Do I need to retain original business expense receipts if I scan them into my computer?
Many taxpayers maintain books and records by using an electronic storage system that either images their hardcopy books and records to an electronic stage media, such as an optical disk. Records maintained in an electronic storage system that complies with certain requirements will constitute records under Code Sec. 6001.

Code requirements
Code Sec. 6001 provides that every person liable for any tax imposed by the Code, or for the collection, must retain records. Any person subject to income tax, or a person required to file an information return, must maintain books and records, including inventories sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown.

A taxpayer’s electronic storage system that meets certain requirements will be treated as being in compliance with the recordkeeping requirements of Code Sec. 6001.

Special Rules
The definition of books and records goes beyond the typical hard copy items when you maintain all or part of your accounting records on a computer. In general, record-retention periods are the same for “machine-sensible” records as they are for their hard-copy counterparts. Machine-sensible records include magnetic tapes, punched cards and computer disks.

Where machine-sensible records are concerned, however, retrievability is important. Not only must certain records be maintained, but the IRS must have access to those records. This becomes especially burdensome when computer systems are upgraded.

If you or your business have more than $10 million in assets*, and you maintain all or a portion of your accounting records on a computer, the IRS requires that your machine-sensible records be in a retrievable format and provide the information necessary to determine the correct tax liability. This requirement applies even if your accounting system is maintained by an outside service bureau. To comply with this requirement, you must retain the following specific documentation for all data files:

Record formats (including the meaning of all the codes used to represent information)
System and program flowcharts
Label descriptions
Source program listings of programs that created the files retained
Detailed charts of accounts
Evidence that periodic tests are performed on the retained records to ensure they can produce the data stored in the records
Evidence that the retained records reconcile to the taxpayer’s books and the tax return
If you or your business have less than $10 million in assets, but you nevertheless maintain all or a portion of your accounting records on a computer, the IRS requires you to conform to the above standards if (1) your books and records are only available in machine-sensible format, (2) machine-sensible records were used for complex computations (such as LIFO) or (3) you are notified by the IRS that your machine-sensible records must be maintained.

* Members of a controlled group of corporations are combined for this purpose.

Taxpayers’ responsibilities
The IRS permits the destruction of the original hardcopy books and records and the deletion of the original computerized records once the taxpayer has:

Completed its own testing of the electronic storage systems that establishes that hardcopy or computerized books and records are being reproduced in compliance with certain requirements; and

Instituted procedures that ensured its continued compliance with these requirements.
Click here for more information on electronic records.

Click here for more information on planned record purging and destruction.

Relevant IRS Procedures and Rulings Pertaining to Records:
http://www.uiowa.edu/~fusrmp/irsprocedures.htm