Tax record retention periods vary from three years for certain income tax returns to indefinitely. If the Internal Revenue Service audits your business or you need to adjust a return, it’s vital to have complete, accurate documents. Failure to keep records could increase your taxes owed substantially and, in some cases, result in penalties.
Read on to explore IRS rules and best practices for retaining tax records and supporting documents.
IRS rules for tax record retention
According to the IRS, auditors generally “include returns filed within the last three years in an audit.” That means you should retain records for three years after filing the return. However, the agency leaves the actual period fairly vague. It said, “If we identify a substantial error, we may add additional years. We usually don't go back more than the last six years.” So how long should you keep tax documents?
The IRS provides the following guidelines for tax record retention:
- If you file for a bad debt deduction or loss from worthless securities: Keep documents for seven years.
- If you underreport income, and it’s more than 25% of your gross income: Retain records for six years.
- If you filed a fraudulent return or no return at all: Keep tax and supporting documents indefinitely.
- If you have employees: Retain employment tax records for four or more years after the tax was due or you paid it, whichever date is later.
The Illinois CPA Society (ICPAS) recommended that businesses “add a year to the statute of limitations period.” At a minimum, this means keeping tax returns for four years. But, ICPAS noted, “It may be more prudent to retain them for seven years.” Indeed, many tax advisors tell business owners to keep most tax records for seven to 10 years, if not permanently. Doing so can help you prepare for an IRS audit.
[Read more: 7 Things Your Small Business Should Still Document on Paper]
Accounting and tax documents to retain permanently
Many accounting records should be kept indefinitely. For instance, if the IRS believes you filed a fraudulent return, they might ask to see statements or canceled checks showing you paid for items you deducted and receipts for the purchase. And there isn’t a statute of limitations for fraudulent returns.
Many tax advisors tell business owners to keep most tax records for seven to 10 years, if not permanently.
The IRS lists several documents that small businesses and self-employed individuals should keep, including 1099s and cash register tapes. Also, the IRS suggested talking with your creditors or insurance company before discarding tax records, as they “may require you to keep them longer than the IRS does.”
The CPA firm Teal, Becker & Chiaramonte recommended that companies retain the following documents permanently:
- Audit reports.
- Chart of accounts.
- Depreciation schedules.
- Financial statements (annual).
- Fixed asset purchases.
- General ledger.
- Inventory records when using the last in, first out (LIFO) method.
- Tax returns.
- Canceled or substitute checks for real estate purchases.
- Information about leases or mortgages.
- Patent and trademark details.
- Corporate shareholder records.
- Stock registers and transactions.
- Employee pension and profit-sharing plans.
- Construction records.
- Leasehold improvements.
Tax record storage guidelines
According to IRS Publication 583, “You must keep your business records available at all times for inspection by the IRS.” Business owners can keep hard copies or electronic records, as the rules apply equally to both methods. This means an electronic storage system “must provide a complete and accurate record of your data” and be accessible to the IRS.
Your system “must index, store, preserve, retrieve, and reproduce the electronically stored books and records in [a] legible format.” The IRS can penalize your company if your electronic records do not meet the requirements and you have already disposed of the paper documents.
Here are the supporting documents that you should keep to back up your tax returns and bookkeeping records:
- Gross receipts: Retain documents showing the sources and amounts of your gross receipts, including bank deposit slips, invoices, 1099s, and cash register tapes.
- Inventory: Keep canceled checks, credit card sales slips, and invoices to show what you paid for stock and proof of payment.
- Expenses: Save receipts and proof of purchase (canceled checks or account statements) for each business expense.
- Travel, transportation, and gift expenses: Follow guidelines in IRS Publication 463 to meet additional recordkeeping rules for these expenses.
- Employment taxes: IRS Publication 15 addresses the types of employment tax records you must retain.
- Assets: Save supporting documents like canceled checks, purchase and sales invoices, and real estate closing statements.
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