You've probably heard that you should hang onto your tax returns for three years. The truth is that tax record retention periods vary from three years to indefinitely depending on the types of documents. And poor recordkeeping could lead to hefty penalties, so it's important to understand the guidelines.
[Read more: Is Your Business Tax-Exempt? How to Find Out]
IRS rules for tax record retention
Though the IRS recommends keeping your records for three years after filing a return, the actual period is fairly vague. The agency states that if it identifies a substantial error, it may ask for additional years, though it doesn't usually go back more than six years.
So how long should you keep tax documents? The IRS provides the following guidelines for specific situations:
- If you file for a bad debt deduction or loss from worthless securities, keep all documents for seven years.
- If you underreport income, and it's more than 25% of your gross income, you should retain records for six years.
- If you filed a fraudulent return or no return at all, you should keep all tax and supporting documents indefinitely.
- If you have employees, you should retain employment tax records for four or more years after the tax was due or you paid it — whichever date is later.
[Read more: Issuing 1099 Tax Forms: Who Gets One?]
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.
The IRS lists several documents that small businesses and self-employed individuals should keep, including 1099s and cash register tapes. Also, the IRS suggests talking to your creditors or insurance company before discarding tax records.
The certified public accounting firm Teal, Becker & Chiaramonte recommends 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 substituted 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.
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.
Tax record storage guidelines
According to IRS guidelines, your business records should always be available for inspection. You can keep hard copies or electronic records as long as both options provide an accurate record of your data and are easily accessible. The system must be legible, and you should keep the following supporting documents on hand:
- Gross receipts: Keep 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 have 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.
[Read more: 10 Smart Small Business Tax Strategies That Will Save You Money]
Risks of poor tax record management
It's easy to not be meticulous with your recordkeeping, but doing so could lead to serious consequences. If you have incomplete or disorganized records, you have a higher risk of being audited, and the IRS may scrutinize your income further if it cannot verify your income and deductions. Misreporting income or deductions could lead to fines and penalties, and there could be legal consequences if the IRS suspects negligence or fraud.
Even if you're never audited, poor recordkeeping can cause challenges in your personal and business life. It could make it harder for you to apply for a loan or sell your business. It could also put your company at higher risk for a data breach.
[Read more: 15 Tax Deductions Your Business Should Know Abouts]
Tools for simplifying tax document retention
Fortunately, there are tools available that can help you simplify your tax document retention. Here are some of the best options to try:
- Document storage: Google Drive, Dropbox, and OneDrive allow you to securely store and organize your tax documents.
- Accounting software: The right accounting software tracks your income and expenses and stores tax-related documents.
- Receipt tracking: You can use software like Expensify to scan and categorize your receipts. Not only can this help you if you're audited, but it can also make tax filing much easier each year.
- Backup solutions: Consider investing in a backup solution like an external hard drive or cloud storage solution.
This article was originally written by Jessica Elliott.
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