When Should You Keep and Throw Out Tax Documents?

Once your 2010 tax return has been put to bed, you can rest easy until it's time to prepare for filing next year...right? Wrong. Before you turn out the lights, collect all the vital materials from your 2010 return and store them in a safe place. The documents you don't need anymore can be thrown away, after shredding them or destroying them, of course.

In many cases, tax returns are now filed electronically, so that cuts down on the mound of paperwork you've faced in the past. But you still have to keep certain records for a minimum period of time. We're not a "paperless society" quite yet. Also, you must also cope with recordkeeping burdens for the 2011 tax year.

What sort of records are we talking about? It depends on your particular situation, but here are several common areas where record retention is a must. Otherwise, you can run any extraneous papers through the shredder.

Securities: Normally, you're advised to keep records of trading activities and 1099 forms for securities, especially as they relate to the "basis" of these investments.

New rules have eased the responsibilities for securities, but you're not completely home-free.

Under a 2008 tax law, financial institutions must provide you with information indicating the basis of securities sold, the amount of the sales proceeds and whether a gain or loss is long-term or short-term. These new rules are being phased in over a three-year period, but they generally apply to sales of stocks and mutual funds acquired after 2010. To establish basis, you still must retain the information for securities purchased before 2011.

In addition, retain 1099 forms for dividends and capital gains reported from mutual fund investments. Set up a system for tracking dividend reinvestments. If you don't, you might end up paying tax on these amounts twice -- once when they are reported as dividends and once when the securities are sold. Finally, it's recommended that you hold onto year-end reports. 

Charitable donations: These tax rules were changed back in 2007. Now you have to meet stricter substantiation requirements for cash and cash-equivalent donations. 

For starters, it's necessary to have a written confirmation from the charity or bank statements or other receipts to prove deductions. For contributions of $250 or more, you should corroborate gifts with a contemporaneous written acknowledgement. If you've donated property valued at more than $500, you must document the information about the gift. Note that an independent appraisal is required for gifts of property above $5,000.

Travel and entertainment: The IRS often zeroes in on travel and entertainment (T&E) deductions that look suspicious. Sometimes, special limits for luxury cars and other T&E items are ignored or misrepresented by taxpayers. 

Keep a contemporaneous record of your T&E events listing all the details on dates, locations, amounts, the business parties involved and your business purposes. For convenience, you can set up a spreadsheet. Receipts for any expenses of $75 or more must be retained.

Home expenses: Hold onto the 1098 forms you've received for mortgage interest and property taxes. For home improvements, keep receipts of expenditures that may be added to your basis. If you sell the home in the future, the basis adjustments can reduce any taxable gain above the usual $250,000 home sale exclusion ($500,000 for joint filers). The improvement documents should be held until you sell the property. 

IRA and retirement plans: Keep records of contributions to traditional and Roth IRAs as well as amounts contributed to a 401(k) or other employer-provided retirement plans. Note: You can't extend the deadline for making an IRA contribution for the 2010 tax year if you've obtained a filing extension. As with securities (see above), retain year-end statements for retirement accounts. 

Finally, remember that organization is important. Store your records neatly in a manner where you can access them quickly. This can also help with the preparation of your 2011 return. 

 

Is Time on Your Side?  

How long do you have to keep the tax records described in this article? Like many issues in tax law, it depends. 

Practically speaking, the statute of limitations on additional tax assessments runs for three years from the time that you've filed your tax return or the due date, whichever comes later. For example, you should hold onto 2010 records until at least April 18, 2014 (October 17, 2014 if you've obtained a filing extension).

However, the IRS has the ability to go beyond three years -- up to a period of six years -- to audit a tax return if it suspects that gross income has been substantially underreported. In this case, "substantially" means an understatement of 25 percent or more of the gross income reported on the return. 

And there is no time restriction if a false or fraudulent return is filed. In those cases, the IRS can go back as long as it wants to assess taxes plus penalties and interest. 

To play it safe, some tax experts recommend keeping records for as long as ten years. Conversely, if you're trying to remove clutter from your files, three years is the bare minimum.