What You Need to Know About Keeping or Tossing Tax Records
April 19, 2017The basic reason you need to keep any tax documentation is so that if the IRS comes calling with questions about what’s on your return, you can prove the numbers. The most acceptable rule of thumb is that for anything you used to put numbers on your tax return, you should keep it at least three years or seven if you’re toeing any lines with what you put on your return. This includes receipts, cancelled checks, tax forms and even bank statements.
But the fact is that any official tax form you receive, such as a W-2, 1099 or 1095-B, was also provided to the IRS. That’s why if you forget to include, say, that withdrawal of your old job’s 401(k) on your return, the IRS WILL send you a letter reminding you (and requesting a little extra for penalties and interest). So do you really need to keep your copy? The answer is a bit of a “yes but…” and you obviously want to keep anything that wasn’t on an official tax form like receipts for donations or property tax statements.
The biggest “but” is that in terms of what the IRS accepts, there is no need to keep a paper copy of anything that you can easily obtain digitally. Since my accountant prefers to receive documents online anyway, I scan everything to a removable jump drive and just keep that in a safe place for three years. Besides being able to substantiate what you put on your tax return, here’s why you need to keep…
W-2s – These are mostly in case you want to do something like buy a house, refinance your mortgage or some other activity that requires you to prove your income.
Bank account statements – In case you are doing any type of mortgage application, the bank will want at least the past 60 days of any checking or savings accounts you hold.
Brokerage account statements – If your only transactions for the year were dividends and interest received, then you can get rid of the statements and just keep the 1099 that you received showing the income for the standard three years. However, if you purchased investments (including dividend reinvestment of a mutual fund), you’ll want to keep the statements as long as you hold the underlying investment plus three years. This is so that when you do sell, you’ll be able to properly calculate any gains or losses based on what you paid for the shares. The “plus three years” is because once you sell and claim the gain or loss, it becomes a tax document.
Receipts for home improvements – That new roof you had to put on your home may have been your least favorite purchase of the year, but if you’re lucky enough to eventually sell your house for a gain greater than the exemption amount ($250,000 for single, $500,000 for married), you’ll be able to reduce the gain by the cost of any improvements you made to the home throughout the years. One simple way to keep track would be to keep a running list, either in Excel, in Google Sheets or even by hand. Then scan and store the receipts with the other tax documents for the year of the expense.
Home sale/purchase documents – Besides providing evidence of any basis you used to calculate a gain (or lack thereof) on the sale of your home, you’ll want to keep these documents in case you need them on future mortgage applications. When my husband and I purchased our home, the title agency uncovered something that indicated he still owned the home in Michigan that he’d sold years before. He had to show them the sale document in order to avoid compromising our purchase.
IRA-related forms – If you ever made a non-deductible contribution to a traditional/pre-tax IRA or converted a traditional/pre-tax IRA to a Roth IRA, you’ll need the documents proving that so when you begin your distributions, you can avoid paying taxes twice on any of your savings. It’s best to create a separate file just for these forms and when they come in the mail each year, either scan them or place them into their designated place.
While you really should keep all tax documents for at least three years, make it seven if the interim years include red flag items like self-employment income, a home office deduction or large non-cash donations. The IRS really has a seven year statute of limitations to audit returns if they have any reason to believe abuse of the tax code. (That statute of limitations disappears if they uncover massive tax fraud so just don’t go there, okay?) The above list is meant to share exceptions or alternate reasons to save certain documents. Again, it’s okay to store your documents digitally, just make sure you’re shredding the originals to help avoid identity theft.
Kelley Long is a resident financial planner with Financial Finesse, the leading provider of unbiased workplace financial wellness programs in the US. For more posts by Kelley or to sign up to have her weekly post delivered to your inbox each Wednesday, please visit the main blog page and sign up today.