Many of us wish to clear out old papers and files and this includes getting rid of old tax returns and supporting documentation. The problem is that we never know when it is quite safe to destroy the old tax documents. Unfortunately, there is no bright line rule to answer this question. Taxpayers with foreign (non-US) assets have particular rules to pay special attention to. Overseas taxpayers may also find it more difficult to obtain records from financial institutions located abroad and thus, they should be even more careful with record retention.
Below are some general guidelines to help determine when it may be permissible to destroy tax paperwork.
First and foremost, I remind clients that in the event of an IRS or State tax audit, the burden of proof is on the taxpayer to provide support for a tax position he has taken on the return. This is especially important when claiming tax deductions. As such, the premature destruction of documents could mean you lose in a tax audit.
The different rules contained in the tax statutes of limitation are very helpful in providing guidance as to the minimum retention periods for tax documents. It is critical that records such as receipts or canceled checks supporting an item of income or a deduction be kept until the statute of limitations expires for that year’s tax return. With this in mind it is important to remember that often, banking records and trading accounts are online and if one closes out the particular account, the records can no longer be retrieved (at least, not with any ease!). It is highly recommended that banking and online trading statements and online copies of any canceled checks be printed out annually and retained in the tax file for that year. If possible, digital copies should also be retained.
Minimum Retention Periods: Different Statute of Limitations Rules Can Apply Depending on the Facts.
Below are some of the key rules about the statute of limitations for US federal returns:
1. For most returns the statute of limitations is three years from the date the return was filed. There are some very important exceptions to this general three year statute of limitation.
2. The statute of limitation never starts if a tax return is fraudulent or when no tax return is filed. This means the IRS can come after you “forever” with regard to that particular tax year.
3. The IRS gets a longer time to come after you with regard to a filed tax return if there is unreported income that exceeds 25% of the gross income shown on the return. In such a case, the IRS has six years from when the return is filed to make a tax assessment.
4. Under a special rule added to the tax law in 2010, the statute can also be extended to six years if you omit over $5,000 from gross income that is attributable to certain kinds of foreign financial assets. Taxpayers with offshore financial accounts or assets must be particularly diligent in record-keeping.
5. Under other tax rules enacted in 2010, the statute of limitations does not begin to run until the taxpayer has complied with all mandatory foreign reporting requirements. This reporting can include information returns regarding ownership in foreign corporations, foreign partnerships, foreign trusts, information concerning “specified foreign financial assets” and many other transactions in the offshore context. Only when proper reporting is made will the statute of limitations begin. Furthermore, even though the statute starts to run, the entire tax return will remain open for IRS adjustments for a period of three years (rather than only for the portions of the return relating to the foreign reporting that had been missing).
6. Any person required to file a so-called FBAR (“Report of Foreign Bank and Financial Accounts” /Form TD F 90–22.1) must keep certain records about the foreign financial account for a period of five years from the due date of the report (June 30 of the year following the year to which the FBAR report relates). Records may need to be maintained for a longer period by persons who have been formally charged with a criminal tax violation.
7. If you are filing a claim for credit or tax refund, you generally have three years from the date the original return was filed to make the claim, or two years from the date the tax was paid, whichever is later.
Sometimes Minimum Retention Period is not Sufficient
In certain cases, record retention beyond the time periods of the statue of limitations will be necessary. For example, if one has purchased any type of property (e.g., whether real estate, stocks or other financial products) it is important to have supporting documentation for the cost basis and any adjustments to basis (e.g., depreciation of real property). This information will be needed when the property is sold. Accordingly, the statute of limitations guidelines are not very helpful in this type of case, since the statute may have run, but the tax returns and supporting documents still need to be retained in order to establish a basis in the asset when it is sold (which can be many years after the limitations period has expired).
If relevant, one should also check State and local statute of limitation rules before destroying any tax files. One should also remember that certain documents should be kept for reasons other than tax. For example, making insurance claims or dealing with a decedent’s assets. Before destroying anything about which you are unsure, discuss the issues with your tax attorney or accountant.