Episode 20: In this episode, Timalyn explains the retention requirements for tax records. As an individual or a business, you need to hang on to your tax records for a period of time. It's a common question Timalyn gets and today, she'll walk you through what you need to do. Be sure to grab your pen and paper.
How long should I keep my tax records for an audit?
There's not one single answer to the question of how long you need to retain your tax-related documents. There are different scenarios to be considered. In general, you need to look at:
If the action, for example, is the purchase of a home, Timalyn recommends maintaining the tax records related to that purchase for as long as you own the property. If the expense is for a business-related activity, you should keep the record for at least 3 years.
Remember, if you are claiming an item/expense on your tax return, you have to be able to substantiate the cost. Your bank statements aren't proof of the expense just how it was paid. You should keep a third-party document such as a sales contract or receipt. While your bookkeeper will need the receipts, your tax professional will assume you have the documentation.
Refunds
Remember, you have 3 years to amend a return and claim a tax refund. As an example, Timalyn uses a 2019 tax return, filed by April 2020. In order to claim the refund, you would have 3 years from the original due date or 2 years from when the tax was paid, whichever is later.
The IRS will usually apply that refund to an existing tax debt or a balance from a different year. Yes, you still get the benefit, but you might not get an actual check refund.
The Tax Transcript
Your tax transcript is a good place to start when you're trying to determine when you paid your taxes. In Episode 7, Timalyn discussed the importance of your tax transcript. If you think you overpaid your taxes in a particular year you can verify your payments with your transcript.
Bad Debt Loss or Worthless Securities
Timalyn explains that the IRS recommends you keep bad debt and worthless security tax documents for a period of 7 years. However, bad debt really only applies to companies on an accrual basis for their accounting. Those using a cash basis don't have bad debt, per se. Yes, you still may have unpaid invoices, but this is an accounting term with a specific meaning.
Income Not Reported on the Tax Return
You should keep your tax records for 6 years, if all of your income was not reported on the tax return and if the unreported income is more than 25% of your gross income. Not reporting all of your income isn't something Timalyn recommends, but she is commenting on an IRS recommendation.
Do I Need to Keep My Tax Records Indefinitely?
You can avoid this simply by filing your tax return. Interestingly, the IRS actually recommends keeping your records indefinitely, if you don't file your returns. Timalyn explains that the IRS has 10 years to collect a tax debt, based on when it was assessed. If you didn't file, the tax was not assessed. Therefore, keep the tax documents.
Remember, if you don't file a return, the IRS can file a Substitute for Return ("SFR"). This is considered a tax assessment. When this occurs, that 10-year collection window begins.
Using a different example, if you properly file your tax returns, you will not be required to keep your tax records indefinitely. If your return was fraudulent, you do need to maintain your tax records. Understand, the IRS can come after you even if it's well beyond the 10-year collection window if the information on the return was fraudulent.
This is one of the reasons you should work with a knowledgeable tax professional to prepare and file your taxes. In Episode 16, Timalyn explains how to choose a tax professional.
Employment Taxes
If your small business pays employees, your tax documentation retention rules are different. This includes IRS Form 941 (Employer's Quarterly Federal Tax Return) and the employee information used to prepare it. IRS Form 940 (Employer's Annual Federal Unemployment Tax Return or "FUTA") should also be kept. Don't forget your W-4s, W-2s showing how you determined the employee's contact and withholding information. These records should be retained for 4 years after the date due or the date paid.
The Importance of Filing the Return
In some circumstances, a business or individual may not have the money to pay their tax liability. Even if this is the case, you should still file the return to avoid the Failure to File penalty, which she explains in Episode 2.
How to Store Your Tax Documents
Timalyn recommends storing your paper documents in a fire-safe container. Remember, you have the burden of proof, so preserving your documentation is your responsibility.
It's a good idea to make an electronic version of your documents. It's easier to store them and takes up less room. You would then be able to shred the paper documents.
There was a lot to consider in today's episode. The key is to ensure you have the documentation you need and that you can easily find it if you ever need to do so. Exercising proper document retention can help you to deal with any problems that may arise down the road. Remember, back taxes shouldn't ruin your life.
As we conclude Episode 20, we encourage you to connect with Timalyn on social media. You'll be able to subscribe to this podcast on Spotify, Apple Podcasts, Google Podcasts, and many other podcast platforms.
Remember, Timalyn Bowens is America's Favorite EA and she's here to fill the tax literacy gap, one taxpayer at a time. Thanks for listening to today's episode.
For more information about tax relief options, visit https://www.americasfavoriteea.com/ .
If you have any feedback, or suggestions for an upcoming episode topic, please submit them here: https://www.americasfavoriteea.com/contact.
Disclaimer: This podcast is for informational and educational purposes only. It provides a framework and possible solutions for solving your tax problems, but it is not legally binding. Please consult your tax professional regarding your specific tax situation.
