Federal and State Tax Records Retention
How Long Is Long Enough?

By Larry Tunnell, Cindy Seipel, and Ed Scribner

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APRIL 2008 - Many taxpayers feel a sense of information—and paper—overload. E-mail, junk mail, regular mail, voicemail, faxes, text messages, and other communications make managing the information flow more difficult. When it comes to the records required to substantiate the information submitted on income tax returns, identifying what to keep and how long to keep it becomes a problem. If anything, record-keeping requirements seem to be growing, as evidenced by the recently expanded requirements for receipts supporting charitable contributions. Records of stock transactions, retirement plan distributions, charitable contributions, childcare expenses, partnership K-1s, and similar materials must typically be kept for as long as taxpayers might need to produce them to support tax return disclosures.

While many businesses opt to digitize documents and keep them indefinitely, for many taxpayers this is impractical. All taxpayers, however, would benefit from knowing the required holding periods, because it would keep their tax records under control by indicating which documents they can safely discard. The problem is that information about these holding periods lies buried in various statutes and is not easy to find, even when contacting the local tax office. This article provides simple tables, based on federal and state statutes, as guidance for retention of evidence supporting income tax returns, both federal and state.

Federal Income Tax Returns

With respect to federal income tax returns, most taxpayers can safely keep supporting records for five years. Assessment of federal income tax by the IRS must generally occur within three years of the later of the date that the return was actually filed or the unextended due date of the return. This assessment period, combined with the portion of the year that the taxpayer held the document prior to the date the return was filed, would equal no more than five years in most cases, even when a possible extension is included.

Suppose, for example, that the taxpayer receives a fax on January 1, 2008, that contains information necessary to support amounts on 2008 Form 1040, filed on March 9, 2009. The IRS would have until April 16, 2012 (April 15, 2012, falls on a Sunday), to audit the return. If the taxpayer filed a six-month extension and did not file the return until October 15, 2009, the IRS would have until October 15, 2012, to complete an audit. Under these circumstances, the taxpayer would need to keep the fax for at least four years, nine months, and 15 days to be sure it was available to support the related item on the federal return.

Rather than calculating the precise holding period, a more practical and convenient approach is to have a general rule that is easy to remember and easy to follow. In this case, it would be to discard every document five years after it was issued. (Of course, evidence supporting the tax basis of property should be retained until the statute of limitations has run out on the return that reports the sale of that property.) Then it would be necessary only to look at the date on the document and determine if was generated more than five years ago when deciding whether to dispose of the document.

If the IRS cannot complete the audit by the deadline, it might ask the taxpayer to grant an extension of the statute of limitations. Although taxpayers are not required to grant such an extension, doing so might be in their best interest because the IRS might otherwise immediately assess a deficiency, in which case the taxpayer would have to either settle or pay the tax. To obtain relief, the taxpayer would then have to either take the case to the Tax Court or file a claim for a refund.

A Form 1040 might be subject to audit for even longer periods under certain circumstances. For example, if a taxpayer underreports gross income by more than 25%, the statute of limitations extends to six years from the date the tax return is filed. For filers of fraudulent returns and for nonfilers, the statute of limitations runs indefinitely.

Exhibit 1 outlines the different statutory holding periods for federal individual income tax returns with different characteristics. It also indicates a possible general rule to be used with respect to documents relating to each type of return. A general rule might be more useful than the specific statute of limitations because of the following:

  • The ending of the limitations period might differ for each taxable year if the return was filed after the original due date;
  • A general rule (e.g., five years after receipt) is generally easier to remember than the statute of limitations; and
  • A general rule can be easier to implement than calculating where a particular document falls within the statute of limitations period.

State Income Tax Returns

Unfortunately, the rules in Exhibit 1 do not take into account all income tax–related reasons for maintaining records. Most states have an income tax, and many states have statutes of limitations that differ significantly from the federal statute. Therefore, the authors searched the statutes of the 50 states and the District of Columbia to compile a summary of holding periods for various jurisdictions. Exhibit 2 outlines the applicable requirements.

Exhibit 2 indicates that the end of the limitations period for state income tax purposes can vary by as much as two years from the end of the period for federal income tax purposes. In fact, some of the more populous states, such as California, Michigan, and Ohio, have statutes of limitations that exceed the federal statute by a full year. In addition to extending the period for such factors as underreporting of income or filing a fraudulent return, most states also extend the limitations period by one to two years if there are changes to the federal return, either because of an amended federal return or adjustments resulting from an IRS audit.

Whatever the underlying causes of the longer state limitation periods, they underscore the need for taxpayers to use a more generous rule when determining when to discard records, rather than adhering strictly to the federal income tax statute of limitations.


Larry Tunnell, PhD, CPA, is an associate professor of accounting and head of the department of accounting and information systems;
Cindy Seipel, PhD, CPA, CFE
, is an associate professor of accounting; and
Ed Scribner, PhD, CPA
, is a professor of accounting, all at New Mexico State University, Las Cruces, N.M.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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