How Long Do You Need to Keep Tax Returns: A Guide to Effective Document Retention

Introduction

Financial records play a vital role in helping you manage your money more effectively. In the same vein, keeping your tax returns in good order not only helps you in the short term but also ensures you stay on top of your finances in the future. But just how long do you need to keep tax returns? In this article, we will provide a step-by-step guide, including IRS guidelines, best practices, document types, and tips and tricks to help you stay organized and efficient in your tax document retention.

A Step-by-Step Guide to Tax Return Retention

The Internal Revenue Service (IRS) generally requires that you keep your tax returns and other documents for at least three years after filing your return, although some situations might require you to keep records for more extended periods. You can extend this retention period to six years if you under-report your income by more than 25%.

In terms of recordkeeping, keep all documentation that supports the income, deductions and credits you report on your tax return until the largest of these two periods (1) three years from the date you filed the return or (2) two years from the date you paid the tax. For example, if you file your 2020 individual tax return on April 15, 2021, you must keep records that support reported income and deductions until at least April 15, 2024. Furthermore, if you owe tax for that year, you must keep the records which support the payment for at least two years from the time you make that payment.

If there are specific events or situations where taxpayers are advised to keep tax returns for longer periods, the IRS tends to include them in a notification. For example, if you maintain a property for more than three years and have claimed depreciation, you must keep your tax return documentation cumulatively for at least four years after filing the tax return. If you sold off stock or mutual fund, it’s best to keep the transaction records as long as you own the asset plus the three-year retention period.

Additionally, taxpayers must keep copies of any filed tax returns and all significant supporting documents, such as W-2 forms, tax payment records, and investment purchase statements. Items that affect more than one tax year may require longer retention, such as home purchase or improvements that require documentation for calculating depreciation or home sale proceeds.

You can store tax information electronically or in paper form; however, it’s advisable to keep backup copies of the electronic documents. Furthermore, remember to keep electronic records in a secure location, preferably by creating backup copies to avoid losing documents due to equipment failure or corrupted data.

Minimalism Your Tax Returns

Minimalism can be achieved by decluttering your financial records. While taxpayers must keep their returns to substantiate the tax returns, you can legally dispose of other financial documents that clutter up storage space. The following financial documents, after three years, can safely go into the shredder: bank or credit card statements that show ATM withdrawals or point-of-sale transactions, receipt for small purchases like groceries or gas, credit card bills that are paid on time, as well as utility statements.

It’s best to digitize documents that you don’t dispose of. By digitizing these documents, you can easily reduce clutter and improve your filing organization. You can opt for programs such as TurboScan or Evernote to convert hard copies into digital copies. Of course, it’s prudent to back up the digital files to avoid losing them due to stolen or corrupted computers.

Keeping Tax Documents in the Digital Age

Keeping your tax records in electronic form is a wise step as it’s environmentally friendly, and you save on storage fees. There are various management software, free and paid, that you can access to get help in retaining your tax documents.

One upside of retaining your tax records electronically is the ease of accessing them remotely. You can access your records from anywhere as some companies that offer these services do so from the cloud. Additionally, by retaining your tax records electronically, you reduce your risk of fraud. Have you ever lost your hard drive or had a break-in where important documents went missing? That’s precisely the sort of thing that can happen with your physical tax records, but virtual ones are generally much safer.

However, it’s essential to be careful where you store such documents. Ensure to use a secure server that creates backup copies to prevent data loss from hacking, corrupted storage devices or hardware breakdowns.

How Tax Return Retention Will Impact Your Future Finances

Keeping accurate tax records can help you to make smarter financial decisions in the future. For example, when you have your previous tax returns close by, you can easily refer to them when filling out new forms or seeking financial assistance. By studying your previous tax returns, you can also identify areas where you might be missing tax credits or deductions, particularly if you had significant life events like having a baby, getting married or divorced, or starting a business.

On the other hand, failing to keep accurate tax records could land you in hot water with the IRS. Penalties and interest charges for unpaid taxes can add up quickly, and the IRS can impose liens or wage garnishments if you fall behind on your tax payments.

Best Practices for Tax Return Retention

Now that you know what tax returns to keep, how long to keep them and where to store them, implementing the systems described below will help you stay organized and efficient:

Store your files in specific physical storage or cloud storage to make it easier to locate them quickly.
When storing physical files, keep them organized by date and category.
For digital files, it’s advisable to use specific file titles and relevant tags to simplify retrieval.
Digitize as much as possible, and use cloud-based services to keep your data secure, backed up, and easily accessible, from anywhere.
Perform regular backups of your electronic documents.
Update your tax records yearly and keep the original copies of documents that you only have one of, e.g., birth certificates or social security cards. Store these originals somewhere safe like a safety deposit box at a bank or else in a secure home safe.

Conclusion

Proper tax return retention is necessary for managing your finances effectively. By following the IRS guidelines and tips and tricks outlined in this article, you will ensure you have the right documents on hand whenever they are needed. By keeping accurate records and organizing them thoughtfully, you can also save time, minimize anxiety, and set yourself up for good financial health in the future.

Take action today to organize your tax documents and set up a system for retaining them effectively. Your future self will thank you.