The IRS and most states have a three year statute of limitations for both conducting an audit and issuing refunds. Most taxpayers know they must retain records associated with their income tax returns in the event they are selected for an income tax examination. However, what truly needs to be retained by taxpayers, and for how long?
Under the three year statute of limitations, the IRS and state taxing authorities are barred from conducting any audit once the time period has elapsed. If a taxpayer files a personal income tax return before the April 15th due date, the statute of limitations period begins on April 15th. For example, if a taxpayer filed a 2013 Form 1040 on February 26, 2014, the statute of limitations began April 15, 2014 and expired on April 15, 2017. If a taxpayer filed their personal income tax return on extension, the statute of limitations period begins on the date the income tax return was filed. Thus, taxpayers who filed their 2013 income tax returns near the extended due date of October 15, 2014 can still be audited, since the statute of limitations remains open through this fall.
Amended income tax returns are subject to the same rules. For example, if a taxpayer forgot to claim a deduction for real estate taxes for a particular year, an amended federal income tax return (Form 1040X) can be filed to request a refund, as long as the statute of limitations has not expired. Lastly, there is one very important rule to note regarding the statute of limitations: if a taxpayer fails to file a personal income tax return within three years of the due date, they risk forfeiture of any refunds that they may have been entitled to.
Every taxpayer should retain bank statements for at least three years after filing their income tax returns. During an audit, the IRS will routinely request all bank statements to search for unreported income. If the taxpayer is unable to provide copies of bank statements, the IRS can issue summonses to financial institutions to obtain this information. In addition, any tax documents that relate to the tax return such as W-2 forms, 1099 forms, Schedule K-1’s, Form 1098 on which mortgage interest is reported, real estate tax bills, and charitable contribution acknowledgement letters should be retained for at least three years. As a general guide, most taxpayers can now discard their records for the years 2012 and earlier, as the statute of limitations has expired for those tax years.
Some records should never be discarded. These include, but are not limited to, prior year tax returns and the closing statements on the purchase of real estate. On the other hand, many taxpayers retain various records unnecessarily. For example, if an individual did not claim a home office deduction, there is no reason to retain years’ worth of utility bills. Also, if purchases made using credit cards did not factor into any tax deductions, then there is no reason to retain the credit card statements.
Careful record-keeping should go hand-in-hand with carefully discarding any records that contain sensitive, personal information. In today’s environment, identity theft is rampant. Identity thieves are known to rummage through trash (sometimes referred to as “dumpster diving”) in search of another person’s personal information. Any documents containing social security numbers, credit card numbers, bank statements, PINs, and other personal and financial information should be properly destroyed in the course of being discarded.