rULE OF THUMB FOR KEEPING TAX RECORDS FROM A FORMER IRS AGENT
Key Takeaways
- Standard rule of thumb for your personal and business tax records: keep everything from the past five years.
- Successful audit preparation is dependent on accurate document retention. Having a tax professional to aid in the audit process can help alleviate stress and confusion.
- Digital storage of tax documents allows for easier organization, sharing and accessibility in the event of an audit.
CWA tax professionals are often asked how long clients should keep tax records related to income, expenses, deductions or investments, which sounds like a simple enough question. But it’s not so straightforward when it comes to busy dental professionals and their practices. While the answer to “how long to keep” can vary depending on a multitude of factors, there are a few basic rules that can simplify the decision-making process for you. This way you aren’t tempted to toss it all in the trash out of frustration or keep it forever out of fear.
WORKING AT THE IRS
“As an agent in the Large Business Investigation division of the IRS, I helped build pilot programs for IRS agents to collaborate with large businesses during the audit process,” CWA Associate Financial Planner Kellee Harrigan said. “I also witnessed relatively painless audits when business owners had the proper documentation in their tax records to support their claims and deductions. Although most CWA client practices would be audited by the IRS Small Business Investigation division, that key principle – keep organized with thorough documentation – can help you avoid the same audit headaches.”
STANDARD PRACTICES FOR KEEPING TAX RECORDS
The standard rule of thumb for your personal and business tax records: keep everything from the past five years. However, to maximize your yearly returns, you may need to keep some records longer. For example, Harrigan recommends:
- For business returns, keep all records of equipment purchases from the initial date of purchase for as long as your practice owns the equipment. If you sell the equipment, even after five years, you will need accurate records to maximize deduction(s) or account for gains.
- For personal returns, keep all records for stocks and bonds from the initial date of purchase for as long as you own the stocks or bonds. Again, even after five years, you will need accurate records to maximize personal deduction(s) or account for gains.
“I always recommend people keep a copy of their actual tax return indefinitely,” says Harrigan. “Do not rely on anyone else to keep copies of your returns. Most professionals do not keep records of their past clients after seven years.”
SOME IRS RECOMMENDATIONS FOR KEEPING TAX RECORDS
The IRS recommends keeping all tax returns and supporting documentation for a minimum of three years but keeping some for up to seven years. Some guidelines from the feds:
- Keep real estate-related records indefinitely, for as long as you own the property. You will need them to accurately figure depreciation, amortization or depletion deductions, and to figure the gain or loss when you sell or dispose of the property.
- Keep records for seven years if you file a claim for loss from securities or write off “bad” debt.
- Keep records for seven years if you think you may need to file an amended business or personal return in the future.
- Keep employment tax records for at least four years after the date that the tax becomes due or is paid (whichever is later).
For records that are no longer needed for tax purposes, the IRS recommends confirming that the documents are not needed for other purposes. For example, an insurance company or creditors may require you to keep them longer than the IRS does.
DOCUMENTATION FOR YOUR PRACTICE
In addition to making any possible audits smoother, thorough documentation ensures your practice and personal returns maximize deductions and credits, and keeps your tax bills as low as possible. Documentation also makes it easier to evaluate budgets and spending habits, ensuring your financial plan is on track.
Harrigan also recommends making sure your practice does not overlook these areas when it comes to tax records:
- If your practice reimburses employees for expenses, be sure employees fill out an expense reimbursement form in detail and keep all the forms by calendar year, along with all submitted receipts. The IRS can treat the reimbursed expenses as wages to the employee if the practice does not have a reimbursement policy in place.
- If your practice offers employee flexible spending accounts as a benefit, be sure to keep all documentation and receipts for those reimbursements by calendar year.
SELLING YOUR PRACTICE
When transitioning your practice to either a private or DSO sale, it’s important to maintain tax records and legal documents after the sale. Harrigan recommends:
- Keeping legal documents indefinitely.
- Keeping documentation of assets sold (purchase receipts, depreciation taken, etc.) for at least 5 years after the sale if no rollover equity was received as part of the sale. If rollover equity was received as part of the sale, then keep these documents 5 years after owning any rollover equity.
SURVIVING AN AUDIT
CWA’s tax department works with a majority of CWA clients on tax preparation services for federal and U.S. state returns, along with other services. For clients that are audited, successful results depend on good recordkeeping.
“One of the most important parts of audit preparation is maintaining documentation that supports the income, deductions, and credits reported on a tax return,” says Senior Tax Research Manager Yunnice Chang. “Taxpayers are ultimately responsible for keeping records that substantiate the positions taken on their returns. When documentation is incomplete or unavailable, it can be more difficult to support deductions and credits during an examination.”
For CWA clients who face an audit, our team often assists by reviewing IRS notices, communicating with taxing authorities, compiling supporting documentation, monitoring deadlines and representing the client to the IRS when authorized. While successful audit outcomes still depend on the quality of the underlying records, having experienced professionals by your side to help navigate the process can make an examination significantly less stressful.
STORAGE AND DIGITIZATION
Maintaining organized digital records is an important part of modern tax recordkeeping. Whether records originate in paper or electronic form, taxpayers should ensure that supporting documentation is stored in a secure location, properly backed up and readily accessible if needed for financial planning, tax preparation or an IRS examination.
Digital records can simplify document sharing with tax advisors and other institutions, reduce physical storage needs, and help preserve important records over long retention periods. When implementing a document retention system, consider:
- How electronic records will be organized and retrieved
- Whether records are regularly backed up
- How sensitive information will be protected from unauthorized access
- Whether digital copies are complete and legible
- How paper documents containing sensitive information will be securely destroyed when no longer needed
A CWA ADVISOR CAN HELP
Looking to stay organized, minimize your personal and professional tax liabilities, and plan for a prosperous financial future? Set up your free consultation today and talk to a CWA advisor about specific guidance on keeping and organizing your tax records.
