“Man forced to put off retirement for two years due to lost tax records.” Could that happen to you? Yes, it could. Or worse.
One of the most frequent questions that comes to TaxMama is — Can I throw out my tax records? Really, how long must I keep them?
Being a pack rat, TaxMama’s preferred response is, hold on to everything forever. But were you to follow that advice, you’d be living with a mountain of paperwork, files and junk, like Monk’s hoarder brother. Clearly, this is not a good solution.
What are reasonable guidelines to avoid hoarding, while protecting yourself?
According to the IRS, individual taxpayers should keep returns for three to six years. Non-filers and fraudsters should keep their records forever. (See the IRS guidelines on record retention.)
The IRS is wrong about this.
Let’s look at the case of David, a teacher. He is a responsible and ethical person who always files his tax returns on time — and correctly. He should be in that three-to-six-year category. Or so he thought.
Recently, David decided to clean out his old files and shred all his un-needed records. He kept the last decade’s worth. No problem, right?
Right. Until he pulled his Social Security record to look up his retirement benefits. He found they didn’t show enough quarters of work. David was short two years. The Social Security Administration (SSA) was missing data from years when he had a job outside the school district.
David started working in his teens. Surely, he has 40 credits (or 10 years) in the system? Yes, he does. But having gotten rid of his older tax returns, he can no longer prove it. David asked the IRS for copies of certain missing years, dating back to about 20 years ago. Not only did the IRS not have copies, but they didn’t even have electronic transcripts going that far back.
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What can David do? Not a thing. He accepted this philosophically, knowing he must work two more years to build up his benefits.
How can you avoid this problem? It’s easy. Never, ever throw out a tax return. The tax returns themselves don’t take up much space. If you need to thin out the files, you could probably shred the back up — but hold on to the W-2s and 1099s. They may turn out to be valuable.
This lesson is especially important to teachers and school or college administrators. Although your district or union may have opted out of the Social Security system in favor of its own retirement system, you may have worked for other employers or operated your own business to build up Social Security benefits. Pull your own SSA records immediately and make sure they are correct — or to see how many quarters you still need in order to collect benefits.
So, reason No. 1 to keep your tax returns forever is — to protect your Social Security or retirement benefits.
Reason No. 2 — You bought things. Whether investments or assets and equipment for your business, keep those purchase documents for at least six years after you sell those assets, or finish rolling them over (for those indulging in tax-free exchanges). If you’re ever audited during the time you own those assets, the IRS can request the original purchase documents — even if the purchase was 10 years ago. Why? It’s still on your tax return as a depreciable asset; or you reported the basis when you sold the asset.
Reason No. 3 — You move around often, or have had income in other states — either via a job or an investment that issues a K-1. A heart-wrenching problem TaxMama® often hears about is people who suddenly find their IRS refunds being grabbed by other states (via the IRS collection system) with no apparent warning. The taxpayer had no idea they owed any money. In some cases, the tax debt might be 10 or 20 years old.
How can the state get away with this? As with the IRS, the state tax system has no statute of limitations on audit or collections for tax returns never filed. If you don’t file and tell them that you don’t owe money, they will assume you do. The state then creates an assessment, which can sit on the books for years waiting for you to respond (if they know where to send correspondence). Suddenly, someone clever looking to raise easy money for the state turns all those delinquent balances over to the IRS — and your refund gets hit.
In fact, we’re at the beginning of one of these fights right now. Steve just got a notice from an eastern state claiming that he owes tax on about $4,000 worth of income from a 2010 K-1. The state saw $4,000 worth of investment income on a K-1 and ignored the $8,000 worth of business losses on the same page. This will be resolved easily — because we have the records to prove his losses. Without them? He’d have to pay taxes, a variety of penalties, and interest on the whole shebang.
If a state comes after you, you may be able to prove you don’t owe them money, too. How? By using your tax return copy for the year in question, you can prepare a tax return for the state collecting from you. You probably have enough deductions or write-offs to wipe out the taxes the state thinks you owe. You may also be able to get the benefit of a tax credit for taxes paid to another state. (Though that may only be available if you file a resident tax return.)
There’s inexpensive tax software back through 2000 at TaxACT. Anything older than that — you must do manually or find a nice, gray-haired tax professional who’s been in business for 20 or 30 years and still keeps the discs (and possibly a DOS computer) to run the software.
Reason No. 4 — Insurance records. The policy may be paid in full, so you’ve forgotten about it. But should you get hurt, disabled or die, it would be really valuable to your family. Companies change hands and their policy rules change. If you have the original documents, you can prove they owe you more than they would currently pay out.
Reason No. 5 — IRA and retirement plan contributions. You get two benefits for keeping these records. First, your state may have had a lower deduction for your contributions. That means, part of your distribution won’t be taxable for state purposes. Second, you may have made non-deductible contributions for federal (and state) purposes in some years. So part of your distribution won’t be taxable for the IRS either.
And of course, there is that universal law — the minute you throw something out that you haven’t looked at or touched in decades — you will need it desperately.
according to yahoo.com
