Proper record keeping and accounting practices make it easier to file your business taxes each year, but the need for organization doesn't end once you've successfully sent the IRS your tax return. If the IRS finds a mistake or problem with your tax situation, or you get selected for an IRS audit, they'll want to see your past returns and supporting documentation, and you could be penalized if you can't produce them for review (along with additional tax burden!). Make sure you keep your business out of hot water by learning how long to keep tax records.
It's not just the IRS's recommendations that you'll need to follow because states have their own laws governing tax audits and amendments too. Find out if you live in a state that requires state tax documents to be kept longer than usual.
Finally, some tax-related documents are simply more important than others and should be kept indefinitely, whereas other business records can be tossed after a period of time. Following proper disposal procedures can protect your business and your employees from identity theft, so when you're ready to discard old tax documents, be sure to shred them to deter malicious activity.
TL;DR (Too Long; Didn't Read)
A copy of your federal tax returns and worksheets should be kept indefinitely, but supporting tax documents can typically be shredded after three to six years depending on the type of document.
What Constitutes Tax Records?
It's a good idea to indefinitely keep the final copy of your annual tax returns and the acknowledgment letter from the IRS that confirms they received your return each year. What about those folders full of receipts that show things like out-of-pocket expenses not covered by insurance, non-reimbursed business expenses and donations to charity? What about cashed checks, pay stubs, bank statements and W-9s? All of those receipts and stubs constitute tax records and help an accountant (and later, perhaps, a tax auditor) confirm that your deductions and income statements are accurate.
It's these tax records that can easily fill a small box each year for a small business. After a while, you're left wondering if you can get rid of those boxes in your latest spring-cleaning purge. All they do is collect dust, and if the IRS wanted to look at them, surely you would have already been contacted, right?
The government isn't necessarily known for its speed and efficiency, so it can take time for the IRS to follow up on mistakes or to discover suspicious trends in your tax returns. However, the government has a time limit for initiating audits. After that period of time, you don't need to keep all of your documents because you won't be expected to produce them as evidence.
How Long to Keep Tax Records
The IRS advises that most businesses keep tax records for three years since the date the return was filed or for two years since the date the tax was paid (whichever happens later). However, there are exceptions to the statute of limitations for tax returns. For example, if you claimed a "loss from worthless securities or bad debt deduction," keep those tax records for seven years.
The IRS also recommends holding on to your tax records for six years if you knowingly failed to report your full income. Employment tax records should be retained for four to six years since the tax's due date or payment date (whichever happens later). Keep all sales records, invoices, payment vouchers, accounts payable and accounts receivable ledgers, expired contracts and cancelled checks for four to six years.
In a few cases, you should keep a copy of your tax records indefinitely. If you know you filed a fraudulent return, do not throw out those records. If you didn't file a tax return at all (even if you were not legally required to do so because your income was too low), keep those records indefinitely as well. Keep a copy of current contracts, cancelled checks for tax payments, audit reports, insurance claims, deeds, payments to retirement accounts and property records indefinitely as well.
State vs. Federal Statute of Limitations
The IRS handles federal taxes, so it's important to follow their guidelines when determining how long to keep tax records for your federal return. What about state and local taxes? Individual states can set their own period of limitations for tax audits. If you live in a state that can audit your taxes after the federal time period expires, you should still keep your tax records.
For example, most states require business tax records to be kept for three years from the filing date or payment date, but Arizona, Kentucky, Michigan, New Jersey, Ohio, Texas, Washington and Wisconsin require businesses to keep their tax records for four years from the filing date. Minnesota wants businesses to keep tax records for three and a half years. If you filed in Maine but understated your business income by more than 50%, you should keep those records for at least six years.
Lost or Thrown-Out Tax Records
Maybe you've had every intention of following the legal requirements for keeping tax records, but disaster has struck. Whether through a natural disaster or sheer accident, sometimes tax records get lost or thrown out. What can you do if the IRS comes knocking and wants to see those documents?
The best thing to do is to not wait for an audit in order to regather important tax documents, like forms W-2 or 1099. Be proactive. You can request a copy from the issuing organization, such as your employer or your bank. In some cases, the IRS itself can supply you with a copy of submitted tax documents, but expect to pay for it.
If you need to collect lost tax documents in order to submit a tax return with an upcoming deadline, you can also ask the IRS for a filing extension in order to give you enough time to assemble your documents and correctly fill in your tax return.
Mistakes on Tax Returns and Audits
If you discover that a mistake has been made on your tax forms, you have up to three years to submit an amended return. Use Form 1040-X to enter the corrected information and submit a hard copy via the mail. To amend state taxes, fill out the federal Form 1040-X and attach it to your state's amendment form (which is called something different by each state).
If the IRS catches a mistake, such as a missing or incorrect Social Security number, you could face a fine. Take care to review your original tax return thoroughly before submission. Get an early start during tax season so you don't feel rushed and accidentally enter incorrect information, and keep all pertinent tax documents well organized so your calculations are easy to confirm.
How to Safely Handle Tax Records
Tax records contain sensitive information, so when it's time to get rid of them, don't simply dump them in the trash. Instead, take a few extra precautions. At minimum, shred the tax records before bringing them to a recycling center if appropriate. Alternatively, you can repurpose shredded tax records by donating them to animal shelters as bedding for cages.
If you are extremely concerned about the information contained in your tax records, consider hiring a company that specializes in the shredding and disposing of confidential documents.
While you're waiting for the holding time period to expire, store your tax records in fireproof and waterproof locked boxes to ensure that the documents remain undamaged and that no tampering occurs. You may want to consider backing up your hard copies with electronic versions on an external hard drive or cloud software.