TAX NEWS - 2010

What records to keep, and for how long?

Q. We're moving to a new smaller location, and I want to go as "paperless" as possible. So we are going through more than 20 years of records. What are the legal requirements for retaining income tax records? And are scanned copies of old paper records acceptable to the IRS?


The retention period for retaining income tax records is based on when the IRS can audit a return and assess a deficiency or when you can file an amended return.

For most taxpayers, the period is three years from the original due date or the date the return is filed, if later. If a return includes a substantial understatement of income, which is omitting income exceeding 25 percent of the gross income reported, than the statute of limitations period is extended to six years.

A good rule of thumb is to add a year to the IRS statute of limitations period, so this means a minimum of four years, but to be on the safe side you should keep documentation for seven years.

State rules can vary, but the seven-year holding period should suffice for both federal and state, assuming both returns were filed at the same time.

There are certain records that should be kept indefinitely. Records that back up the cost basis of property that can be sold, such as investment property and business fixed assets, should be kept based on the record retention period for the year in which the property is sold. Tax returns, IRS and state audit reports, business ledgers, and financial statements are some examples of records to be retained indefinitely.

There are other non-tax reasons to retain records, such as insurance policies, leases, real estate closings, employment records and other legal documents.

The IRS permits taxpayers to store certain tax documents electronically. The rules permit taxpayers to convert paper documents to electronic images and maintain only the electronic files. The paper documents can then be destroyed.

The requirements are spelled out in IRS Revenue Procedure 98-25. In general it requires the taxpayer to retain copies of all "machine sensible" records used to prepare information and tax returns for the IRS.

In this era when invoices, orders and other "documents" may be entirely electronic, the IRS rules require taxpayers to be able to re-create these items if necessary. Additionally, the IRS requires taxpayers to provide the resources to access the data – appropriate hardware and software, for example – if the agency chooses to examine the records itself.

Every business should have a written record retention policy. Know what to save and for how long. And when it is time to discard records, be sure you do that properly, too. Your CPA can provide the advice you need to help you set up a good system.

Roy I. Levine CPA specializes in taxes at Levine, Jacobs & Co. LLC, Livingston. Participants in Ask the CPA are members of the New Jersey Society of Certified Public Accountants.