Tax records you can toss

By Jeff Schnepper

I can build a papier-mâché replica of the Empire State Building with my old tax records. But unless financial nostalgia brings you a warm feeling on a cold night, you probably want to dump your old records as soon as possible, like the rest of us.

You have more sense than that -- I hope. You know that within two weeks of your bonfire, the IRS is going to demand exactly those documents you burned.

So, what information do you have to keep? And how long do you keep it?

Let's start with your magic shield of absolute protection from the Internal Revenue Service -- the statute of limitations. This limits the number of years during which the IRS can audit your tax returns. Once that period has expired, the IRS is legally prohibited from even asking you questions about those returns.

The concept behind it is that, after a period of years, records are lost or misplaced, and memory isn't as accurate as we might hope. There's a need for finality. Once the statute of limitations for a certain year has expired, the IRS can't go after you for additional taxes. But you can't go after the IRS for additional refunds, either.

How the 3-year rule works

For assessment of additional taxes, the statute of limitation runs generally three years from the date you file your return. If you're looking for an additional refund, the limitations period is generally the later of three years from the date you filed the original return or two years from the date you paid the tax. So for your 2007 return (filed in 2008), the three-year rule expires in 2011. For the 2009 return you file in 2010, the statute of limitations expires in 2013.

There are some exceptions:

• If you don't report all your income and the unreported amount is more than 25% of the gross income actually shown on your return, the limitations period is six years.

• If you've claimed a loss from a worthless security, the limitations period is extended to seven years.

• If you file a fraudulent return or don't file at all, the limitations clock never begins to run. The IRS can, in fact, get you at any time.

If you're deciding what records you need or want to keep, you have to ask what your chances of an audit are. A tax audit is an IRS verification of items of income and deductions on your return. So you should keep records to support those items until the statute of limitations runs out.

Assuming that you've filed on time and paid what you should, you have to keep your tax records only three years. But some records have to be kept longer than that.

Video: The odds of an audit

Remember, the three-year rule relates to the information on your tax return. But some of that information may relate to transactions more than three years old.

Here's checklist of the documents you should hold on to.

Continued: Capital gains and losses

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