How long to keep tax records
While there aren't specific rules about keeping your business records in general, IRS rules are quite clear that tax records should be preserved for at least three years – longer in some cases. But that doesn't mean you'll need to hang onto those tax records indefinitely.
No one wants to be a hoarder, but every business owner should make it a regular practice to organize and file their past tax records. This article will help you understand which tax forms you'll need to keep and for how long.
Why should I keep tax documents?
Business reports can be beneficial for any company, as this data can be used for planning and strategy. Using software to accept payments can put you ahead of the game by keeping your transaction records organized and easily accessible.
Your tax documents can serve a variety of additional purposes. In fact, your tax records can improve your relationship with the following individuals and agencies:
Internal Revenue Service
First and foremost, keeping your tax records ensures that you comply with internal revenue service (IRS) rules. You may need these tax documents if you need to file an amended return while failing to keep them can leave you vulnerable to an IRS audit.
Looking for a small business loan? Many lenders and financial institutions will expect to see numbers before they approve your loan.
Your business documents provide information about the size of your business and your sources of income. Your most recent tax return might be used to provide potential lenders a snapshot of your company's overall success.
Some landlords may want to verify your gross income before giving your business access to a rental property or retail space. Your tax return or other tax documents might strengthen your negotiating position and ensure that you get the space your business requires.
If you ever decide to sell your business, potential buyers may want to see your tax records to better understand the history of your business and its potential income.
Your financial documents may prove valuable if you're ever on the receiving end of a lawsuit. Make sure to check with a lawyer who can provide legal advice if you're in this position, as your professional counsel may guide you on which types of business, tax, or property records may be valuable for your case.
How long to keep tax records
The Internal Revenue Service (IRS) generally requires individuals and business owners to keep records for three years from the date that they file taxes.
Why three years? Three years broadly corresponds to the period of limitations, which is the period of time in which you can file an amended return or the IRS can audit you or your business.
However, there are several circumstances in which business owners should keep tax records longer than three years. How long should you keep your tax records? That will depend on the type of document you're using, as well as the circumstances surrounding it.
Business tax returns (3 years)
If you're a small business owner, you'll need to keep your tax returns for at least three years from the date you originally filed them. This is true for both your federal and state income tax returns and any supporting documents used to prepare them.
If you relied on a tax professional to prepare your taxes, you'll need to make sure to obtain a copy of your tax return for your own files.
This three-year period of limitations is important because two things can happen during this period:
- You may file an amended return
- The IRS may perform an audit
For example, if you discover that your business owes additional taxes, you have to file an amended tax return during this period of limitations.
Keep in mind that if you relied on tax software, you will likely have to pay additional e-file fees for your amended tax return.
After this period of limitations expires, you'll no longer be able to claim a tax refund on your return. If you were entitled to any money back, you're out of luck; it now belongs in the hands of the government.
Returns with omitted income (6 years)
Before you get out the shredder, be aware that the statute of limitations doubles for tax returns in which you omit part of your income.
In other words, if you fail to report income and the omitted income exceeds 25% of the gross income shown on your tax return, the statute of limitations extends to six years from the date that those taxes were due.
Returns with Bad Debt Deduction (7 years)
The period of limitations is even longer for businesses with a bad debt deduction or worthless securities reported on their federal tax returns.
What is a bad debt deduction? A "bad debt" occurs when one of your clients just doesn't pay. You can deduct this from your income tax returns, which can lower the total amount of taxes you owe.
Worthless securities work much the same way. A worthless security is a stock or a bond that no longer has market value. While the IRS requires that investors pay capital gains tax on investments that generate revenue, a worthless security can be written off as a loss on your federal return.
If either of these tax deductions appears on any of your tax returns, you should keep these tax records for seven years.
Because of the specialized nature of these two deductions, you should also make sure to retain any records related to the bad debt or worthless security for seven years. This is particularly true of a bad debt deduction, as you may be asked to provide supporting documents to indicate the amount of debt as well as the steps you took to attempt to claim that debt.
Receipts (3 years)
Most business owners will want to claim business expenses on their tax returns. Claiming these expenses may entitle you to a tax refund. But what if you don't have the receipts?
While it's important to document the deductions you make on your tax return, many tax professionals admit that a receipt isn't always necessary for every expense. For instance, you may not require a receipt in the following circumstances if the expense is:
- Less than $75.00 (though this doesn't apply to lodging)
- Used for transportation
- Falls under an accountable plan with a per diem allowance
But that doesn't mean these deductions can't be questioned in the event of an audit. For that reason, your receipts should be kept with the rest of your tax-related documents. Without these receipts, the IRS may accuse you of filing a fraudulent return, or at the very least, assess additional tax penalties.
The period of limitations is generally three years, though as we noted above, you may wish to keep these receipts (along with other tax documents) for as many as seven years if your tax returns contain omitted income, bad debt, or worthless securities.
Employment Tax Records (4 years)
If your business has employees, you'll need to retain your employment tax records for up to four years from the due date. For reference, your employee's tax records should contain information about the employee, as well as document their taxable income.
This information should include:
- Employees' names, addresses, and Social Security numbers
- Employees' positions and dates of employment
- Wages, annuities, and pensions and dates of payment
- Taxes withheld, including FICA and Medicare
- Records of tips or other benefits paid (when applicable)
- 1099 documents for independent contractors
If your company made any traditional IRA contributions, your tax records will likewise record this data.
Bottom line: the seven-year rule
One of the more common pieces of tax advice is to keep all of your tax records for seven years. This ensures that you're totally protected from any possible audits or other investigations into your filed tax returns. Be advised, however, that the three-year period still applies for those seeking a tax refund or to amend their return.
Additionally, some banks and insurance companies may have additional requirements for the length of time you need to keep records. Check with your insurance company or lender for any policies that may require you to keep records of your taxable income for longer periods of time.
Returns filed more than seven years ago are not necessarily free of the threat from an audit, however. Even after the period of limitations expires, the IRS can still investigate your business if they believe you filed a fraudulent return. For that matter, there's no limitation at all if you failed to file your annual tax returns.
Thankfully, the IRS has a high burden to demonstrate that you've filed a fraudulent return. And if you've used tax preparation software for returns filed in the past, you can store these records indefinitely in electronic form.
Where can you keep your tax records?
This raises an important question. If your business is expected to retain seven years' worth of income tax returns, where can you store these documents?
Saving paper copies of your past tax returns can be a logistical headache, especially for startups, where space is already at a premium.
Thankfully, the IRS has already ruled that electronic copies of your tax returns and other documents are legally the same as the originals. This means you won't have to keep records in file drawers or boxes where they can age to the point of being illegible.
Be careful, though, that you keep records of your income and expenses in-house. Never rely on banks, insurance companies, or tax professionals to retain copies of your records for you.
Past and future tax returns should be retained by your company directly for seven years, if not more. The good thing about a digital system is that you can store your tax returns and related records indefinitely, all without sacrificing a square inch of office space.
Don't get audited...get organized
If you're already thinking about preparing future tax returns for your small business, now is a good time to consider how a cloud-based system can transform the way you do business.
At Invoice2go, a Bill.com company, we provide cutting-edge solutions so businesses can be more agile and efficient. The software we provide can help you stay organized so you can be prepared for tax season. We can help you get organized, so you can worry less about getting audited.
Frequently asked questions
If you need specific tax advice, it goes without saying that you should seek a tax professional. But here are some of the more common tax preparation questions we hear from small business owners.
You can only claim a tax refund within three years from the date your taxes were initially due. However, if you need to report income to the IRS that did not appear in the gross income shown on your tax forms, you can do so after this initial period expires.
If you owe less than $50,000, you can ask for a 72-month installment plan to pay your debts. If you owe more than this, you may have to negotiate for a plan of the same length.
Businesses pay unemployment tax on their employees. Each time you hire someone, you must report the hire to the state tax authority, who will use the final headcount to calculate your unemployment tax rate. This tax money can then be used to pay eligible employees for unemployment benefits.
Businesses that own property must pay tax in the same way that individuals do. In some cases, the IRS will allow you to deduct portions of your property tax from your federal return, but this is largely up to local tax authorities to set the circumstances in which this is allowed.
If the property is obtained in a business sale, both you and the seller must share in the property taxes.