One of my clients is a marriage counselor. We’ve been friends for many years and shared many humorous stories. However there is one piece of advice he gave me with great sincerity. He said that wives remember the good things we do for three hours and the bad things we do for a lifetime. I was disappointed to hear that because I can only remember the good things I say and do.
So today we want to talk about how we can remember what we put on our tax return years later.
- Statute of limitations.
I am often asked how long we should keep our records. The knee-jerk answer from the media is always the same, the statute of limitations on an income tax return is three years and therefore you need to keep your records for three years. After that you can destroy them.
The problem with this analysis it’s only partially true. The statute limitations for a regular tax return is three years and therefore you really should keep your records for at least three years. However special items have special statutes that are much longer. Let me give you some examples:
– If you accidentally omit more than 25% of your income, the statute of limitations is six years. When someone pays us income, they’re supposed to file a form 1099 with the IRS and we are supposed to report that form 1099 information on our income tax return. The IRS then matches that form 1099 income with the income on our form 1040. If there’s a difference, then a correspondence audit often results. It is common place for people to forget some of their 1099 income, though it is not common for them to forget income that comprises more than 25%. In any event, the statute of limitations can be six years when there is a substantial unreported item of income. If the omission is deliberate- fraudulent-there is no time limit.
– many people have losses from their businesses. These losses carry forward for many years. They are particularly significant in startup businesses where we have a lot of early expenses and the income is delayed for several years. So the statute of limitations may only be three years on that return but your carryforward may be 15 years or more. When you get audited in a later year the IRS will ask you to justify that operating loss carry forward, and can even audit each of the earlier years on that issue.
– likewise if you were an investor and sold a stock , bond, or other asset at a loss, the statute of limitations may be closed but your carryforward loss may be in jeopardy unless you keep those cost records.
-Another example of this would be the sale of an asset at a gain. The form 1099 will reflect the sale of the asset but not the cost of that asset. I frequently see people who sold stocks or bonds with an investment firm that has sent a form 1099 to the IRS. In those cases you will have to go back and prove the cost of that stock or bond or asset that was sold.
– Another example would be a home. You can defer much of the gain on the sale of your home indefinitely if you have proper records showing what it cost you and improvements you made. People often buy their homes and live in them for many years. They will struggle to go back and remember what it cost them, including all the repairs and maintenance expense, the roof replacement, repainting, landscaping that sort of thing. This could be significant if you have a large gain on the house or if you bought it at an low price. Again the statute of limitations on that old year may be closed but the cost may be critical to you in a later year.
- Electronic Storage
Folks, it seems to me that one of the good things technology provides us is an ability to scan our records and hold onto them indefinitely in a permanent file. So long as you have an adequate back up then this would help protect you beyond that three-year period.
Taking this one step further, it would be ideal if you could keep all of your records, even those that you use within the three-year period, on an electronic hard drive. In this way if you were audited within the statute of limitations you would have good records that could be re-examined to protect your tax return.
With that in mind, I have opened a new directory in my computer that is going to contain all the good things that I say and do in the future for my wife . When she reminds me of the boneheaded innocent mistakes that I am prone to make, I will immediately be able to access offsetting and far more valuable good things that I did and said.
But would she even listen ?