In Fiscal Year 2024, the IRS closed 505,514 tax return audits, recommending over $29.0 billion in additional tax.
The burden of proof is on you
You might think the IRS has to prove you owe them money. The reality is the opposite. The burden of proof is entirely on the taxpayer. You must substantiate every single deduction, credit, and expense you claim on a tax return. If you cannot produce the original document during an audit, the IRS can simply disallow the deduction. This leads to additional tax. It leads to interest. It often leads to penalties.
Record retention is not just about cleaning out old filing cabinets. It is a vital part of financial defense. A disorganized file room is a liability. A missing receipt is a financial leak. You need to know exactly what to keep to protect yourself or your clients. You also need to know what to throw away to protect data privacy. This guide outlines the federal rules in plain English so you can make confident decisions about your files.
Key takeaways
- General Rule: Keep tax returns and supporting documents for 3 years after filing.
- Substantial Error: Keep records for 6 years if the return omits more than 25% of gross income.
- Bad Debts: Keep records for 7 years if you claim a loss from worthless securities or bad debt.
- Payroll: Keep employment tax records for at least 4 years after the tax is due or paid.
- Assets: Keep property records until you sell the asset plus the limitation period.
The Federal Baseline: Three Years
The standard period of limitations for a federal income tax return is three years. This is the amount of time the IRS has to initiate an audit after you file. Consequently, this is the minimum amount of time you must keep the records that support that return.
General rule: keep supporting records for 3 years from the date you filed your return or 2 years from the date you paid the tax, whichever is later.
You need to be careful about when this clock actually starts. The clock starts on the day you actually file the return. However, there is one exception. If you file early, the clock does not start until the due date of the return. For example, if you file on March 1st but the due date is April 15th, your three-year period begins on April 15th. If you file late or obtain an extension, the period begins on the day the IRS receives the return.
Special cases: Six and seven years
The three-year rule covers routine returns. However, the IRS has a longer reach when they suspect significant errors. You need to account for these exceptions in your retention policy because you often do not know if an error exists until years later.
Keep records for 6 years if you omitted more than 25% of your gross income.
This six-year rule applies to substantial underreporting. It gives the IRS double the standard time to find the missing income. Since you cannot always predict if an auditor will allege that income was underreported, many tax professionals default to a longer retention period for all income records just to be safe.
There are even longer requirements for specific types of deductions. Keep records for 7 years if you file a claim for a loss from worthless securities or a bad-debt deduction.
These claims are complex. Proving that a debt became “worthless” in a specific year is difficult. The IRS allows itself more time to investigate these specific claims. You must ensure that any client writing off bad debts holds onto the relevant contracts, unpaid invoices, and collection attempts for this full seven-year window.
Employment tax records
Payroll taxes operate under a completely different set of rules. The cycles are shorter and more frequent, but the retention period is strict.
Keep employment tax records for at least 4 years after the date the tax became due or was paid, whichever is later.
This four-year requirement applies to a wide range of documents. You must keep your employer identification number. You must keep records of the amounts and dates of all wage, annuity, and pension payments. You need to keep copies of every return filed. You also need dates of employment for each employee. The IRS is very aggressive regarding payroll compliance. Missing payroll records can lead to personal liability for business owners. Do not purge these files early.
Asset and property records
Treating property records like annual expense receipts is a common mistake. You cannot throw away property records after three years. You need these records to prove your basis in the asset. The basis is usually the cost of the property plus improvements minus depreciation.
When you sell a building or a business asset, you must calculate the gain or loss. You cannot do this accurately without the original purchase documents. You also need records of every improvement made over the years. You need records of all depreciation claimed in prior years.
Therefore, you must keep basis and asset records until you dispose of the property. Once you sell the property, the clock starts ticking. You must then keep those records for the period of limitations that applies to the year of the sale. This effectively means keeping property records for the entire life of the asset plus another three to six years.
Supporting documents: What counts as proof
A credit card statement is usually not enough. The IRS wants to see exactly what you bought. A line on a bank statement that says “Office Depot” does not prove you bought office supplies. It could have been a personal gift.
You need to keep the actual sales slips, invoices, receipts, and canceled checks. These documents must clearly show the payee, the amount, the date, and a description of the item purchased. For travel, entertainment, and transportation, the rules are even stricter. You need to record the business purpose of the expense at the time it occurred.
Electronic recordkeeping
The days of warehousing paper boxes are ending. The IRS has modernized its rules to accept digital records. You do not need to keep original paper receipts if you have a compliant electronic storage system.
The electronic system must be reliable. It must produce legible and readable copies. You must be able to index the records for easy retrieval. The most important requirement is integrity. You must ensure that the digital copies cannot be altered after they are created.
You should scan documents regularly. Back up your data to a secure off-site location or cloud service. Test your backups occasionally to ensure the files are not corrupted. If an auditor asks for a specific receipt, you must be able to print a clear copy. If your digital records are messy or unreadable, the auditor can reject them and demand the originals.
Best practices for tax professionals
If you run a firm, you are managing risk for hundreds of clients. You need a higher standard of organization than an individual taxpayer.
First, establish a written document retention policy. This document should state exactly how long the firm keeps client files. It should state who is responsible for the original documents. You should include a summary of this policy in your client engagement letters. This prevents disputes later if a client asks for a ten-year-old file that you have already destroyed.
Second, separate your files. Keep a “permanent file” for each client that rolls over from year to year. This file holds long-term documents like partnership agreements, stock basis records, and depreciation schedules. Keep a separate “annual file” for each tax year that holds the specific receipts and workpapers for that return. This makes it easy to purge old annual files without accidentally destroying vital long-term data.
Third, check state laws. This guide focuses on federal rules. Your state may have a longer statute of limitations. Some states have four-year or five-year statutes for tax assessments. You must follow the longest rule. Check with your state tax agency or legal counsel to confirm the local requirements.
Why following the rules saves you time
You do not want to be the professional who tells a client that their deduction is valid but you cannot prove it. Proper retention is about confidence. It allows you to close out an audit quickly. It allows you to answer client questions about old transactions instantly. It reduces the fear of regulatory scrutiny.
For firms that want a simple way to centralize and search retention records, see MagicBooks.
Common questions about retention
Q: How long should I keep a filed federal income tax return and its supporting receipts?
A: Keep the return and supporting records at least 3 years from the date you filed or 2 years from the date you paid the tax, whichever is later. This is the IRS federal baseline for most items.
Q: If a client omitted more than 25% of gross income, how long do I advise them to retain documents?
A: Retain supporting documents for 6 years. The IRS can assess tax for that longer period when income is substantially underreported.
Q: For a client claiming a worthless-security loss or bad-debt deduction, how long must records be kept?
A: Keep those records 7 years from the return due date for that year. See Publication 583 / Topic No. 305.
Q: How long must an employer keep payroll and employment-tax records?
A: Employers must keep employment tax records at least 4 years after the date the tax became due or was paid, whichever is later.
Q: How long should I keep documentation of property basis?
A: Keep basis and asset records until you dispose of the property and for the period of limitations that applies to the year of disposition. In practice, keep them until the asset is sold plus the usual limitation period.
Q: Are scanned or electronic copies acceptable instead of paper originals?
A: Yes. The IRS accepts legible electronic copies if they are accurate, accessible, and retained in a way that preserves integrity and allows retrieval. Maintain backups and an organized index.
Q: When should records be kept indefinitely?
A: Keep records indefinitely if you never filed a return for that tax year, or if you filed a fraudulent return. There is no statute of limitations in those situations.
Q: Does a state requirement ever override the IRS retention period?
A: State rules or specific grant/contract terms can require longer retention. Always check the applicable state tax authority or the contract terms. Federal periods are minimums.
Q: How long should a tax preparer keep client files and workpapers?
A: Firms should adopt a written retention policy. Many professional bodies recommend keeping client files at least as long as the period during which the return may be audited. This is commonly 3 to 7 years. Some engagement rules or regulators may require longer. Follow AICPA guidance and any client contract terms.
Q: If a client receives a notice from the IRS, how does that affect retention timing?
A: If you receive an IRS notice relating to a particular year, preserve all records for that year until the matter is fully resolved and any appeal periods expire. Notices can restart or extend limitation periods. When in doubt, keep them until resolution.
