What Are Tax Returns?
A tax return is a form you complete and submit to the Internal Revenue Service (IRS) every year. Your tax return reports your income, expenses, and other tax information to the IRS. By submitting your tax return, you calculate your tax liability and can possibly request a refund for tax overpaid.
Why Are Tax Returns Important?
Not everyone is required to file a tax return in the U.S. Your tax filing status and gross income determine whether you are required by law to file tax returns. Even if you are an immigrant on a visa, you may be required to file taxes.
It could be useful to file your taxes, even if you aren’t required to by law. In some cases, you may be able to claim deductions that reduce your tax liability and could even result in a tax refund!
If you are required to file your taxes but don’t file your tax return in time, it could mean late filing penalties applying. You want to avoid this at all costs, as this penalty just increases your liability over the long run.
How Long Do You Need to Keep Tax Returns?
Let’s get into the critical question. How long do you need to keep tax returns?
The only reason you need to keep your tax returns and tax records is if the IRS has questions to ask you about it. So, the answer to how long do you need to keep tax returns depends on how long the IRS has after you submit your tax return to come back and ask you questions. If the IRS comes back to ask you questions, you need these records as a backup to prove everything you put on your tax return.
The general rule of thumb for this is three years. In most cases, there is a three-year statute of limitations that apply. If there is nothing wrong with your tax return, the IRS can’t query your tax return after these three years expire.
But there are important exceptions to the three-year statute of limitations. In these situations, you need to keep your records for longer.
If you substantially underestimated your income, the statute of limitations is six years. When will the IRS regard your income as substantially understated? If you understated it by 25% or more of your gross income. For example, if your actual gross income is $200’000, but you claimed it was $100’000, it would be regarded as substantially understated.
The six-year statute of limitations will also apply if you substantially overstated the cost of your property so you could minimize your taxable gain. If you sold a piece of property for $200’000 and claim you originally paid $100’000, but in fact, you paid $50 000, the IRS has six years to take action against you.
Keep in mind, you have to keep records of the property you purchased for as long as you own the investment. If you ever sell the property, you will need these records to prove the cost you initially paid for the property.