What the Statute of Limitations Means for Your Tax Records

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When you went into business, chances are you weren’t imagining grand evenings filled with paperwork. Maybe you thought tax records were a thing you would think about once a year and have your accountant deal with. But, the truth is, as you progress in business, you come to realize that record-keeping for your taxes needs regular maintenance. In fact, even after you breathe a sigh of relief once that return has been double-checked and sent off to the IRS, you may need to make a change to the document.

That’s where the statute of limitations comes in. It refers to the periods of time during which both you and the IRS may make changes to your tax return (not just audits). Those time frames are clearly delineated in IRS publications[1].

Here they are:

  • No limit if you did not file a return
  • No limit if you filed a fraudulent return
  • Three years after filing if you filed on time (or with extensions), you did not understate your income by 25 percent or greater, and you did not file fraudulently
  • Six years after filing if you filed on time (or with extensions) but you understated your income by greater than 25 percent
  • If you filed an amended return or already made changes to the original return (like a quick refund claim), either three years after filing or two years after paying the tax
  • Seven years from filing for a claim filed for a bad-debt deduction or loss from worthless securities

Keeping Appropriate Records

Aside from letting you know how long you have to make changes to a return, the statute of limitations also lets you know how long the IRS has to audit your return. If an audit occurs, you are going to need all of your tax records to prove your deductions. What does this mean for your record keeping habits? Hang on to those records until any chance of audit has passed.

The following are a few guidelines for making sure you hold on to the appropriate records long enough:

  • Employment Tax Records—If you have employees, you need to save your employment tax records for four years after whichever date comes later, the date payroll taxes were paid or the date they were due. An easy way to do this is simply to keep six separate drawers in your filing cabinet for each tax year. Every year, discard the sixth drawer when it’s statute of limitations expires.
  • Records for AssetsYou have certain assets that are pertinent to your tax return for as long as they remain in the depreciable category. Examples of such assets include your office building, computers, desks, and even your car. If you are depreciating those assets, they will be on your tax return. Otherwise, if you are using Section 179 to expense the assets, you may be able to recapture the depreciable class life.

For example, let’s say you purchased a desk for $1,500 and depreciate it over the seven year Modified Accelerated Cost Recovery System (MACRS) life, which takes eight years. You’ll still have to prove depreciation in the eighth year. So, you need the record of the original purchase in the eighth year and through the eleventh year to meet the three year statute of limitations (the time during which this purchase is subject to auditing). The example works the same if you used Section 179. Any assets with more than a one year class life should be kept in a separate, permanent file so they don’t get tossed out with files whose statutes of limitations have expired.

Record Keeping Tips

As mentioned in the section on employment tax records, you can simplify your file system by devoting separate drawers for each tax year. In those drawers, you’ll put any information on assets, income, and other information applicable to your return. The first drawer will be where you put all documents as you acquire them throughout the year. The next drawer is last year’s tax documents. The drawer after that contains documents from three years ago, and so on until you reach the year at which your statute of limitations expires.

In order to use this method, it’s important that you file your taxes on time or file an extension so you know for sure your specific time frames. At the end of each year, the last drawer gets dumped and you move the other drawers down, starting a new drawer for the current year. It’s really simple once you put the system in place. Record-keeping may seem tedious, but remember, it shows you where your business has been and where it’s going, like a runner trying to improve their time. You can’t improve the numbers if you don’t know what they are.

  1. IRS Pub. 583, Starting a Business and Keeping Records (Rev. December 2011), Dated Feb. 17, 2012, p 12.