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April 14, 2005
ORGANIZING YOUR FINANCIAL RECORDS
Well, it’s the last week of tax season and I’d like to respond to a question that I received from a reader asking, “How long do I have to keep copies of my tax returns?”
The general rule is that you must keep copies of tax returns for 3 years. That means you may now throw out your 2001 and older tax returns. Besides keeping just the tax form, you should also keep your 1099, W-2, self-employment records and cancelled checks for anything you deducted on those tax returns.
As with any rule there are always exceptions to the rule. The three year rule mentioned above deals with something called the statute of limitations. The statute of limitations defines the period of time the IRS has to audit your tax return and can vary depending upon how and if you filed a tax return.
1. The first exception to the three-year rule is that if you under report your gross income by more than 25%, the statute of limitations is extended to six years. This exception generally applies to self-employed individuals who either get paid in cash or get paid by check and just cash the check and not report the receipt as income.
2. The second exception to the three-year rule extends the statute of limitations to 7 years if you took a deduction for a worthless stock. Occasionally, stock investors will buy stock in a company, like Enron, and in the year the company goes belly-up, they take a loss on the stock.
3. Filing an amended return also extends the statute of limitations. If you file an amended return because you forgot to claim a deduction and get a refund, the statute of limitations remains three years or 2 years from the date of the refund, whichever is later. Let’s say you forgot to deduct your IRA contribution for tax year 2002, so in June 2004 you amend your tax return to claim an additional refund, and receive your refund in September 2004. Normally, the statute of limitations for the 2002 tax return would be April 15, 2006, 3 years from April 15, 2003, the due date for the 2002 return. Under this rule the statute of limitations would be extended to September 2006, 2 years from the date you received your refund.
4. There are two cases in which there is no statute of limitations. The IRS is able to go after you for an indefinite period of time. This occurs when you either do not file a return or file a fraudulent return. It is for this reason that some people continue to file tax returns even though they are technically not required to file. They want to start the statute of limitations.
So, for the 99.9% of you who have been filing tax returns and have not under reported your income by 25%, or filed a fraudulent tax return, you may now get rid of all of those old tax returns. But before you throw everything away, here is another exception to the rule.
LARGE PURCHASES AND VALUABLES –
For large purchases you will want to keep a record of when you bought the item and how much it cost. Homeowners should not only keep a record of their original purchase but also any improvements made to the property. These figures should be kept until you either die or sell the property and will be used to figure your gain or loss on the sale of the property. For large purchases, other than the home, these receipts will be helpful for insurance claims or tax losses.
INVESTMENTS – If you buy and sell stock, you should keep records of your purchases for three years after you sell the stock, along with your other tax records. The most common problem area is when you purchase stock and participate in the dividend reinvestment plan. For tax purposes, each time a dividend is reinvested, it is considered an additional purchase and adds to your cost. Now, in the age of computers, most mutual funds keep track of your cost basis when you participate in the dividend reinvestment plan. So, before throwing out old records, make sure that either the mutual fund company is keeping track of your cost or that you have retained copies of dividend reinvestment statements.
MISCELLANEOUS ITEMS –
Insurance policies – For accident, health, auto, homeowners, etc, only keep the current policies.
Cancelled checks – Unless needed to document items noted above, keep them for one year.
Wills, Trusts, Durable Powers of Attorney and Health Care Proxies – Keep the current copies. I recommend that you give your Health Care Proxy to the person that you have nominated to act as your health care agent as well as your doctor. The remaining documents should be kept in a safe place. A safe deposit box is a good place to store these documents as long as someone else has access to the safe deposit box.
Household Inventory – Because the only time that you will ever need this list is if your house burns down, I recommend that you keep this is a safe deposit box. In addition to making a list, photographs of valuable items could make insurance recovery easier.
Properties and Securities – After seeing what a couple clients had to go through when their home was broken into and a large safe carried out of their basement, I recommend the following:
· Savings Bonds – Keep them in a safe deposit box at a bank. Be sure to check that they are still paying interest.
· Stocks – I am not a fan of having actual stock certificates in my house. Open an account at a stockbroker and deposit all of your shares in the account. This makes it easier to buy and sell as well as making it much easier upon your heirs upon your death.
· Deeds – Many people treat the deed to their house like gold. The truth is that it just a piece of paper. What matters is what is recorded at the registry of deeds. So, if your deed is recorded at the registry of deeds (which it should be), don’t worry if you burn it, recycle it or just throw that deed. It doesn’t matter.
This article gives general information and not specific advice on individual matters. Persons wanting individualized advice on matters discussed should contact an advisor experienced in those matters. To the extent this article provides information on legal matters, it is based on law in effect in Massachusetts on the date of posting (laws in effect in other states are often quite different).
Ronald H. Surabian is a CPA and attorney who works at the Elder Law Center in Saugus, Ma. He also holds a masters in accounting and a masters in tax law. He currently serves on the board of directors of the Massachusetts Chapter of the National Academy of Elder Law Attorneys.