Deciding how long to keep tax and financial records might rank relatively low on many businesses’ list of top concerns, but a sound and well-thought-out record retention policy is actually an important good business practice. Consistent, systematic record management can save time, expense, and frustration, while also mitigating risk in the event of an audit or other circumstances when it’s critical to quickly locate needed documentation.

When deciding how long to keep financial records, seven years is often cited as a good rule of thumb. In practice, however, things are not always that simple, especially now that many records are stored digitally. The recommended retention period can vary depending on the income, expense, or other transaction that a given document records.

Although the IRS and other organizations offer general guidance on record retention, every business is different, with unique transaction processes and documentation requirements. Always consult with your legal and accounting professionals for specific advice about how long to retain various tax and financial records.

How Long Is Long Enough?

To avoid drowning in a sea of old records, receipts, and random paperwork, many businesses conduct an annual purge of outdated documents. It’s a practice that’s comparable to old-fashioned “spring cleaning” in a household—with one important difference.

When you’re cleaning out closets and organizing storage at home, the popular adage is, “When in doubt, throw it out.” In the case of a business’s tax and financial records, however, that can be very bad advice. In fact, it’s generally better to take the opposite approach.

For federal tax records, the basic guiding principle is to keep all returns and supporting documents for as long as it is possible that the IRS could still question or audit them, or the taxpayer could file for an additional credit or refund. The default statute of limitations for income taxes is generally three years after the date the return is due (including any extensions) or the date it is filed, whichever is later.

But that window can extend to six years if the IRS determines a return has “substantial omissions,” which the agency defines as understating gross income by more than 25% or omitting more than $5,000 of income related to undisclosed foreign financial assets. There is no statute of limitations for filing a false or fraudulent return, or for not filing a return that was due.

In most cases, the limitation period for taxpayers to file an amended return to claim a refund or credit is three years from the date the original return was filed or due, or two years from the date the tax was paid, whichever is later. On the other hand, taxpayers have up to seven years to file a claim for an overpayment resulting from a bad debt deduction or a loss from worthless securities.

There are different retention requirements for records related to employment taxes, such as payroll records, receipts for tax payments, quarterly employment tax returns, and all supporting documents. The IRS requires companies to keep these records for at least four years after filing the fourth quarter return for the year.

Of course, any records relating to property or other business assets should be kept much longer. In addition to determining depreciation, amortization, or depletion deductions during the life of an asset, such records are needed to calculate the gain or loss when property is eventually sold or otherwise disposed of. Therefore, they should be retained at least until the period of limitations expires after the asset’s disposal.

Other Factors to Consider

Federal tax requirements are just one of many factors to consider when deciding how long to retain records. Some local and state taxing authorities’ requirements mirror the IRS rules, but others do not. Lenders, investors, insurers, and other stakeholders will have their own expectations and requirements which also must be accommodated.

Developing a record retention policy that adequately addresses all these variables can be difficult, which is why so many companies simply rely on the basic seven-year rule of thumb as their standard. Additionally, some documents (such as business formation documents, pension and retirement plan documents, business licenses and permits, and various other permanent records) should be kept indefinitely.

The advent of digital documentation and cloud storage systems has had a major impact on this issue, eliminating the physical space concerns that often drive annual purges of old records. Generally speaking, both paper and electronic records are now accepted for most purposes including IRS documentation, but before destroying any paper original it’s important to verify that a digital copy will be adequate.

Digital documents are easier to save, store, retrieve, and exchange, but their use also raises new questions, such as where and how to store the files, how to control access to sensitive records, and how to maintain adequate safeguards against tampering and cybersecurity threats.

The IRS has published several publications that address its document retention policies. These include Tax Topic 305 (https://www.irs.gov/taxtopics/tc305) and Publication 583 (https://www.irs.gov/pub/irs-pdf/p583.pdf). As noted earlier, however, these publications are necessarily general in nature, so it is important to get specific professional guidance when deciding how—and how long—to retain various tax and financial records.

Please contact Holbrook & Manter with any questions you have on this matter.