According to the IRS,
one must keep IRS tax records indefinitely if you file a fraudulent return.
I find this very confusing because they also give guidelines that as long as you didn’t file a fraudulent return, you only need to retain tax records for 3 years. But what if I file a return that I don’t believe is fraudulent, and the IRS, after 30 years, decides it might have been fraudulent. In that case, it seems as though they’d have expected me to retain those records for 30 years.
Of course, in the age of computers, it’s easy to save tax records indefinitely. However, when it comes to small business expenses, we build up a lot of receipts. And while digital 1s and 0s are cheap to store, I’d prefer the option to strategically delete receipts after X period of time. This way, if I am ever audited, I can honestly tell the IRS, “I only have the last 3 years of digital receipts stored, because that’s what your guidelines stated”
My concern is if I keep 30 years worth of detailed receipts with my tax documents, that an audit in 30 years might mean I legally have to hand them all over, and then pay a CPA Lawyer $500 an hour to go through them with the auditor. Whereas if I just keep the seemingly mandated 3 years it will be cheaper. Also, there’s a strong chance I’ll make some small mistakes over the course of 30 years of filing taxes. And I don’t want to get assessed penalties for 30 years worth of records that they found a few thousand dollars per year of expenses as ineligible for one reason or another.
In essence, it seems like the IRS is saying everyone must keep their tax records indefinitely, in the event that we decide that you may have submitted a fraudulent return. It’s unclear if they have a definition of fraudulent or not. Or if like porn, they know it when they see it. If I create fake receipts for $500k worth of expenses that didn’t exist on $600k of income, that seems fraudulent to me. But if I accidentally double counted $2,000 worth of hotel receipts alongside $200k of legitimate receipts, is that a mistake, or is that fraud? Does fraud require intent? If so, do they need to prove intent beyond a reasonable doubt, or simply beyond a preponderance of evidence?
My guess is that it’s the intent that counts plus the amount of the discrepancy. There might be a certain threshold below which it’s not worth their time and money to try to pursue. Your examples above are good ones.
Tax fraud and tax evasion are not precisely defined, but in general, they are defined as cheating on your tax return to avoid paying the entire amount due. Entities who cheat on their taxes most often misrepresent their annual income and indicate that they received less in a year than they actually did.
That being so, the IRS keeps its records for about six years and prosecutes about 2000 criminal cases a year. About 90% of those cases result in convictions, and many of them result from unrelated crimes in which the prosecutors can’t get a solid conviction. Example: If you rob a bank but don’t pay taxes on the money you steal, you can go to jail for tax fraud. Tax fraud is often easier to prove than other crimes.
Honest mistakes are not crimes, and the IRS will look at a number of years to see if your mistake is a one-off event or a pattern. Given its high conviction rate, the IRS will often pass on cases in which it is not sure it will obtain a conviction – and then will parade that conviction as a deterrent to others.
Audits may increase beginning on 2018 returns as fewer people will itemize. This assumes the same number of auditors stay on the job, but the IRS may be downsized or focus resources elsewhere.
Bottom line – I would not keep, other than property- and investment-ownership records for assets you still may own, for more than six years. If the IRS discards them and you discard them after six years, very little evidence may exist for the IRS to use.
Be careful of digital media and store it on media that you will be able to retrieve into the future. Hard and jump drives and memory chips fail or get lost, and floppy drives require obsolete readers. Cloud-based storage companies may cease to exist, hold your data hostage, or lose it.
My concern is less of one where I underreported income because I get 1099s from my clients and report all of it. I even report the <$5 of interest I get from my several bank accounts I keep active with a few dollars in them.
My concern is more of expenses. I’m constantly traveling to my clients and I’m too cheap to pay an accountant. So I wind up with thousands of receipts at the end of the year. I keep a spreadsheet as I go biweekly, but at the end of the year, I always find some errors (and then correct them). Sometimes I scan the same hotel invoice in twice. When you’re scanning in 200 of them, it’s easy to double-scan the same one. Also, sometimes the travel expenses are on two separate types of invoices, leading me to double-report them in my notes. For example, book a flight and get an email invoice. But then get a second invoice PDF downloaded on their site in a different format.
When I catch these during my own internal one-man audit, before filing taxes, I remove them. But there’s a solid chance I have some unintentional mistakes in there, doubt it would be more than $10k per year of double-counting expenses, against $100k of legitimate expenses. More likely, possibly around $1k, or even $0 since I do check. I say only that there might be a mistake and if so, it’d be under $10k of double-counting expenses. And I’m terrified in 30 years, they might go back and nail me on that and charge me 30 years worth of back interest.
It’s the same six years, but in this case, the IRS has none, or very few, of your expense records, so there is little for them to examine, so little reason for them to come snooping – especially if your income matches what’s been reported. If you report the stuff under $600, that’s bonus points that cancel out any demerits that the DIF (one of the IRS computer matching systems) tags.
Also, you may make a mistake and omit something just as easily as you double count it, no? I don’t see any fraud in anything you’ve noted, but you do have to be diligent, If it’s too challenging for you to accurately keep track of your records, then it might be wise to hire a part-time bookkeeper or set aside more time to more thoroughly and definitely account for your expenses.
Looking at it another way, whether or not you make a mistake, you have less than 0.002% chance of facing a criminal indictment – and that’s only if you are running a true scam or a cash business and with intent do not pay what you owe, AND the IRS is nearly certain you will be convicted. Beyond six years, there is virtually no chance unless someone turns you in with evidence to convict you. All of this is time-bound, and IRS auditors are scored based on what they return versus how long it takes and what it costs. Anything spanning more than six months, $6000 or involving six people is exceptional and requires approval.
Bottom line is you either have to live with your terror, imagined or not, or find some way to manage it. I cannot imagine how or why the IRS would go back 30 years — when have you ever heard of a similar situation? Especially for $10K or less?
Filing a tax return is admin work. Meticulous record keeping and tax and estate planning (from competent sources) are the keys to success.
Great points! I just fear I might piss off the wrong person in 30 years and then selective enforcement can come and get me. Everyone of us commits several felonies a day. There’s so many laws on the books it’s impossible not to commit at least a few. It’s also reasonable to believe there’s several contradictory laws on the books such that whether you DO X or NOT DO X, it’s illegal either way, against different laws.
Where do you get the 6-year figure from? It sounds like it’s 6-years only if you underreport income. Since I’m appropriately claiming all of my income, I’m only worried about the 3-year period, I think.
I do intend to keep ALL of my tax returns, forever. The IRS has them, so I should, too. It will come in handy to ensure Social Security is properly paid out and my Roth IRA remains tax-free. However, what I want to get rid of is the thousands of scanned receipts for my business expenses.
I’ll gladly let an auditor comb through my old 1040s for 30 years. The Schedule C will show $X in expenses. I won’t have the receipts anymore after 3 years, so they won’t be able to prove any kind of issue as long as the total expense amount seems reasonable, which they are.
One of the big issues in Enron’s collapse was the destruction of their records. I believe most of it was done after legally required retention minimums, but it didn’t happen regularly until it was clear that there had been serious accounting problems and discovery requests would be coming soon. That went poorly for Enron and their accounting firm.
If you want your good faith record destruction to hold up against any suspicion of intentionally destroying evidence, do it regularly and keep track of that somehow. Maybe store a summary with your 2017 tax documents that you also destroyed your 2013 (or whatever is allowable for you) records with a summary that those were 50 paper receipts shredded and 20 electronic files deleted and wiped (and remember backup copies or email attachments).
Evidence of a consistent pattern could be a big asset if you ever get asked why you no longer have certain records.
Already do this. It’s nice to have a backup, especially when dealing with the government! They could eventually turn around and say “well, we don’t have those records at SS anymore, and that record isn’t enough”
This is a great idea! It seems like it might be weird to do, since I’m one person, but I can write out a brief Tax Guide for myself, perhaps even state that an accountant I conferred with recommended it.
I already do have a bit of a systematic approach to doing my taxes and this would further codify it.
Log in to all online bank accounts and check for annual interest and 1099-INTs. Banks may not issue a 1099-INT for amounts under $5 but I am still responsible to pay, so check all of them.
Check for HSA distributions and file Form X as needed.
Review outstanding tax records. Maintain copies of 1040s but for data storage purposes, delete the detailed receipts folder if greater than 3 years old from date of tax submission. While the receipts don’t take up much digital hard drive space, they do clutter up the data indexing system of the operating system.
If it’s travel expense tracking that you’re worried about, I don’t think you are open to a bunch of liability. The number of days you were on the road at the IRS per diem rates is going to set a floor for your expensing. So you’d only be on the hook if you routinely spent more than the per diems for food/lodging and couldn’t prove it later, right?
If you’re frugal, it might be better to just use the per diem method rather than actual.
Definitely going to use the per diem method for food. But I was under the impression you did need to substantiate receipts for the lodging as well?
Or is it possible to use per diem lodging rate with no substantiation of receipts?
Also, how does the IRS know how many days I was on the road? There’s no place on the tax return to document that, to my knowledge. Or do you mean if I am audited, then they’ll ask? And my expenses in previous years might have been a bit high, but not lavishly high.
I documented a cash tip to maids of about $10 per night ($15 in cities like Seattle, SF, and NYC) - and I was on the road about 300 nights per year, so that was $3,000 in cash tips that I documented, and wrote off my taxes, but other than my spreadsheet, I can’t prove that I left them.
I found something online claiming “Note: Per diem rates can’t be paid to individuals who own 10 percent or more of the business.”
I wonder if that means I wasn’t allowed to take the per diem for meals in past years? I didn’t keep receipts and just used the per diem in the past for meals, but did save hotels. This was as a sole prop.
And I’m just now learning that first and last day of travel uses a reduced per diem meal rate. Ooops. I’m not sure how I missed this in the past. Maybe I should have hired an accountant.