Which Tax Documents Should I Save, Which Should I Shred?
The IRS, which is dealing with a backlog of unprocessed tax returns dating back to 2020, has urged taxpayers to file their returns electronically. But filing electronically doesn’t stop the clock on potential audits, nor on your right to file an amended return.
Generally, the IRS has three years from the date you file to audit your return. You also have three years to file an amended return. That means for the 2021 tax season, for instance, you should hold on to your Form W-2s and any 1099 forms generated from freelance income, unemployment benefits or investment income (such as taxable dividends, capital gains and interest), records relating to a 401(k) rollover or other retirement information, and receipts for deductible expenses until at least 2025. Some experts suggest keeping your documents for four years to be on the safe side.
Although your chances of being audited are slim—the IRS singles out less than 1% of all individual tax returns—you may need these documents to file an amended return if you overlooked a deduction or credit that could have lowered your tax bill or increased your refund.
For example, suppose you itemized deductions on your original return but didn’t claim the medical expense deduction because you didn’t think your expenses exceeded 7.5% of adjusted gross income (the threshold required to claim that deduction). If you realize later that you had enough medical expenses to cross the threshold, you could file an amended return on IRS Form 1040X and claim the deduction.
Non-itemizers, meanwhile, may discover that they overlooked a contribution to charity. For 2021, taxpayers who claim the standard deduction can deduct up to $300 of cash donations to charity. The $300 amount is per person, so if you’re married, you can deduct a total of $600 (the limit was $300 per tax return in 2020). The standard deduction for 2022 is $12,550 for single filers and $25,100 for a couple filing jointly.
There are important exceptions to the three-year audit rule. The IRS has six years from the date you file your return to audit you if you underreport your income by more than 25%. This sometimes happens to freelancers who lose track of a stray 1099 or individuals who win the lottery or some other type of cash prize and fail to report all of their winnings.
Even if you’re confident you’ll never be audited, you may need to keep tax documents for other purposes. You might need to keep a W-2 for more than three years to document your income if you plan on buying a home. If you invest in stocks and mutual funds in taxable accounts, you may also need to keep documents showing your purchases until you sell—which may be much longer than three years. For advice on how to store documents in a digital format.
Homeowners: Save Everything
The housing market is still making headlines as it sizzles for sellers. Home prices logged a nearly 17% annual gain in 2021, with some cities seeing even faster price appreciation, according to the National Association of Realtors (go to “Where Home Prices Are Headed in 2022,” for more on home prices). Owners who have lived in their home for decades may be enticed to downsize and cash in their gains.
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