Throw away no record until it's time -- and the IRS says it's OK
By Cora M. Barnhart • Bankrate.com

Every business owner knows that it's vital to keep good records. However, the moment does come when you can do the flamenco on them while wearing spiked track shoes.

But hold on, don't grab your shoes or that paper shredder right away. You can always get rid of something you decided to keep, but finding out you should have held onto something that you destroyed could be disastrous.

If the IRS penalizes you for not having a record they request, tidying up will also prove to be expensive. So what's a neat freak to do?

Keep tax receipts for three years
The IRS says you have to keep records as long as your income tax return can be examined. That means you have to keep the paperwork around to prove an item on your return until the statute of limitations expires for that return. Usually, that's three years from the date the return was filed.

The IRS attaches a big asterisk, though: There is no statute of limitations on fraudulent returns. That means if the IRS comes after you and says that you filed a fraudulent return 30 years ago, it can demand records from that year.

So that means you have no choice but to set aside a place for at least three years' worth of receipts, canceled checks and other documents supporting any income or deduction that you put on your return.

Property owners often hang onto records such as contracts, real estate transactions records and records of property improvements until they sell the property. However, selling the property doesn't mean you should shred those records just yet, at least not if you want to stay out of trouble with the IRS.

Hough & Company, an accounting firm in Venice, Fla., recommends retaining this information for at least seven years after the property is sold.

Some records should stay longer
And there are other records you should hold onto even longer. The IRS recommends keeping records such as property records indefinitely, in case you need them to prove the amount of gain or loss if the property is sold.

Why should business owners keep these paper trails for such a long time? Simply put, there is no way of knowing exactly when you might need that canceled check or bank statement to back up an entry on an old tax return.

Many taxpayers don't realize that the IRS has up to three years to enact an audit. And if the IRS suspects you've underreported your income, you'll wish you had held onto those records even longer. If the IRS has reason to believe you've underreported your income by 25 percent or more, it can audit you up to six years later.

And as mentioned before, "creative" taxpayers should be especially careful about discarding these documents. When it comes to filing a fraudulent return, there isn't a statute of limitations that constrains the time period the IRS can go back and check. So if the IRS has reason to believe you intentionally filed a false tax document, there isn't a restriction on how long they can wait to question you about an earlier tax document.

In fact, some financial Advisers encourage business owners to seriously consider keeping certain records permanently.

Hough & Company prompts clients to keep a permanent copy of records such as annual tax returns so that they will have proof that these returns were actually filed. They justify not shredding records such as this "partly due to long-term needs and partly because they take up very little room."

-- Updated: September 13, 2005