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Know This: You can't just toss your paperwork willy-nilly without missing out on some potential tax benefits. Cleaning the files may be cathartic, but not every document is created equal.
I walk into home offices where people are so afraid to throw things out that they keep everything. They have receipts from 1972 but they don't have the items, so all they really have is the mess. If most people knew the rules for all of the paperwork, they'd shred or burn a lot of stuff and be a lot better for it.
So here are the rules for keeping or tossing various types of financial statements:
- Investment papers: Tax rules say that you need to be able to make a "good-faith estimate" of the price you paid for your investments, so you want to keep documents that establish your cost. For mutual funds and stocks held in direct-purchase plans, that includes dividend reinvestments, as well as ordinary deposits. All that paperwork allows you to establish the basis for his good-faith estimate. Further, let's say you decide to take half of your money out of the fund; shares you bought at the market's peak are down significantly. If you specifically sells those shares -- through written instruction to your fund company -- he can take a loss on them. By maximizing your loss, you at least gets the biggest possible tax benefit; if you simply sell at the average cost per share or on the "first in, first out" method, you'll sell at break-even or possibly at a gain (shares you held for more than a decade are up), and give away some tax benefit.
- That said, investors typically need to keep only their final statement from each calendar year, as the December paperwork shows every deposit, withdrawal and dividend reinvestment in the account. Getting rid of the first 11 months' paperwork can significantly thin the files.
- There's a fine line between keeping too little paperwork and too much. There are people who get their refund and pretty much throw everything away, which could be a problem, and there is the other extreme when they keep every tax paper for years or decades.
- IRS Publication 552, on record keeping for individuals, lays out the complete details, but the basic rule is this: Keep tax records as long as the IRS might need them.
- Assuming you are not filing fraudulent returns -- for which there is no statute of limitations -- your income tax return boils down into several different types of paperwork. There is the return itself, typically the one document people want to clog their files. Old tax returns -- especially those covering the purchase or sale of property -- can be important for compiling future returns, possibly decades into the future.
- Support documents and backup paperwork -- any and all of the information that helps determine what you owe, from receipts to canceled checks, to bills, and tax forms -- must be kept for three years after the return was due (if you are late, make that from the date the return was filed). That means that the bulging file of stuff from 2005 can now be purged, as that return was filed in 2006 and the three-year period ended this spring. If you filed late, remember, 3 years from the date the return was filed, not the date it was due!
- Before you burn those older tax documents, however, pull out anything related to home improvements and any records covering dividends or capital gains that were not part of year-end investment statements. Those documents may come in handy for calculating profit or loss when you sell the home or the investment.
- If you like being extra safe, hang on to the forms related to your income for six years, the length of time the IRS has to challenge a return on which it believes gross income was underreported by 25% or more.
- Paycheck stubs: Assuming you receive everything you are entitled to and have no dispute with your employer, dump the paycheck stubs. Use the last stub of the year to cross-check your employer's tax reporting, get the value of any donations you make through your paycheck and, depending on circumstances, to have the amount of money you paid out for health-care coverage. Armed with that information, you can shred the year-end stub too. But wait till your W-2 has arrived!
- We have a pamphlet for our clients which details the paperwork retention requirements of the Federal Government for tax purposes. Just ask for one!
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