Audit Intelligence: How long to keep financial records

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Just because you received a refund does not mean you can forget about an audit. Hang on to receipts, canceled checks and whatever else might help support income, deductions, exemptions and other items on your return. Do that at least until the expiration of the statute of limitations for an audit or for you to file a refund claim, should you discover a mistake after filing. The statute of limitations is the limited period of time after which the IRS is no longer able to come knocking and you cannot recover an overpayment. In most cases, the tax collectors have only three years to audit your return after you file it. For instance, the deadline is April 2007 for the government to start an examination of a return for tax year 2003, with a filing due date, for most persons, of April 2004.

There are two exceptions to the three-year test, though they do not apply to most persons. The first exception authorizes the IRS to double the audit deadline from three to six years if the amount of income a person failed to report on his or her return is greater than 25 percent of the amount shown on it. Using the six-year test, the deadline expires in April 2005 for returns for tax year 1998 that were submitted in 1999. Under the second exception, there is no time limit on when the IRS can come after someone who fails to file a return or files one that is deemed false or fraudulent. The audit, admonishes the IRS, can begin “at any time.”

Copies of returns. You should retain them indefinitely. They take up little space and are always helpful as guides for future returns or amending previously filed returns. Moreover, copies of tax forms might prove helpful in case the IRS claims you failed to file them.

Excessive refunds. If you receive too big a refund because of an IRS computer goof, return the overpayment immediately rather than holding it until the feds discover the error. Because you have the use of the money, the law authorizes the IRS to charge you interest on the overpayment. If, for example, you receive a check for $66,000 instead of an expected refund of $600, either return the $66,000 check in full, or deposit it and send your own check for $65,400.

Tip: One of my IRS sources recommends that you send your own check and deposit the government’s. If you return the IRS check, you will have to wait about eight to 10 weeks to get a check for the correct amount. In addition, should your check go astray, you can stop payment and send another one. If you return the IRS check and that happens, it might prove more difficult getting the matter straightened out.

Tax payments. Make checks payable to the “United States Treasury,” not “Internal Revenue Service.” However, the feds still accept checks made payable to the IRS. Whichever payee designation you use, don’t be casual about what you write on the pay-to-the-order-of line of a check going to the IRS. Your tax tab could double if you merely make the check payable to “IRS,” instead of to the “Internal Revenue Service,” and it winds up in the wrong hands. That “IRS” can easily be altered to “MRS” followed by a name, or altered to a name by combining the initials “I.R.” with a last name—for instance, “I.R. Smith.” And never send a check without filling in the payee line, as some obliging taxpayers do.

Tip: The same “write-in-full” advice applies to names specified by state or local tax agencies. An example: Write “N.Y. State Income Tax,” instead of “NYS.             

Julian Block is a nationally renowned tax expert. You can e-mail questions and comments to him at julianblock@yahoo.com.