Keep or Toss?

You may be able to shrink your tax and other financial files, but first you need to understand what you must keep, in what format, and for how long.

There’s a good reason for that stack of papers on your desk at home or the rubber-banded bundle in your safe deposit box. You know you’re supposed to hold onto certain financial, insurance, and government documents in case you’ll need them later on, but you’re not entirely sure which ones to keep, or for how long.

Providing backup for your tax returns is just one reason why you should hang onto your records. You may also need documents relating to insurance claims; purchase receipts for warranties, exchanges, and returns; and certificates of marriage, birth, or death to verify identity and beneficiary status.

Financial records such as W-2 wage forms, receipts and canceled checks, and stock-trade confirmations let you prove the amount and nature of your income as well as substantiate deductions or credits you claim on your tax returns. If you discard these documents too soon, you won’t be able to provide evidence that you filed your returns properly, and you could owe penalties and back taxes if the IRS or state authorities challenge your returns.

The IRS has guidelines on document retention. Generally, the agency says, the limit for reassessing tax that you owe is three years following the return’s filing deadline, so it’s necessary to keep supporting documents during that period. If you neglect to report sums that represent more than 25 percent of your gross income, the IRS has six years to come after you. It’s smart to keep financial documents for this long after filing a return to prove you’ve reported all the income that was required. (These three- and six-year guidelines apply to many tax records, but not all. For example, you must keep purchase data for stocks until you sell them to determine cost basis, and IRA records until all distributions have been made.)

You can shred many documents after digitizing—including tax-related records, as the IRS accepts digital copies.

Here’s the problem: “There is no period of limitations to assess tax when a return is fraudulent or when no return is filed,” the agency says. That means you could be held liable if the IRS deems your return fraudulent and you lack documentation to prove that it’s not. For this reason, “we recommend people keep their tax records for at least seven years,” says Jimmy Lee, CEO of the Las Vegas-based Wealth Consulting Group.

Different retention rules apply to other kinds of documents. For example, you should retain records of your cost basis for investments until you sell them because taxes typically are levied on the profits, so you need to be able to establish what you paid originally. Keep forever your loan documents, even once you’ve paid off the debt, as well as the papers that support your estate plan, including Social Security cards, and certificates of birth, marriage, divorce, and death. Institutions often require death certificates to issue benefits, in some cases years after the original account holder has died.

Try to maintain the paper original of any legal document or contract that’s important enough to require an official seal or notarization, Lee says, although a copy may suffice if the original has been destroyed. This includes records of large transactions like home deeds as well as vital-records certificates.

“We recommend keeping originals of any documents that legally may require wet signatures,” says Robert Trinchet, chief information officer of Florida-based GenSpring Family Offices. Among examples he cites are wills and estates, passports, copyrights and patents, abstracts for real estate, deeds and mortgages, property easements, birth and death certificates, marriage records, divorce decrees, and adoption papers. These documents belong in safe deposit boxes at a bank or a fireproof home safe, but Lee recommends keeping electronic copies as well.

You can shred less crucial documents after digitizing—including tax-related records, as the IRS accepts digital copies. Be certain to save those copies in a widely used format such as PDF so that you’re not dependent on software that might become obsolete years from now, says financial advisor Pete Lang of North and South Carolina–based Lang Capital. And to protect against loss, store the documents online, via a cloud-based server.