A common question many people have is “How long must I keep my tax returns and supporting documents?” While the answer given is usually three years, the generally applicable time period in which the Internal Revenue Service may audit your tax return is three years from the date you file the return, which can be as much as nine and a half months after the end of that year. For example, if your 2008 tax return, which had an original due date of April 15, 2009, was placed on extension and filed October 15, 2009, that 2008 income tax return could be audited as late as October 15, 2012.
Having the supporting documentation for expenses deducted during the audit period is critical; IRS agents will simply disallow any expense without appropriate documentation. That documentation should include copies of cancelled checks and the invoices identifying the expenses. Copies of cancelled checks are often difficult to obtain in this age of electronic payments. You should try to maintain a current file of cancelled checks or other evidence of payment relating to business expenses, since dealing with a bank years after the fact might prove time consuming and expensive. One area that is a particular issue with IRS agents is the maintenance of a mileage log for automobile expenses for business. Without a mileage log showing the date, destination, business purpose and miles driven, automobile expenses are almost always disallowed.
Supporting documentation may be necessary for events occurring many years before the audit period when the issue is the calculation of the gain on the sale of investment assets, such as securities or real estate. The taxable gain on the sale of an asset is the proceeds received minus your cost. If you purchased the asset 20 years ago, the IRS will require you to prove the cost in order to reduce the gain. Without adequate documentation of the cost of an asset, the IRS will treat the cost as zero and all of the proceeds will be taxable.