This question is regularly asked by our clients. Retention of financial records can be time-consuming, and many times will require a significant amount of floor space to keep these records.
Some of our clients are hesitant to throw any records away and will have store-rooms filled with every piece of paper for all prior years. Other clients will want to destroy records as soon as possible.
As a result of this, articles are published regularly addressing this issue.
The standard advice for record retention is to keep records for at least six years. This is based on IRS audit statutes. IRS audits generally can go back for the three prior years. If there is a ‘substantial omission of gross income’ the statute will be six years. Thus, the basis for six-year retention advice is that the IRS can, in some cases, go back for six years to audit. (If more than 25% of gross income is omitted then the three-year statute extends to six years.)
I find that this advice, while it will cover most situations, does not full address the issue – record retention is much more complicated and should be approached differently.
The statutes of limitations (the number of years that are open for audit or challenges) are different for different areas of the law. This includes federal tax laws, state and local tax laws and civil litigation issues.
Examples of these different statutes of limitations include the following:
- Federal tax liens. The IRS can pursue collection of a tax liability for up to 10 years. The liens can cover certain assets and, in certain situations, can be refiled (extended) by the IRS.
- Personal property tax filings. Many businesses must file an annual statement with their local assessor providing information as to the value of the business’s personal property holdings. Required information includes the year the property was acquired along with the historical cost of the property. Michigan laws specifically state that property tax reporting data must reflect the ‘original’ cost of the property along with the original year that the property was placed in service. If a company sells its assets to a new buyer these prior, historic, values must still be reported by the purchaser. As long as the asset is in service the original records must be retained. There is no statute of limitations.
- Nexus laws. States can have “nexus” laws whereby the historical origin of income requires a payment of tax to the originating state. California has a “Trailing Nexus” law which states; “So long as the retailer continues to generate sales from the lingering effects of its physical presence in California, the retailer is considered to be engaged in business in this state”. Again there is no statute of limitations, per se, on this tax reporting law.
- Payroll records. The American Payroll Association recommends that most payroll records should be kept for a minimum of four years.
- Wage and hour laws (per the Fair Labor Standards Act (FLSA) allow for employee wage claims to be filed within 2 years of wage payments. If there is ‘willfulness’ the statute is extended to three years. If the required wage and hour posters, as required by the FLSA, are not displayed by an employer there is no statute of limitations – a civil liability can be imposed with no limitation. However, there can be different statutes for state wage and hour laws. For example – New York. New York allows for wage claims to be filed within six years.
- Embezzlement by employees. Employers in Michigan can go back, per the statute of limitations, for six years.
The original documents and receipts of a business may be required to be maintained for a number of different situations each of which may have a different statute of limitations.
For most businesses and in most situations a six-year retention policy will be sufficient. There are situations in which this policy is not adequate. I would recommend that a business review the various potential issues, including a brief discussion with legal counsel, before disposing any business records.