Clients ask me this all the time, and are quite surprised when I tell them 3 years. Yes, the government only has three years to audit you. (I don’t know where the 7-year rule came from, or why it is so widely propagated.)
To back me up, I just consulted WikiAnswers, which says the following (I have added the bolding):
“Federal laws specify how long you must retain the documentation to support the filing of income tax returns.
“For most taxpayers, this period is three years from the original due date of the return or the date the return is filed, whichever is later. For instance, if you filed your 2006 Form 1040 April 17, 2007 or sooner (disregarding the extended NE “storm” due date), the IRS has until April 17, 2010, to audit the return and assess a deficiency if necessary.
“The statute of limitations period extends to six years if a return includes a substantial understatement of income (defined as omitting income greater than 25% of the amount reported on the return). There is no statute of limitations if a taxpayer fails to file a tax return or commits fraud. A taxpayer is considered to have committed fraud if he/she submits a false return or if there is a willful attempt to evade tax.
“If a required return is not filed, the records must be kept forever, as the statute of limitations does not begin until the form is filed. Failure to keep adequate records is a separate violation from failing to pay or to file.
“And of course anything in a return that may be required to prove a position in a future return, should be kept as support for that position. For example, basis calculations that effect an ongoing holding, amortization of mortgage points, etc.
There may be non-tax reasons to retain these records. If you are unsure you should contact a financial advisor and/or tax specialist.”
So there you have it, folks. If you’ve filed your 2009 tax return, you have my permission to go shred your 2006 tax papers, and anything earlier than that.