What Is a Tax Return, and How Long Must You Keep Them?

What Is a Tax Return?

A tax return is a form or forms filed with a tax authority that reports income, expenses, and other pertinent tax information. Tax returns allow taxpayers to calculate their tax liability, schedule tax payments, or request refunds for the overpayment of taxes. In most countries, tax returns must be filed annually for an individual or business with reportable income, including wages, interest, dividends, capital gains, or other profits.

Understanding Tax Returns

In the United States, tax returns are filed with the Internal Revenue Service (IRS) or with the state or local tax collection agency (Massachusetts Department of Revenue, for example) containing information used to calculate taxes. Tax returns are generally prepared using forms prescribed by the IRS or other relevant authorities.

In the U.S., individuals use variations of the Internal Revenue System's Form 1040 to file federal income taxes. Corporations will use Form 1120 and partnerships will use Form 1065 to file their annual returns.

A variety of 1099 forms are used to report income from non-employment-related sources. Application for automatic extension of time to file U.S. individual income tax return is through Form 4868.

Typically, a tax return begins with the taxpayer providing personal information, which includes their filing status, and dependent information. 

The Sections of a Tax Return

In general, tax returns have three major sections where you can report your income, and determine deductions and tax credits for which you are eligible:

Income

The income section of a tax return lists all sources of income. The most common method of reporting is a W-2 form. Wages, dividends, self-employment income, royalties, and, in many countries, capital gains must also be reported.

Deductions

Deductions decrease tax liability. Tax deductions vary considerably among jurisdictions, but typical examples include contributions to retirement savings plans, alimony paid, and interest deductions on some loans. For businesses, most expenses directly related to business operations are deductible.

Taxpayers may itemize deductions or use the standard deduction for their filing status. Once the subtraction of all deductions is complete, the taxpayer can determine their tax rate on their adjusted gross income (AGI).

Tax Credits

Tax credits are amounts that offset tax liabilities or the taxes owed. Like deductions, these vary widely among jurisdictions. However, there are often credits attributed to the care of dependent children, individuals aged 65 or older, or those with permanent and total disability. Note that there may be income limitations or restrictions to these credits.

After reporting income, deductions, and credits, the end of the return identifies the amount the taxpayer owes in taxes or the amount of tax overpayment. Overpaid taxes may be refunded or rolled into the next tax year.

Taxpayers may remit payment as a single sum or schedule tax payments periodically. Similarly, most self-employed individuals may make advance payments every quarter to reduce their tax burden.

IRS and Record Retention

Generally speaking, the IRS recommends that filers keep tax returns for at least three years. However, other factors may require more prolonged retention. Some situations may require indefinite retention of filed returns. If a tax return contains errors, an amended return should be submitted to correct the discrepancy.

You should keep documents related to income, deductions, or credits on your tax return until the period of limitations for that specific tax return expires. The period of limitations is the time during which you can amend your tax return or the IRS can assess additional tax.

The years mentioned generally refer to the period after the return was filed, treating returns filed before the due date as filed on the due date.

The IRS has outlined many different periods that will pertain to different taxpayers. The language below from the IRS outlines these record retention suggestions:

1. Keep records for three years if situations (4), (5), and (6) below do not apply to you.
2. Keep records for three years from the date you filed your original return or two years from the date you paid the tax, whichever is later, if you file a claim for credit or refund after you file your return.
3. Keep records for seven years if you file a claim for a loss from worthless securities or bad debt deduction.
4. Keep records for six years if you do not report income that you should report, and it is more than 25% of the gross income shown on your return.
5. Keep records indefinitely if you do not file a return.
6. Keep records indefinitely if you file a fraudulent return.
7. Keep employment tax records for at least four years after the date that the tax becomes due or is paid, whichever is later.
   

Other Tax Return Uses and Retention

Aside from an IRS audit, you may find yourself needing to provide a copy of your federal tax return to an external party for a variety of reasons. Below are some of those reasons along with general guidance on retention. Note that the periods listed may vary based on your situation, and there may not be direct, specific guidelines on the time frame when you may be asked for your return.

Loan Applications

When applying for a loan, you may be asked for copies of your recent tax returns. Lenders often request tax returns as part of the loan application process to verify the financial info provided by applicants. Mortgage lenders commonly require tax returns to assess an individual's financial stability, so they may ask for multiple years.

Rental Applications

In the context of a rental application, maintaining tax returns for several years is advisable. Landlords may request tax information as part of the rental application process to evaluate an applicant's financial capability and responsibility. Certain units, especially those catering to lower-income individuals, may require proof of income for stipended or reduced rental rates.

Financial Aid Applications

When applying for financial aid through the Free Application for Federal Student Aid (FAFSA), it is prudent to retain tax returns for at least two years. The FAFSA requires applicants to provide detailed financial information including income and tax details.

Government Assistance Programs

For individuals applying for government assistance programs, consider keeping tax returns for at least three years. Some government assistance programs may require tax information to determine eligibility and calculate benefits. By maintaining tax returns, individuals ensure compliance with program requirements and can more quickly get the benefits they may need.

Opening Financial Accounts

When opening investment accounts, you may need to show older tax returns. This is especially true based on the type of account you may be opening and the incentives the institution, broker, lender, or bank is extending to you.

Personal Finance Planning

When working with your financial planner, they may be interested in seeing as many tax returns as possible. This arms them with valuable historical information on how much you earned and how to appropriately plan for the future regarding savings, tax, and retirement.

The Bottom Line

A tax return is a document filed with the tax authorities that reports income, expenses, and other relevant financial information to calculate and pay taxes. It is recommended to keep tax returns for at least three to seven years to comply with potential audit requirements and the period of limitations for tax amendments.