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Tagged: Taxes

Net Investment Income Tax (NIIT)

By Bob Palechek, CPA | October 2, 2020

Today’s blog is about Net Investment Income Tax, otherwise referred to as “NIIT”.   NIIT came into existence on January 1, 2013, and applies to individuals, estates, and trusts.  The focus for today is on individuals.

NIIT is a tax on certain types of investment income applied at 3.8% if the taxpayer has income above certain income thresholds.   The income thresholds for single filers is Modified Adjusted Gross Income (MAGI) above $200,000.   For married filing jointly files, the MAGI amount is $250,000.  These thresholds have been the same since 2013 and are not indexed for inflation.

The 3.8% is applied to the lower of net investment income or the amount of your MAGI that exceeds the applicable threshold amount.   For example, if a married couple has net investment income of $150,000 with a MAGI of $305,000, then the 3.8% tax will be applied to $55,000 (since $305,000-$250,000 is lower than $150,000).   In this scenario, the NIIT tax reported and owed will be $2,090.  The calculation and reporting of NIIT is found on IRS Form 8960.

Types of Investment Income included in NIIT:

-Interest and dividends (including qualified dividends)

-Capital gains and capital gain distributions

-Rent and royalty income

-Non-qualified annuities

-Income and gains from passive activities (where the owner is not involved)

-Gains from the sale or disposition of those passive activities

Types of Investment Income not included in NIIT:

-Tax-exempt interest

-Distributions from qualified plans (typical IRA’s ROTH’s, and 401(k)’s)

-Any portion of the gain on your home if excluded under Section 121.

So RMD’s from my IRA are not subject to NIIT?   Correct, but if the RMD amount raises your MAGI above the applicable threshold, it will trigger NIIT on your net investment income.  This is especially important when looking at Roth Conversions!  If this causes an additional 3.8% tax on your investment income, it should be factored into the current cost of the Roth Conversion.  Fortunately, the tax planning software we utilize factors all of this into the Roth Conversion Analysis plans we perform for our clients.

One last common item that I see preparers miss on tax returns:   If a business that you own and operate rents from real estate that you also own, a sale of that real estate that generates a capital gain is excluded from NIIT.  The IRS allows the gain to be considered as part of the business activity and not subject to the 3.8% additional tax, if applicable.

Tax Planning With Charitable Donations

By Bob Palechek, CPA | August 7, 2020

This article is to provide you a summary of how charitable deductions work, what is allowed and not allowed, limitations, and new items (see end of article).

Charitable donations are deducted on Sch A as itemized deductions.  With the increase in standard deduction amounts (now $24,800 for married filing jointly) along with a $10,000 limit on State and Local Taxes (SALT), breaking the threshold for claiming itemized deductions versus the standard deduction is harder than ever.  This means while your charitable intent is a good thing, it may not necessarily bring tax savings.  At least through 2025, after that we go back to the old rules.

It can therefore make tax planning sense to lump or bunch together charitable donations in every other year.  Trying to max out a year to receive a tax benefit.  Charity paid with a credit card counts in the year of the credit card charge and not when you pay the credit card.  Donor-advised funding can help with breaking the threshold in the year of the donation then spread the gift in smaller amounts to specific charities over several years.

Allowable donations include; money or property donated to churches, synagogues, temples, mosques, other religious organizations, non-profit schools and hospitals, public parks, and public charities.  If you are unsure, please visit WWW.IRS.GOV.  The IRS maintains a database of qualifying charities.

Non-Allowable donations include; money or property donated to civic leagues, sports clubs, chambers of commerce, most foreign organizations, individuals and politicians.  If you are unsure, please ask your tax person.  An addition to this category began in 2018, if you make a payment to a college for the right to purchase sporting event tickets, that payment is no longer deductible!

Substantiation of donations that do not exceed $250 in any one day to anyone organization can be supported by bank records.  Cash donations require written acknowledgment from the Charity as well as all donations that exceed the $250 rule.

Non-cash donations, the most popular being made to resellers of thrift goods.  Think clothing, books, household items, electronics, etc.  Best practice is to keep detailed records of precisely what you donated, exact quantities, and fair market value of each item.  Larger claimed deductions should have the best records.  The IRS has taken several taxpayers to court previously and were successful in their efforts.  The Courts believed the donations occurred but denied the deduction because there were no detailed records to back-up the donation deduction.

If you make a donation but receive something in value in return, the fair market value of what you receive needs to be deducted from the donation amount.  For example, if you bid on a gift basket at a charitable auction, only the amount you actually pay above the value of the gift basket is deductible.

There are limitations in how much you can deduct each year.  Cash donations are limited at 60% of adjusted gross income currently through 2025, then back to 50%.  Capital gains property, for example, stock in a public company is limited to 30% of adjusted gross income.  This can be a nice tax planning tool if you have some highly appreciated stock, as you get the fair market value as a possible deduction on Sch A and can avoid paying capital gains tax on the appreciation.  If you choose to only deduct the cost of the stock, you can obtain a 50% limitation, but this would be kind of unusual.  The good news, anything not allowed by virtue of a limitation can carry forward for up to five years.  The same percentage limits carry forward as well.

New for this year only (CARES Act):  The limitation for cash donations is now 100% of AGI, not 60%.  You can shelter all of your taxable income this year with a charitable donation.  The same five-year carryover rule applies.  Also, under CARES Act, anyone can claim a $300 charitable deduction without having to itemize.

Investment Management: Cost Basis Choices in the Drawdown Phase

By Scott Roark, MBA, PhD | April 17, 2020

When it comes time to start living off the investment accounts you’ve spent a lifetime building up, there are some choices that can help you manage your taxes.  The rest of this article presumes that you have taxable brokerage investments – such as stocks, ETFs or mutual funds that are not part of retirement accounts.  Of course, any distributions from a retirement account, such as an IRA or 401k, will be taxable as ordinary income and the only choice you have is how much to withdraw.

In a taxable account, however, there are some other considerations.  This is because any time you sell a holding, the IRS will want to know what the tax consequence of that sale is.  There are three possible scenarios:

  • The first possibility is that you sell some shares of your investment for exactly the same price that you paid for those shares. In this case, there is no taxable gain or loss and so there is no effect on your taxes.  All the proceeds of the sale are available for whatever use you desire.
  • A second possibility is that you sell some shares of your investment for less that you paid for those shares. In this case, you have a loss that can be used to offset gains on other investments you sell or the loss can offset up to $3,000 of otherwise taxable income.
  • The third possibility is that you sell some shares of your investment for more than you paid for those shares. In this case, you have a capital gain.  Depending on how long you have held those shares, you have either a short-term capital gain (taxed at your ordinary rate) or a long-term gain (taxed at lower rates).

With those scenarios as background, there is one important choice you can make with your brokerage account that can help you manage your tax situation.  That is the choice on the cost basis.  The cost basis refers to how much was paid for a particular share.  In many accounts, particularly those with mutual funds where distributions from the mutual fund company are reinvested, there are many different transactions that occur over time.  For instance, if you purchase 1000 shares of an S&P 500 index on January 1 and you have elected to have any distributions from the fund reinvested, there will likely be four additional purchases of shares in your account over the course of a year.  This is because many of the S&P 500 firms pay dividends and these are passed through to mutual fund owners – usually on a quarterly basis.  In addition, many investors make periodic purchases by adding new money to an account over time.  So in any account with mutual funds, there are likely a rather large number of separate transactions to buy shares.

Because these shares have been purchased at different times throughout the year, there is likely a different purchase price (and cost basis) for each transaction.  In the example outlined above, there is the initial purchase, the quarterly reinvestments and the quarterly additions of new money.  In all, there are nine transactions in this simple account.  Let’s walk through the spreadsheet below and look in more detail at these transactions.  We will need this example in order to make sense of the choices an investor has when we discuss these choices later.

Here is a numerical example (roughly modeled on 2018 when there were sizable fluctuations in the market over the year):

Jan 2 – Investor makes an initial purchase of $25,000 for $25.00 per share.  The investor has a total of 1,000 shares.
Here is a numerical example (roughly modeled on 2018 when there were sizable fluctuations in the market over the year):

Mar 30 – The investor receives a dividend of $0.11 per share.  This is $110 and they can reinvest and get 4.51 shares at the new price of $24.38.  In addition, the investor puts in $5,000 of new money in and gets 205.09 additional shares.  The new share total is 1,209.60.

June 30 – Dividend of $0.117 per share.  The dividend is $141.52 (equal to 1209.60 shares x $0.117 per share).  This is reinvested at the new price of $25.10 and results in 5.64 new shares.  In addition, the investor puts in $5,000 of new money and gets 199.20 shares for a new total of 1414.44 shares.

Sept 30 – Dividend of $0.122 per share.  The dividend is $172.56 and at the new price of $26.91 per share, the reinvestment results in 6.41 new shares.  The investor also adds $5,000 of new money and gets 185.80 new shares for a total of 1606.66 shares.

Dec 30 – Dividend of $0.128 per share.  With the share total of 1606.66, the dividend is 205.65 and after a deterioration in the share price, the dividend reinvestment results in 9.48 new shares (at the new price of $21.70 per share).  With the addition of $5,000 of new money, the investor also gets 230.41 additional shares.  The total shares at the end of the year is now 1,846.55.

The total invested over the year comes in 3 flavors:  the initial purchase (of $25,000), the additional contributions of $5,000 per quarter (total of $20,000) and the reinvested dividends which total $629.74.  The cumulative invested over the year is $45,629.74.

Now to the choice you can make to help manage taxes.  There are 3 main alternatives to determining the cost basis of the mutual fund shares you sell from your taxable account:  average cost, FIFO and specific share identification.

  • Average cost means that all of the shares are treated as coming from one big bucket and the cost basis for each share is the average price paid for all the shares in the bucket (including any reinvested dividends or capital gains). In the example, this would mean the average cost per shares is $45,629.74 ÷ 1846.55 shares = $24.711 per share.  Whenever a share is sold, its cost basis will be considered $24.711 per share.
  • FIFO is short for “First In, First Out”. This means that the oldest shares are sold first.  In the example provided, any number of shares sold up to the initial 1000 purchased will have a cost basis of $25.00 per share.  After those first 1000 shares are sold, the next 209.60 shares will have a cost basis of $24.38 per share.  After that will be 204.84 shares with a cost basis of $25.10, etc.
  • Specific share identification means that you tell your brokerage firm which shares to sell – you “specify” the shares. The cost basis for the shares you sell will depend on which shares you specify.  You have some shares that have a cost basis of $25.00, some at $24.38, some at 25.10, etc.

Here is how your choice of cost basis makes a difference.  Let’s say you needed $10,000 on February 1, 2020 – when the share price of your S&P 500 index fund is $29.80 per share.  You will need to sell $10,000 ÷ 29.80 = 335.57 shares to get that money.

If your choice of cost basis is Average Cost, then for each share you sell, you will have (29.80 – 24.711) in capital gains.  In this case the total gain is $1,708 and you would pay long-term capital gains rates on this for your taxes.

If your choice of cost basis is FIFO, then for each share you sell, you will have (29.80 – 25.00) in capital gains.  In this case the total gain is $1,611.

If your choice of cost basis is Specific Share Identification, you have more flexibility.  If you want the lowest possible tax hit, you can choose to sell the highest cost shares first.  In this case, you still need to sell 335.57 shares and you can do that by selling 192.22 share you bought at $26.91 per share and sell the remaining shares (143.35) which have a cost basis of $25.10.  In this case, your gain will be only $1,229 – potentially saving you a few hundred dollars in taxes in the current year.

One quick point worth mentioning here.  If you sold ALL of the shares in any given year, the amount of the taxable gain will be EXACTLY the same.  The only thing that is changing when you select different methods is the timing of the taxes.

The big takeaway from all of this is that investors have a choice as to which cost basis method they use.  The default is likely the Average Cost Method or the FIFO method, depending on your brokerage firm.  However, the Specific Share Identification Method provides the most flexibility in managing your tax situation when selling shares from your brokerage account.  In order to change methods, you likely only need to go online and make a selection of “Specific Share ID” and you are set.  Then when it comes time to sell some of your holdings, you select which shares to sell in order to best manage your tax situation.

IRA Rollover Rules and Taxation

By Bob Palechek, CPA | April 3, 2020

You own your retirement funds.  That grants you some flexibility in what you do with the funds and where you put them.  But with flexibility comes responsibility, and you are responsible for following all of the IRS’s rules.

You may get help from plan custodians, administrators, or bankers, but that does not relieve you of the responsibility of getting it right.  And a word of caution: many actions cannot be undone.

You may decide to move your retirement funds (1) between plan types, (2) to new accounts, or (3) to a new holder or custodian of your assets.  If so, your goal is generally to achieve this without creating a taxable event and, done correctly, that should be achievable.

Our goal is to provide you with that knowledge.  Or to show why you might want to consult with a tax pro before you start.

Transfers versus Rollovers

The transfer process is relatively straightforward.  The rollover process is more complicated.  Let’s look at both.


A transfer is typically done between IRAs.  You let your new IRA know of your wish for it to ‘receive funds’ from another IRA, and you provide all the details of your original IRA.  The new IRA will pull the funds across.  No taxes are withheld, and you receive no funds.  It is a safe and easy way to transfer retirement funds.  You do not need to report a direct transfer on the IRS’s Form 1099-R, so you shouldn’t be alarmed if you don’t receive one.


All movements of funds that do not qualify as transfers are considered rollovers.  And, they are more open to having something go wrong if not handled correctly.

Employer 401(k)-related rollovers

A typical rollover occurs when you reach out to your employer 401(k) plan and request all or a portion of that money.  This may occur through an in-service withdrawal (if the employer plan allows it) or after departing from that employer.

  • If you want to preserve your funds in a retirement account, you will request a rollover and provide the name of the new qualified plan or IRA account.  The original holder of the funds will issue a direct payment to the plan or account electronically, if available, or via check.  No taxes need to be withheld. You will receive a Form 1099-R to use when reporting the rollover on your taxes.  The distribution amount is shown in Box 1, but none of the amount should be taxable, and the code in Box 7 will be a ‘G.’  All is good.
  • If you receive a check to deliver to the new custodian, you will want the check to be payable to the new custodian, and not to you personally.  That way, this will be considered a direct rollover, and no tax withholdings are required.  The same reporting of the Form 1099-R will occur.
  • If you receive the check payable to you, a 20-percent federal withholding is required.  If your goal is a tax-free transaction, you have 60 days from the ‘constructive receipt’ of the check to deposit it into the new qualified plan or IRA account.  (‘Constructive receipt’ is when you have reasonable access to possession of a check.)
  • If you should miss the 60-day window to deposit, the distribution will be taxable to you and may be subject to a 10-percent penalty if you are below age 59½.  There are no exceptions.  If the 60-day window is missed because of cause, the IRS does provide a relief process but only under strict circumstances.  It should not be relied upon if the deadline was accidentally missed or if you changed your mind.

To remedy the situation and to achieve a complete tax-free rollover in these circumstances, you will have to make up the 20-percent withholdings with other funds.  You will be able to recover the 20-percent withholdings when you file your taxes the following year if you are overpaid.

IRA-to-IRA or Roth-to-Roth rollovers

The other typical rollover is from one traditional IRA to another, or from Roth to Roth.  These rollovers can either be direct (where the check is made payable to the new custodian or IRA) or indirect (where the check is made payable to you).  The first option is preferred because the 60-day window rule is not an issue.

  • On indirect rollovers of a traditional IRA, a 10-percent federal withholding rule is standard but not mandatory.  As in the remedy described above, the 10-percent withholdings would have to be made up with other funds to achieve a tax-free rollover.
  • One inconvenience of the indirect rollover of traditional or Roth IRAs is that you are only allowed one rollover per year.  The rule that introduced that limitation in 2015 exempted rollovers from 401(k)s.
  • If you do an indirect rollover, it will generate a Form 1099-R to use when reporting the rollover on your taxes.  Since an indirect rollover is where the check is received by you and payable to you, the Form 1099-R will come with a taxable distribution code on the form.  The code in Box 7 will typically be a ‘1’ or ‘7.’ However, the issuer has no way of knowing your intentions.  It also does not know if you met the 60-day window rule or the once-per-year rule.
  • If you have someone preparing your taxes, make sure to provide them with all the details of your rollovers so you will not get taxed as though you took the money from your plan.

And if you would like help to ensure that you have followed all the rules, make sure to reach out to your tax professional.  It’s always a good idea to make sure your T’s are crossed and your I’s dotted.

Five Positives and a Negative about the SECURE Act

By Bob Palechek, CPA | February 7, 2020

The U.S. Government is finally reacting to its concern that Americans are not saving enough for retirement. (About one-quarter of working Americans have no retirement savings.) So, Congress started writing bills and resolutions that would make it easier for certain employers to offer retirement plans to their employees – and for workers to save more money.

The name they gave it was the SECURE Act: the “Setting Every Community Up for Retirement Enhancement” Act of 2019. After months of delays, Congress finally passed the Act in December 2019 by tucking it into an Appropriations bill that had a year-end deadline.

But, not all of the parts of the new law will “enhance” everyone’s retirement, especially someone planning to use a specific strategy that benefits future generations. First, let’s see the five key positive changes, and then the one that may call for some crucial retirement plan adjustments.

Five Key Positive Changes

  • Before the SECURE Act, you had to distribute a minimum amount of your qualified retirement accounts (called RMDs) beginning in the year you turned 70½. (In the first year, the percentage to be distributed is about 3.65% and increases each year.) For higher net worth taxpayers, being forced to add this income to Social Security benefits can create a sudden jump in the taxes due. This Act raises the starting age to 72 for anyone younger than 70½ at the end of 2019.
  • Until this Act passed, you were allowed to contribute to a Roth IRA after age 70½, but not to a tax-advantaged traditional IRA. The Act removes the age limit on traditional IRAs. Yeah! Please keep in mind that you still need “earned” income to contribute. Part-time wages or consulting income (Sch C) works just fine.
  • Thanks to the Act, you now have increased access to lifetime income options (annuities) inside qualified retirement accounts.
  • If student loans somehow figure into your finances and you own a 529 Plan, you can now take a tax-free distribution from the plan to pay toward qualified student loans. The lifetime limit of $10,000 per child means a maximum of $40,000 for four children, for example. You cannot take a deduction for any student loan interest associated with these payments, but that deduction was phased out for many taxpayers in any case. What isn’t clear yet is how the states will handle this and which ones will conform or not.
  • The Kiddie Tax is going back to the old rules, starting in the tax year 2020. Changes in the Tax Cuts and Jobs Act of 2017 had some undesired tax effects as soon as they were implemented in 2018. Some families with minor or college-age dependents found they were hit with high tax rates on their Social Security benefits or taxable scholarships received by the kids. Taxpayers can opt out when filing for 2019, and can also amend their 2018 returns if it makes sense.

A Change with Cause for Concern

This change – the elimination of the lifetime Stretch IRA – was placed in the law to help offset the government’s overall decrease in tax revenues caused by the Act’s various positive changes. (And if it is good for the government, you should question if it’ll be good for you.) Before the Act, you could use the Stretch IRA provision when leaving an IRA to your kids.

It allowed them to spread the required distributions (RMDs) over their lifetime. For a middle-aged child with good earnings, for example, this protected the inherited money from very high tax rates. Now, instead of lifetime distribution, the new Act says the IRA has to be distributed in 10 years or less. Ouch!

A good Certified Financial Planner can find workarounds for retiring and retired clients. For example, by making Roth conversions during low tax rate years before death, you can leave more tax-friendly IRAs to the kids. This change only applies to IRAs inherited after January 1, 2020. And, the Act exempts surviving spouses, minor children, and individuals who are not more than 10 years younger than the decedent.

If any of these changes can potentially impact your existing retirement plans, be sure to check with your financial advisor for a re-evaluation. Besides what is in this summary, many nuances exist that could be even more beneficial to you.

Tax Scams: How Not to Be a Victim

By Jo Madonna, E.A. | January 3, 2020

Thousands of people lose personal data and millions of dollars to tax scams each year, despite the IRS publishing its ‘Dirty Dozen’ list of top scams year after year. The IRS encourages Americans to remain ever vigilant and to become aware of the scams and tactics used in order to protect personal information. While scammers are active year-round, certain activities peak around tax-filing season.

How Scammers Initiate Contact

  • Scammers use regular mail, telephone, email, or social media.
  • While tax scams take many shapes and forms, many IRS impersonators use threats to intimidate and bully people into paying a fabricated tax bill. They may even threaten to arrest or deport their would-be victim if the victim doesn’t comply.
  • For a list of recent tax scams, you can visit https://www.irs.gov/newsroom/tax-scams-consumer-alerts.

How the IRS Will Never Initiate Contact

Unlike scammers, the IRS doesn’t initiate contact with taxpayers by email, text messages, or social media channels to request personal or financial information.

The IRS will never:

  • Call to demand immediate payment through a specific payment method. (Scammers often propose using a prepaid debit card, gift card, or wire transfer.)
  • Demand payment of taxes without allowing you to question or appeal the amount they claim you owe.
  • Threaten to have you arrested by local police, immigration officers, or other law-enforcement for non-payment of taxes. Nor can they revoke your driver’s license, business licenses, or immigration status.

These are all tactics used by scammers to intimidate you into falling for one of their  tax scams.

How the IRS May Contact You

The IRS uses the U.S. Postal Service as its primary means of contacting you. Before any other contact, the IRS will have mailed a bill to anyone who legitimately owes taxes.

Under certain circumstances, the IRS may call or come to your home or place of business. However, they will never demand payment. If they call, they will provide you with an official IRS number where you can call them back. If a caller refuses to give you a contact phone number, that is a good indication that you are dealing with a scammer.

If you do receive a visit from an IRS representative, you have every right to request to see official identification. A legitimate agent will provide you with two forms of ID.

The first will be a pocket commission. This is a red leather folder with the IRS seal embossed in gold on the outside, and the words “United States Treasury Department, Internal Revenue Service.” Two inserts are attached inside and include the representative’s printed legal name and job title, plus issuing information and the representative’s photo and signature.

The other ID will be an HSPD-12 card, which is a government-issued smart card that verifies the identity of Federal employees.  You can ask the representative for the IRS phone number used to verify the information on the HSPD-12 card and confirm the representative’s identity.

If you are comfortable after examining both forms of ID, you can speak with them about your case. Again, though, remember they cannot demand payment immediately.

How to Make Payments to the IRS

If you do owe taxes, the IRS instructs taxpayers to make out payments to the “United States Treasury.” Specific guidelines on how to make tax payments can be found at irs.gov/payments.

Third-Party Collections

The IRS has contracted with four private collection agencies to collect on the tax debt. They are CBE, ConServe, Performant, and Pioneer. First, the IRS will write to you to let you know your overdue tax account was assigned to such an agency. The letter will provide the name and contact information of the agency assigned to your account. Then the private agency will write to you giving details on how to resolve your tax issue.

Both letters provide a Taxpayer Authentication Number linked to your identity. You can also use this number to check that any caller is legitimate, as a scammer will not have it.

Know Who to Contact

If you have any trepidation that someone is trying to scam you, make sure that you do not give any personal information. You can always contact someone directly at the IRS to confirm any questions that you may have. Your tax professional should also be able to determine the legitimacy of the notice or call.

Here are some Federal Government agencies you can contact to report different types of scams:

  • Contact the Treasury Inspector General for Tax Administration to report a phone scam. Use their “IRS Impersonation Scam Reporting” web page. You can also call 800-366-4484.
  • Report phone scams to the Federal Trade Commission. Use the “FTC Complaint Assistant” on FTC.gov. Please add “IRS Telephone Scam” in the notes.
  • Report an unsolicited email claiming to be from the IRS, or an IRS-related component like the Electronic Federal Tax Payment System, to the IRS at phishing@irs.gov.

Lastly, should you have monetary losses related to an IRS incident, report it to the Treasury Inspector General Administration (TIGTA). Also, file a complaint with the Federal Trade Commission (FTC) using their Complaint Assistant, so your information becomes available to investigators.

Tax Document Retention: When the IRS Can Request Documents

By Jack Krumeich-Miller, E.A. | November 21, 2018

When I first began preparing tax returns for friends and family, it was all done on paper.  It was all mailed in.  It was all physically saved in filing cabinets.  And, I was always told I could shred anything after 3 years.  However, that is not exactly true.

Now it can all mostly be done electronically.  Aside from certain forms and IRS and State Department of Revenue notices, I can handle my tax work from my computer.  No more pencils, no more grabbing blank forms from the high school library.

One of the first things I learned when I started doing more tax returns than just friends and family was how important it is to keep every single document or copy of documents that comes my way.  I also began informing my friends and family to keep their documents for at least three years.  I say “at least” 3 years because that is not the only amount of time the IRS can request them or dispute your tax return or tax situation.  They can take action at any time for several different reasons.  If a taxpayer does not have the documents needed to properly respond to the IRS, they can assume they were right and move forward with whatever steps are within their power to collect.

There is a term − statute of limitations − which is the allowance of time given for the IRS to act.  The IRS has three years from the time your return was filed to act against your return for matters related to clarifying discrepancies between what they think you owe and what you claim you owe.  If they suspect tax fraud, the statute of limitations can be six years from the last act committed, not from the period the tax fraud began.  There is no statute of limitations if the IRS suspects you filed a false tax return; you did not file any tax return; or you committed a willful effort to evade paying taxes owed.  And remember, it is not a matter of if you committed any of these offenses, it is a matter of whether or not the IRS suspects you did.

The IRS also has a Whistleblower program where anyone can direct their attention to potential questionable tax activity.  Anyone could feel motivated to call the IRS with any number of accusations and, with their incentives for a successful recovery of taxes owed to them, the IRS will investigate.

Collection of your tax debt involves a separate statute of limitations.  Currently, that limitation is 10 years from the date of the last assessment of tax debt.  If you owe one year, and then seven years later, owe an additional amount from another tax event, they start the collection clock over from the most recent debt assessed.  If you file bankruptcy or begin the process of applying for a payment plan, or any number of events that put a pause to the IRS collection efforts, it pauses the clock on the 10-year statute of limitations.  When the event ends the IRS can begin collection efforts again and the statute of limitations clock picks up right where it left off.  The IRS can also file for judgment, and when judgment is awarded, they can renew the judgment and start the clock over again.

While there are technically time limits for the IRS to act, it doesn’t mean they won’t try another avenue to investigate your tax situation. To me, there are fewer reasons to shred your documents after three, six or ten years than there are potential reasons to keep them as long as possible. Thankfully, with today’s technology, document retention is much easier, faster and less expensive than ever before. These services offer protections from data breaches, file deletion, or damage to your hard drive. Maintaining your tax documentation is important, and even though it is often felt three years of retention is adequate, the IRS has many opportunities to request data further back than that. I strongly recommend you digitize and store your tax filing documents for ten years minimum – just to be on the safe side!