If you are not aware, you should always keep the six most recent years of your tax return paperwork and receipts.
The reason is not arbitrary.
Standard three years
The federal statute of limitations for an IRS audit is three years from the April 15 due date of the return filed three years prior. If you filed for an extension, your due date changed to October 15, making that the new starting point for the statute. If you missed that date and filed late, it starts from the date you filed.
While three years is the standard, there are situations that extend the statute to six years.
Everyone knows you can face repercussions from the IRS for omitting income on your tax return. However, you can also face a penalty for overstating your income as well. If you sell a property and claim you invested more in it than you actually did, that is overstating, and Congress granted the IRS a six-year statute of limitations on investigating overstatements.
Understatement of income
The understatement of income is self-explanatory. If you fail to list all of your income on your return, the IRS can audit you as far back as six years. The standard is a “substantial understatement” equaling 25% or more. Understating is fraud, and if the IRS determines you committed fraud, they can audit an unlimited number of years back. However, if the understatement pertained to deductions or credits, the six-year statute does not apply.
It is in your best interest to monitor your risk for audit. You always know that it goes back no more than six years.