How Long Do You Keep Your Tax Records?

Taxpayers often ask how long they have to keep their tax records. Many taxpayers only keep records for three to six years. In Reyonoso v. Commissioner, T.C. Memo. 2016-185, the court considered a case that turned on whether the taxpayer could produce records to support that he had made a mark-to-market election nearly twenty years ago.

The facts and procedural history are as follows:

  • The taxpayer was a successful chiropractor.
  • He stopped filing Federal income tax returns in 1997.
  • He continued to submit claims to insurance to obtain payment for his services.
  • The insurance companies required that he provide his Taxpayer Identification Number on a Form W-9 to obtain payment.
  • The taxpayer used different Social Security and Taxpayer Identification Numbers on the Forms W-9 and to establish the bank accounts that he deposited the insurance checks into.
  • He then consolidated the monies into his brokerage accounts.
  • The taxpayer incurred significant losses each year by trading stocks in the brokerage accounts.

The taxpayer argued that he did not believe that he had to file income tax returns given his significant losses from trading stocks. Put another way, he argued that he thought his investment losses could offset his business earnings.

Tax Treatment of Stock Gains and Losses

Losses for investors and stock traders are capital in nature absent a mark-to-market election. Capital losses can generally only offset capital gains and then up to $3,000 of ordinary income, such was business earnings, each year. Excess capital losses carryforward and can be used in future years to offset capital gains or up to $3,000 of ordinary income.

The mark-to-market election is provided in Section 475(f). It provides an exception to the capital treatment of stock losses. The election requires that all gains and losses from securities be treated as ordinary in nature and all securities on hand at year end are deemed to be sold at the year end market value, thus recognizing unrealized gains and losses. Ordinary losses can offset other items of ordinary income, such as earnings from a business.

Making the Mark-to-Market Election

The Section 475(f) mark-to-market election is made by following the procedures in Rev. Proc. 99-17, 1999-1 C.B. 503. These rules were changed in 1999. For taxpayers who made the initial election, they had to (1) attach an election statement to either their timely filed return or extension request for the year preceding the year the election is first effective and (2) attach a completed Form 3115 Application for Change in Accounting Method to their return for the year of change. The election was effective for the tax year for which it was made and all subsequent tax years, unless revoked with the consent of the IRS.

As noted by the court, Reyonoso argued that he made a mark-to-market election in 1997. This was before Rev. Proc. 99-17 was issued and before there were formal mark-to-market election rules:

Revenue Procedure 99-17 didn’t come out until 1999. Before 1999 the IRS had no procedure for how to make a mark-to-market election. See Knish, T.C. Memo. 2006-268. To make an election for the 1997 tax year, as Dr. Reynoso insists he did, would have required a very sophisticated understanding of the Code. If it were the case that Dr. Reynoso had a sophisticated understanding of the Code, it would not be the case that he thought he didn’t have to file his tax returns for eight years in a row. See sec. 6012(a). Even after the IRS released the Revenue Procedure, Dr. Reynoso still couldn’t have made a mark-to-market election—he broke the rules when he didn’t file his tax returns. See Rev. Proc. 99-17, sec. 5.03. And in any case, we reiterate, there is no proof that he ever made such an election.

This raises the question as to how a taxpayer is to prove that he made a mark-to-market election nearly twenty years ago, when he did not keep a copy of his nearly 20 year old tax return or records. Even the IRS does not even keep most income tax returns or related records for this long.

In this case, there were several factors that indicated that the taxpayer acted in bad faith. This included keeping no business records whatsoever. So the court was able to sidestep the issue as to how a taxpayer is to prove that he had made a mark-to-market election in the past.

In reading the court case, one is wondering if the outcome would have been different if the taxpayer did not act in bad faith. Would it have been sufficient if the taxpayer had prepared and presented schedules to account for his stock trades on a mark-to-market basis? What if he had done so contemporaneously each year and documented the timing of the records in some fashion?