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How long to keep your tax returns

(MoneyWatch) This is the time of year when I get a lot of questions from folks about how long they should keep their tax returns and records. Most people squirrel away these documents forever, unnecessarily accumulating boxes of papers. Although they think they're being cautious, in reality this is a security risk, as these records obviously contain lots of personal and financial information.

Still, you'd be surprised at how much you can safely discard. Here is what you should keep and how long you should keep it.

Three Years. Keep your federal and state income tax returns and related receipts and statements for at least three years. If you are audited, the IRS reserves the right to review tax returns filed during what is known as the "period of limitations," which is generally the past three years from the date you filed your most recent tax returns. This also includes requesting to see supporting documentation for the income and deductions you reported.

As a result, you will need to keep your 2008 tax return and related papers until April 2012. It's generally safe to shred and discard it after that (unless a situation described below applies to you). See IRS Publication 552, Recordkeeping for Individuals, for more information.

Six Years. If you may have under-reported income by 25 percent or more, then you'll need to keep tax returns and all related information for six years. When there is substantial activity from a closely held business, or the cost basis records for property or securities sold are unclear, under-reporting income is a real possibility.

My rule: Keep records and tax returns for years that include atypical transactions (sales or donations of property) and irregular income (stock option exercises, trust income, etc.) for six years after the filing date of the return. Keep a 2005 tax return that includes reporting of irregular items until April 2012. So if the IRS hasn't raised any issues about your 2004 tax return by now, then it should be safe to shred and discard it.

Seven Years. Keep any tax return and documentation that includes a claim for deducting worthless securities for seven years.

There you have it. Check back in a few days and I'll share a few more tips on what to keep indefinitely and how to keep your records organized and safe.

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