The IRS suggests that you hold on to your tax records for three years, but some tax advisors recommend that you keep them for seven. It doesn't hurt you to err on the side of caution. Additionally, if you have taken net operating losses or deductions in the same vein, you will want to keep your tax records from when you first took the deduction/loss.
The reason that most tax advisors will caution you to keep your tax records for three years is because three years is the statute of limitations for the IRS to audit a tax return. This means that you could receive a notice in the mail requiring follow up information on your tax return from three years ago. Audits of this nature are uncommon, but can happen and the best way to avoid paying unnecessary taxes as a result of the audit is to keep your tax records and paper trail handy.
Additionally, if you are filing taxes for a business, it's wise to keep the previous seven years of tax records. This is the general recommendation because you will most likely be filing net gains and losses with each return. Net gains and losses can be a red flag for an IRS audit that will require an additional paper trail.
If you are looking at your filing cabinet and wondering how you will be able to keep seven years of tax records on file, don’t panic. The simplest way to keep accurate information and ensure it is available when you need it is to scan all the documents onto your computer and save the information onto two different back-up sources such as a CD and an online backup server. By scanning and sorting your business documents and tax records online, you will not only save space, but you will also create an easily accessible means of getting the information quickly.