Not only are receipts critical to good bookkeeping and tax returns, the IRS requires businesses (and individuals) to provide records to support their business or personal tax deductions.
If you don't have supporting business records to support deductions, and you are audited, you have a dilemma.
Supporting documents include sales slips, paid bills, invoices and receipts. Your supporting documents should show the date, location, amount paid and an essential character or purpose of the expense that shows the amount was for a business expense. For meals and entertainment expenses, you also need to list the people involved.
Tax regulations state that "unavailability of a taxpayer’s records does not relieve the taxpayer of the burden of demonstrating his or her entitlement to deductions claimed". But if you can’t find one, contrary to popular belief, you are not out of luck.
The case of Cohan v. Commissioner provides an exception to stringent IRS record-keeping requirements and allows taxpayers to prove by “other credible evidence” they actually incurred deductible expenses. According to the rule, the IRS allows business owners to deduct their expenses that were incurred to run the business and whose receipts can’t, aren’t, or weren’t documented.
The Cohan rule still allows taxpayers to prove by “other credible evidence” that they actually incurred deductible expenses. Mr. Cohan testified that he paid in cash, and others also supported Cohan and remembered big and expensive dinners. Of course, this is a tough way to prove expenses.
Case Summary: George M. Cohan was a Broadway pioneer and a flashy guy who tended to pay in cash. In the 1920's, Mr. Cohan was audited and the IRS disallowed his (very large) travel and entertainment expenses for lack of receipts and was told that he will not be allowed to claim deductions on the expenses that he wasn’t able to show proof of. It was wrong of him to not keep the receipts, but he still appealed this ruling that even though he didn’t have the official receipts to prove it, he did incur the expenses and therefore must be given a fair trial. The trial court upheld the IRS. Again, Mr. Cohan wouldn't take no for an answer and appealed to the Second Circuit.
Luckily the courts sided with him which forced the IRS to accept all his estimates of the expenses. In 1930, the Appeals Court rocked the IRS back on its heels with the Cohan Rule. Mr. Cohan testified that he paid in cash, and others too remembered big dinners. Of course, this is a tough way to prove expenses.
Today, the same rule allows many business owners to deduct some of their business-related expenses even when they have no receipts to show that they were incurred. Not surprisingly, the Cohan Rule often doesn’t impress the IRS. You may have to go to court, and the argument doesn’t always work even there. Still, the IRS or a court may be convinced by oral or written statements or other supporting evidence. This will serve as a foundation on whose basis a reasonable approximation has been made.
It's great to be able to take tax deductions for all of your business expenses, but it's even better to be able to prove those deductions in an IRS audit.
A good rule of thumb - If you can't prove it, don't deduct it.
If you get over that hurdle and can make a reasonable approximation of the expenses, your tax position may be sustained despite your lack of documentation. If you provide sufficient credible evidence, the IRS will have no choice but to deduct those expenses from your tax returns. And it isn't just business expenses that can be substantiated in this way. Even charitable contributions have been allowed under the Cohan Rule, although not in cases subject to special strict substantiation requirements.
It's important to note that although a competent tax preparer will ask to see the documentation on your tax deductions, taxpayers aren't required to provide their CPA or tax preparer with this substantiation. The AICPA guidelines indicate that a CPA may rely upon, without verification, information furnished by the taxpayer and the burden of proof (the responsibility to prove entries, deductions, and statements made on your tax returns) falls on the taxpayer.
Should you need help implementing an SIMPLE & EASY way to avoid losing your receipts in the future, please don't hesitate to call us. Reducing the reporting burdens of small business owners is what we love to do!
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