It is surprising to most taxpayers that when it comes to IRS issues, you are guilty until YOU prove yourself to be innocent. This flies in the face of the Constitution's Due Process etc., but there is reasoning to it.
The IRS laws and regulations provide for NO presumption of deductions to income and any deductions claimed must therefor be shown as correct. The proof needed to support any claimed deduction lays squarely on the taxpayer. Is this the way it should be? well perhaps not, but it IS the way it is.
When filing a tax return, the taxpayer signs under penalty of Perjury.
Tax perjury is when a person willfully signs a tax return or other tax document that contains false information. Tax perjury is a felony and people committing tax perjury can face up to three years of prison time as well as a fine up to $100,000 for individuals and up to $500,000 for corporations.
This highly suggests that any claims of deductions be truthful and supported by adequate proof if ever challenged. The way the IRS challenges veracity is to Audit returns. Not all AUdits suspect criminality, some do. Most audits are attempts to collect more tax and therein is the game. You say you have deductions, the IRS says, PROVE IT.
So what is good proof of a deduction being valid? I think it is layered answer.
The following elements are what you must prove if challenged on any deduction:
- That the Business or other purpose of the deduction is necessary and ordinary
- That the transaction actually took place as shown by presentation of contemporaneous receipts/records, canceled checks, credit card statements and any other documentation involved
Many Accountants and other Tax preparers only fill out the needed forms and do not audit nor keep your records. Since you are the one signing under penalty of perjury you also are the one who may have to prove a deduction. Some Accountants who also provide the Bookkeeping for an Individual or Business client will have more contact with financial transactions and some may also keep a degree of records/receipts in their client's file. NOTE: Never depend on an Accountant for keeping your receipts and paper trail records even if they claim they have them. Even if duplicate efforts are made, maintain your own files with records and receipts adding pertinent info like dates, purpose, check #s, cards used etc
I like the old school accordion files premarked for months. Of course, there is nothing wrong with scanning items into a laptop and some accounting programs allow fir uploading receipts right into the program. A nice convenience but don't throw out the originals.
An accordion file folder marked for Months makes it fairly easy. Just place receipts front to back which will be oldest to newest. That establishes a date ordered batch by the Month is readily accessible and searchable. Actual original receipts and documents is the best proof. Showing up to an audit or even US Tax Court with organized files is a sure way to wipe that smug smile off an IRS attorney's face.
What proves a deduction is ordinary and necessary can vary. Industry publications might be a good source or a flow chart detailing where it falls on the steps needed to produce a product or service are good. Some deductions have a NO PROOF needed status if using the IRS's formula. This is common for business miles driven. You can either use actual expenses (receipts please) or the “no receipt needed” option of $0.58 per business mile drive. The caveat is to have a contemporaneously kept mileage log with good detail showing where, miles driven, who was seen, business purpose etc. A good program for logging miles is MilesIQ but there are several and most can help.
WIth 87,000 more IRS agents being hired, audits are bound to increase. And don;t fall for the PR line being given that the increased Audits will only be for the wealthy. Trust me, it is for thee and me.
Keep records. Period. Keep them for up to 7 years. Keep them organized and hope they are never needed. But if they are, you will be prepared.
Here is a good video interviewing a knowledgeable tax pro. BTW, the Wealthion Channel is a personal favorite for insightful interviews with many excellent people on varied financial subjects.
As always, if I can be of any assistance and you are a client, your call is always welcome. Not a client, join up on the site by completing the form. I respond quickly.
Best of Luck to You,
Donn Marier
DM-Your Own CFO