Today, I would like to continue answering questions that I am commonly asked. Hopefully, the answers will save you time and money — and maybe some heartache.
So, here goes:
There is a common perception among the public that the IRS will not allow a deduction unless you have the actual receipt for the expense, so people frantically keep large boxes of receipts in case they are audited. There are even electronic apps that allow you to scan these receipts into a computer for permanent access — some even allow classifying the expenses by category.
Folks, this perception of our deductions being disallowed is simply not true. In reality, the federal tax law allows us to deduct out expenses even if we don’t have receipts. Instead, we can simply estimate our deductible expenses if we have a reasonable explanation of the amount and purpose of the expense, and especially if we have some kind of indirect affirmation. Case law is filled with examples.
Here’s one example. Suppose your business rents office space, but you pay cash for it each month. So you have no receipts and also no checks to the building owner. Nevertheless the entire amount will be deductible. The same can be true for charges to your credit card.
The capable IRS agents know this and will not only allow the expenses but may help you reconstruct what a reasonable deduction should be. The problem is the IRS auditors who deal with the unrepresented public — especially on small cases. Many of them tend to be bullies and are very aggressive in erroneously denying allowable deductions.
So, the rule is really quite simple — keep the receipts if you have them but don’t worry if you don’t. If you are audited, hire a good tax representative and make a reasonable effort to reconstruct the deductions you are entitled to.
An interesting side note: The U.S. Tax Court judges don’t like to hear these substantiation cases. In fact, in private, before trials, judges have actually told me they wouldn’t hear a substantiation case. This puts pressure on the IRS to settle these cases without trial.
So, the moral here is to keep the records if you have them but don’t sweat it if you don’t. Do get a good tax adviser to represent you so that you don’t have to go through the abuse.
I have had new clients tell me they wanted to hire a tax adviser to represent them during an audit but were either afraid of creating an adversary relationship — or they felt like the auditor was really nice and would help them. Both of these perceptions are untrue.
In my experience, the “nice auditor” part has often been a ruse. And any adversity is up to the agent.
One other thing is worth mentioning. I almost never let my clients be interviewed by the auditor for a variety of reasons. And it keeps the bullying to a minimum and their stress level way down.
Next week more questions will be answered.