IRS Audit may occur when we cannot submit all necessary receipts. Receipts may be misplaced, forgotten, or not processed properly. Knowing the consequences and possible solutions to this type of situation is important.
Audits and Receipts
An important issue to remember is that IRS audits tend to focus more on self-employed individuals. Logically, when your employment depends on an employer, returns are filed through W-2 forms and, except for exceptional situations, are not usually subject to audits.
The self-employed, however, do receive audits: moreover, these are complete audits in which it is necessary to submit all the data required by the tax authority.
The receipts are a fundamental part of the data and documentation since, in many cases, they are proof of payment that, if not presented, can generate problems. However, as we will see, there are alternatives for these missing receipts.
Why the IRS audits you
First, you should know that the IRS does not specifically clarify the factors that determine who to audit or not. However, some elements are common to most audits or may generate the tax authority’s interest.
The most common elements would be the following:
- Absence of income reports in counterpart to reports of payments towards our company made by other companies.
- Deduction models are very unclear or excessively high: an example may be philanthropic contributions of a very high-income level.
- Having high incomes: audits target higher income earners to a greater extent.
- Documentary errors or omissions: this is another of the great classic audits. For example, missing information or employee classification statements can occur on W-2 and 1099 forms.
What happens when receipts are missing in the audit?
We should remember that the tax authority has up to three years from the time of the expiration (or declaration) of a tax to add additional taxes. That means the period one must keep receipts concerning a current tax year is very long.
What happens, very often, is that not all receipts supporting income or expenses are kept or cared for in the same way. That may mean that, at the time of the audit, we have forgotten some of them.
The first thing to remember is that the IRS, in the first instance, will often provide substantiation of expenses from other tools when receipts are found to be missing.
For example, you may be required to provide evidence of claiming business expense deductions. That means you should re-create the corresponding business expense histories at the time of the audit.
This type of document review can sometimes be complex. Specialists advise against claiming expense deductions on estimates; therefore, it would be ideal for checking the specific business expenses at each point. This way, the costs claimed in the tax return will correspond to what you can prove. Logically, this is a big step forward in the audit.
Cohan’s rule on audits with incomplete documentation
We should not think that an audit with incomplete documentation is something new. When we talk about the Cohan rule, we are dealing with a case that went to court in the 1930s.
In that case, Cohan (a celebrity at the time) declared in court that his activity did not allow him to maintain a good organization to record the travel or leisure expenses claimed on his tax return.
The claim was rejected, and after the court period, the so-called Cohan rule was established, according to which taxpayers without documentary receipts for business expenses can claim such costs when they are reasonably credible.
However, this does not mean that you can claim the full amount of these expenses. When you do not submit receipts, you usually cannot deduct the full amount of the costs. The calculation will be made on a standard amount according to the services or items determined, and only one deduction is allowed for each expense.
Although at the time, it was a very interesting rule for those who found themselves with tax claims without being able to provide full documentation of expenses, the courts have been gradually limiting the impact of this rule. One example is the progressive disallowance of unsubstantiated travel expense deductions when it is impossible to document the amount of travel, its volume, and purpose.
For years I have studied American finance regulations. All the information in this blog is sourced from official or contrasted sources from reliable sites.
Salesforce Certified SALES & SERVICE Cloud Consultant in February 2020, Salesforce Certified Administrator (ADM-201), and Master degree in “Business Analytics & Big Data Strategy” with more than 13 years of experience in IT consulting.