What’s ‘Adequate Proof’ to the IRS?

How should you substantiate your expenses for IRS purposes? The technical answer is – it depends on the type of expenditure and upon the IRS auditor’s evaluation of the situation.

Internal Revenue Code Sections, such as 274(d), specify the requirements to have records, but they do not explain what is adequate. IRS Regulations do provide more detail, but it still comes down to the auditor’s judgment about what is adequate.

Here is a summary of what you should have as the minimums:

  • Auto expenses – Keep a log of daily travel if the vehicle can be used for both personal and business. The lack of a log probably makes this the number- one most often adjusted item on tax returns.
  • Travel expenses – Meals and other expenses (excluding lodging) under $75 can be substantiated with a log or expense report. See Publication 463 for more information.
  • Depreciable Fixed Asset purchases – Keep the purchase documents for at least three years after the asset has been sold or abandoned.
  • Operating expenses – These are all the other ordinary and necessary expenses required to operate a business. The big problem in audits is all those expenses were paid with a credit card, such as supplies from Home Depot. The credit card statement just shows that you have bought something, not what that thing was or why it was necessary. Keeping the individual cash register receipts can help convince an auditor that these expenses were legitimate.

A few things to keep in mind when thinking about substantiation.

  • Your calendars from years past can help in proving auto and travel if you do not have a log.
  • There is the Cohen rule which comes out of case from 90 years ago that does give taxpayers a weak tool to claim expenses based on estimates. This rule does stand up in the courts — sometimes.
  • Your testimony also counts. After all, you’re the eyewitness. However, this only works if you have established credibility with the auditor by showing that all your other expenses were reasonable and adequately documented.

Understanding what is at risk can help to justify the pain of keeping all these records. If the IRS examines your return for any one year and discovers materials deficiencies, they will disallow at least part of these expenses. And, they will typically also audit all the other returns for which the statute of limitations has not run out. This means that the one-year tax adjustment is probably going to be times three as a minimum. Caveat Ductus!

Author: Jim Payne

Jim Payne, a Florida Certified Public Accountant (CPA) since 1976, offers candid insights on getting square with the IRS — with the least pain, and at the lowest cost — with (or without) the help of a tax representative. Mr. Payne is a former IRS agent and expert in business profitability, IRS audits, IRS payroll tax, and IRS non-filer issues. As a Tax Representative, his goal is clear: " I will speak on your behalf to all IRS agents, so you never have to, and I'll guide you in executing a strategy to resolve your IRS problem so you can get back to enjoying life."

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