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Why Documentation Is Needed?
Key: Key: Documentation
is the key to sustaining your tax position.
Cemetery: Cemetery: Without documentation, you
end up in the tax deduction cemetery, losing all of your bona fide deductions.
The law: The law: Documentation is required by
law.1
IRS states in its official publications IRS states
in its official publications that you must maintain records that support
accurate tax returns. The records should be made at or near the time
of the expense when there is accurate recall. Such records must be permanent,
accurate, and complete.
Walked on: Walked on: Failure to meet the adequate
documentation standards of the Internal Revenue Code can result in disallowance
of your valid deductions.2
Guilty: Guilty: IRS thinks you might cheat on
your taxes; accordingly, you are assumed guilty until you prove that
you are innocent.
HOT TIP
Burden of support is on you: Burden of support
is on you: IRS examiners are not required to help you keep records.
You have total responsibility for proving your deductions.3
Own demise: Own demise: Failure to meet the requirements
costs you bona fide deductions.
Fraud: You now answer questions concerning your
automobile mileage records under penalty of perjury.4 Congress has instructed
IRS to ask for fraud penalties when taxpayers don’t have good records
of automobile use.5 You now answer questions concerning your
automobile mileage records under penalty of perjury.4 Congress has instructed
IRS to ask for fraud penalties when taxpayers don’t have good records
of automobile use.5
WARNING!
Big, big penalties: Big, big penalties: Failure
to keep good records results in penalties among others, equal to:
- ½ of 1% a month delinquency penalty during the period
that you fail to pay the proper amount of tax;6
- 20% of underpayment attributable to negligence or
disregard of the rules or "did not have a reasonable basis for
the deduction;"7
- 75% of any underpayment attributable to fraud;8
and
- You may deduct some interest paid to the IRS, if
it was were due to a business deduction on your Schedule C.9
Strategies to Meet The Records Requirements
Strategy 1: Build a documentation system.
Three distinct records: Three distinct records:
Regardless of how you conduct your business, whether as a corporation
or as a sole-proprietorship, you need three separate and distinct tax
records:
- Permanent files
- Regular files
- A daily diary
Permanent files: Include your prior years’
tax returns, stock purchases and sales, equipment purchases, and sales
and similar entries. Generally, you want to keep any record that relates
to more than one tax year in your permanent file. If you purchase property,
your permanent files should include the purchase documents, closing
statements, deed, and other expenses related to the purchase. Include
your prior years’ tax returns, stock purchases and sales, equipment
purchases, and sales and similar entries. Generally, you want to keep
any record that relates to more than one tax year in your permanent
file. If you purchase property, your permanent files should include
the purchase documents, closing statements, deed, and other expenses
related to the purchase.
Regular files: Regular files: Include time sheets
for part-time help, receipts, invoices, canceled check, and other corroborative
evidence.
Daily diary: Your daily diary – which can
be your appointment book – is the focal point of your documentation
system. This is especially true if you operate a personal service business.
The smaller your business, the more important this document becomes.
Your daily diary should include: Your daily diary – which can be
your appointment book – is the focal point of your documentation
system. This is especially true if you operate a personal service business.
The smaller your business, the more important this document becomes.
Your daily diary should include:
- All of your appointments;
- Where and when you travel;
- Where you go by automobile; and
- Where and when you entertain your business contacts.
Strategy 2: Use three-part checks:
Keep a separate business checkbook and use three-part
checks. Regardless of your business form, whether a corporation or sole
proprietorship, the three-part check is necessary to build good, easy-to-use
records in your regular files.
- Send part one, the original of the check, to the
vendor.
- Staple supporting evidence such as receipts or invoices
to the yellow copy (part two) of the check and file alphabetically
in the vendor file.
- Put part three in a numerical file for later viewing
by IRS and reference by you.
Strategy 3: Keep Form 1099 information separate.
Negligence penalties are automatic if you fail to report
all the income that’s reported to IRS on Form 1099.10 The negligence
penalty applies to your total underpayment of tax, not just the portion
due to negligence.11 Any deposit that you make that would not normally
be included in a 1099 or W-2 should be copied. Thus, if you get a large
gift, insurance reimbursement, or transfer money from one account to
another, make copies of the checks. Failure to do so may result in the
IRS treating the deposit as income.
Strategy 4: Join the pack-rat brigade and pay less
tax.
HOT TIP
Save every receipt, whether personal or business, for
all money spent. It’s virtually impossible for you to know all
of the receipts you are required to keep. Since you don’t know
what’s important and what’s not, it’s safest to save
everything for at least three years. Remember, you carry the burden
of proof. It’s rare that you can establish proof retroactively.12
Strategy 5: Use a business credit card.
To keep your record – keeping burden to a minimum,
use a separate charge card for all your business expenditures. The charge
card copy acts a receipt for your travel, entertainment, and gas and
oil purchases. It also eliminates the need to make an audit trail for
the deductible interest. By using one or more credit cards solely for
business, you can deduct the finance charges on the business cards as
well as the annual fees on all cards used solely for business.
Strategy 6: Think like a prosecuting attorney.
You carry the burden of proof and your records are the
evidence you gather. Think like a prosecuting attorney and put together
all of your evidence in a fashion that unquestionably supports your
deductions.
- An airline ticket shows the name of the passenger.
- An airline ticket shows the destination and any stops
made en route to or from a business destination.
- Lodging receipts show single or double occupancy.
- Signatures on gasoline credit card charges can indicate
use by family members other than the taxpayer.
- Repair bills can establish the accuracy of automobile
mileage.
Hindsight: Hindsight: An audit of your tax return
takes place almost 18 months after you have filed it. Your documentation
system must be maintained on a daily basis, but in a manner that establishes
intent for an entire year.
- IRC § 6001.
- Rugel v. Commissioner, 127 F.2d 393 (8th
Cir. 1942).
- Reg. § 31.6001-1 (a).
- See IRS Forms 2106, Employee Business Expenses, 4562,
Depreciation and Amortization and declarations above the signature
lines on Forms 1040, U.S. Individual Income Tax Return.
- Conference Committee Report on P.L. 99-44, as found
in [1988] 8A Stand. Fed. Tax. Rpt. (CCH) ¶ 5528.034.
- IRC § 6651(d)(1).
- IRC § 6662+1.6662-7T(c) of the regulations.
- IRC § 6653(b)(1)(A).
- IRC § 6621(a)(2) but see Redlark, 106 T.C.
Page 62 (overturning the regulations).
- IRC § 6653 (a).
- Reg. § 301.6653-1(c)(1)(I).
- Rev. Proc 92-71 (1992-35 I.R.B. 17) (where checks
in some circumstances are no longer needed to be kept where other
appropriate evidence is available).
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