What receipts are required for your tax deductions to survive an IRS audit?
Lack of documentation is easily the most common reason taxpayers lose deductions during an audit.
Ask five different CPAs what receipts to keep for business tax deductions and you might get five different answers.
- Some might say you can get away without any receipts, based on court cases where reasonableness was mercifully allowed.
- Other’s say you better have all receipts, or you’ll lose the deductions in an audit.
The variation in answers from tax experts can be frustrating to a business owner.
…to be fair, it’s because the tax laws are often ambiguous, and there are countless tax court cases of taxpayers challenging IRS audit results which create new interpretations of the laws.
While some tax laws and court cases show deductions allowed without receipts, the ultimate law to keep in mind is that the Burden of Proof is on the Taxpayer.
So, you might get lucky with an IRS auditor who is very reasonable. Or you might get a stickler that is on a warpath to harvest every tax dollar back for the Treasury.
If looking for a quick and simple answer to what the IRS requirement for receipts is, my official (“CYA”) answer is: Keep every receipt
If you are good with that, skip to the last section about how to do so while making your life easier.
Because I understand the natural tendency of people to push back when told to do something overbearing (ahem, wear a mask for two years), I’ll provide some context.
My unofficial answer to the question of what receipts the IRS requires is…
“Do you want to pay now or later?”
- If the prospect of an IRS audit is something that keeps you up at night, you should retain and organize receipts for everything.
- If writing a check for thousands of dollars to the IRS as a result of an audit would break your bank, retain and organize receipts for everything.
- If you are the sophisticated rebellious type and believe that actual tax laws and court cases overrule what the IRS wants you to do, you might get away with it…but you better be willing to spend a lot of time and money defending your case.
- If you want to do the right thing but just can’t make yourself do it by the book: keep receipts for big-ticket items, meals, travel…and for the rest, make sure your accounting system includes the detailed descriptions required.
Because the tax laws are often ambiguous, the courts generally apply a sense of reasonableness.
…As long as the taxpayer can otherwise provide documentation that reasonably shows evidence of the date, amount, and business purpose of the expense.
For example, the IRS is ok if you don’t keep a mileage log for every day of the year. If you have a regular business driving routine, you can log your mileage for one week or month, and extrapolate that out for the year.
At the same time, IRS regulations still say you must provide receipts for some things.
Can you now understand why I gave an “official” and “unofficial” answer about IRS receipt requirements?
Without perfect documentation, you are subjecting yourself to someone else’s definition of what “reasonable” is.
There are some things all business owners should do to comply with IRS documentation requirements, no matter what your risk type is
- Maintain an accounting ledger that is periodically reconciled to bank statements
- For every expense, have records of the amount, date, payee’s name, and business purpose of the expense. This can be noted in your accounting system.
- Have records of your bank and credit card statements readily available.
- If any expense was not run through your business bank or credit card account (paid for with personal funds or petty cash), you should retain the receipt.
- Receipts for lodging (hotel, etc.)
- For meals and entertainment, show the business relationship of people at the event — for example, list their names and occupations and any other information needed to establish their business relation to you.
- For auto expenses, have mileage logs showing the date of the trip, the mileage, and the business purpose of the trip for each vehicle used in the business. Mileage logs should include business use trips as well as other personal use to determine the business use percentage for the vehicle.
- For Purchases that are big (to your business), keep the receipt.
- Keep the receipt and business use description for any item which could be used personally as well as for business…whether it’s used 100% for business or not. The IRS likes to challenge expenses for things like laptops, furniture, vehicles, camera, phone, etc.
- Gifts or donations require documentation
- Maintain strict separation of business and personal accounts. It’s much easier for an auditor to buy your story that an iPad purchase is for business use when you don’t have personal expenses regularly charged to your business credit card.
You’ll buildup much more goodwill with an IRS auditor if you can respond quickly with documentation that was created in real-time. It would not be a good start to an audit if you have to create documentation to substantiate deductions that occurred two years ago.
How long to keep tax records?
Here’s another area where you’ll hear many different answers. Three years, Six years, Seven years….which one is it!?
Three Years is the rule for most cases on how long you must keep tax records.
- If you file your tax return on or before the original due date (ex. April 15), the three-year clock starts on April 15.
- If you get an extension, the clock starts ticking on the extended due date (ex. October 15) even if you file before the extended due date.
- If you file late, the clock starts on the day the tax return is actually filed.
There are a few instances where you would keep records for longer, but for most tax returns….three years is the answer.
You should keep some records permanently, like business organization information.
A final note on record retention: It is not usually recommended to keep records longer than needed. That could potentially backfire on you because any documents that exist can be requested or subpoenaed…even if older than three years.
Thanks to modern-day technology, businesses can maintain impeccable records of receipts for the IRS, with only a little effort.
With Dext, you and your employees can take a picture of receipts from the app on your phone to retain paperless documentation. The software uses OCR to read the receipt details (payee, date, amount, description, etc.) which are used to organize a database of your expenses. The user can input the expense category, a description of the business purpose, or any other notes. You can easily search your receipt database by all of these fields to get what you need.
Bill.com is a software I highly recommend for any business that writes 10 or more checks per month. It intakes your bills, reads the details, and mails paper checks off for you. A secondary benefit is that it retains copies of your bills that can be easily accessed in the future.
Both of these tools can be easily implemented in one day.
If you use cloud-based accounting software like QuickBooks Online, Dext and Bill.com will automatically send the expense transaction into your accounting software with all the details.
With the time saved by not having to manually enter expenses into your accounting ledger, you may actually reduce your time spent with accounting activities while audit-proofing your deductions!
Reach out if you are interested in any of these solutions. Wayfinder is a wholesaler partner and can provide guided implementation.
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Chris Naquin
Wayfinder CPA
Wayfinder CPA