The importance of documentation for expenses and deductions claimed on your tax return (business or personal) is becoming more and more apparent as both formal (audit) and informal (discrepancy) notices are increasing.  We are hearing that the IRS and state agencies are ramping up for increased examination and enforcement of several areas of taxation which are frequently abused.

By now many of you have heard our horror story of a taxpayer who was audited by the IRS.  She had prepared her own return but hired us to represent her during the examination.  The IRS reduced or totally disallowed many of her deductions because she lacked appropriate documentation showing the amount and/or business purpose for the items claimed.  In particular, $ 1,700 was claimed as non-cash contributions.  The taxpayer had 2 receipts but did not have an itemization of the items donated.  The IRS allowed a deduction of only $ 2!

While being able to document all of your expenses is important we want to focus on a few areas which are under additional scrutiny:

  Donations:

• Cash (monetary) donations which are made by cash, check, debit or credit card are only  deductible if you have a receipt or acknowledgement from the organization or have a bank record of the payment. If you put a $ 20 bill in the donation plate at church each week you will NOT be able to deduct it on your tax return.
• For non-cash contributions we suggest you keep a description of the items given (i.e. 6 men’s shirts, 4 pairs of shoes, etc., not just “2 bags of clothes”).  You must also be able to justify how you arrived at the item’s value (i.e. what they would sell for at a thrift shop, not what they cost originally).  It is usually up to the taxpayer to assign the value to donated goods.  Goodwill Industry and the Salvation Army have lists of dollar values typically allowed for commonly donated clothing, household and furniture items.  It will save us time (and you money) if you compute the exact value you intend to claim for each such donation.

  Mileage/Auto Expenses:

• Many of our clients use a personal vehicle for business purposes. Any time expenses for a vehicle are deducted you must be able to substantiate how the amount was determined.  You should keep a log book detailing the business mileage and total mileage of the vehicle.  This is true whether you use the mileage rate or a percentage of actual operating costs (you must document how you arrived at the percentage).  Records must also be kept if you claim Medical mileage, Charity mileage or include mileage as part of Moving expenses.

  Meals and Entertainment:

• Companies and individuals are entitled to a partial deduction for business-related meals and entertainment expenses.  There are very specific rules for documenting the date, place and nature of the expense as well as who the participants were.  This is a common area of abuse and is often the first thing an agent may examine.  If you incur such expenses it is very important to keep contemporaneous records and receipts to support the deduction.

  Travel Expenses:

• There are a variety of ways travel expenses may be deducted but all require documentation to support where and when the expenses were incurred and how they relate to your business.

It is up to the taxpayer to keep records to support all expenses and deductions claimed on their tax return.   “Same as last year” and “As much as we are allowed” are NOT acceptable answers if asked to provide specific details for deductions.  Records must be created at the time the expenses are incurred, not when it is time to prepare your tax return or respond to a notice.

If you have questions or would like more information about free IRS publications which explain many types of deductions in more detail please contact our office.