Key Takeaways:
- The IRS may audit tax returns flagged for abnormal information, and some small businesses are audited every year
- How to prepare for an audit:
- Gather requested documents
- Keep everything organized
- Never ignore an IRS notice
- 8 steps when facing an audit without receipts:
- Try not to panic
- Follow directions
- Provide bank statements
- Use email records
- Use calendars and logs
- Gather mileage and travel records
- Use photographs
- Understand the Cohan rule
A big fear for many small business owners is getting audited by the IRS. It is daunting to think of the government monitoring your books and receipts, even if all information is reported correctly on your tax return. You have enough to worry about throughout the year when maintaining your records and staying on top of business operations.
Audits do happen, however. IRS data shows that in 2021, the agency closed 738, an IRS audit doesn’t959 audits, which caused around $26.8 billion in additional tax recommendations. Being prepared is an important way to protect your business.
One big problem many taxpayers face is not having enough documentation to support the claims made in their returns. Reported information about income, expenses, credits, and deductions must be supported with records of transactions.
What happens if you get audited and don’t have receipts? This guide covers when a business may be audited, how to prepare for an IRS audit, eight steps to take when facing a Schedule C audit with no receipts, and best practices for recordkeeping that will help you stay prepared.
When Businesses Might Get Audited
Being notified of an IRS audit doesn’t necessarily mean there is anything wrong with your tax return. The IRS uses a “random selection and computer screening” method that automatically triggers certain returns based on a statistical formula. It compares returns based on what it typically finds in similar returns, which helps the agency sift out abnormal or suspicious tax paperwork.
The other approach cited by the IRS is “related examinations.” In this case, the IRS selects a tax return for an audit based on issues it finds relating to other taxpayers (for example, investors or business partners) when those individuals’ returns were flagged for an audit.
The IRS may be triggered to take a closer look at a business tax return if income was misreported, there was a significant number of itemized deductions, expenses seem excessive, or there were a lot of cash transactions, among other potential issues.
The IRS can typically only include returns filed within the last three years, unless a substantial error was made up to six years prior. The agency will request an audit be conducted either through an in-person interview or by mail. An in-person meeting may take place in an IRS office, at the taxpayer’s workplace or home, or at an accountant’s office.
How to Prepare for an IRS Audit
It’s always a good idea to be prepared for an IRS audit, even if you aren’t currently being audited or don’t suspect the IRS has a reason to audit you. With a good system in place, you’ll be ready should it happen. Here’s how you can prepare if you are notified that the IRS is auditing your business:
Gather the Requested Documents
The types of records the IRS wants to audit depends on factors like your business situation and the component of your tax return they want to double-check. The IRS will likely ask for documents like:
- Receipts for expenses
- Invoices
- Legal documents
- Loan contracts
- Bills paid
- Travel tickets, like flights
- Schedule K-1 for shareholders
- Medical records
- Financial logs or journals
- Documents related to theft or loss, like an insurance report
- Employment records
Keep Everything Organized
The IRS says you should organize your records by year and type of income or expense. You should also include a summary of transactions.
Never Ignore an IRS Notice
Receiving a letter from the IRS in the mail should never be ignored. The audit won’t go away if you don’t respond, and, in fact, your penalty will be worse if you put it off. Follow all instructions in the audit letter and take action as soon as possible. Your notice will likely have a deadline attached to it.
Keeping organized records and reporting all income and expenses accurately each year can help make you a less likely candidate for an IRS audit. Working with a tax professional is another way to move forward when you’re unsure how to respond to an audit. A tax expert will help you prepare your documents and respond to the inquiry appropriately.
What Happens if You Don’t Have Receipts for an Audit?
If you are dealing with being audited and don’t have receipts for your claimed deductions, the IRS may disallow those deductions. In order to claim a deduction on your tax return, you must be able to prove that you incurred the expense and that it was related to a business or investment activity.
While receipts are the best form of proof, there are other ways to substantiate expenses such as bank statements, cancelled checks, or credit card statements. However, if you cannot provide any form of substantiation, the IRS may disallow the deduction and assess additional taxes and penalties.
8 Steps to Follow When Being Audited by the IRS Without Receipts
Even the most diligent business owners may find themselves facing an audit from time to time. It isn’t always easy to stay on top of recordkeeping, especially when you’re running a new business and have never had to deal with the IRS before, beyond submitting an annual tax return. It can be daunting and stressful if you are audited and don’t have receipts. Take these steps if this happens to you:
1. Try Not to Panic
First, try to avoid unnecessary panic. Audits happen all the time, and many people don’t have perfect recordkeeping processes. Just because you may not have actual receipts to support your numbers, it doesn’t mean you will be penalized by the IRS. Several other types of records may satisfy what they’re asking for.
2. Follow Directions From the IRS
The IRS may take a couple different approaches with your audit. The notice you receive will tell you exactly what to do, including if you need to meet someone in person for the audit and bring records with you, or if you need to mail the documents they’re requesting. You will always mail copies of your documents and never the originals. Follow the instructions you’re given closely to stay in compliance.
3. Provide Bank Statements
You may be able to use bank statements as legitimate proof of your income or expenses listed on your tax return. These statements may include your business checking or savings accounts or credit cards used for the business. Statements include transactions the IRS may be interested in. They can usually be generated quickly when you’re logged into your bank’s online account management system, or you can visit the bank to get a statement for a specific time period.
4. Use Email Records
Many businesses and vendors now provide receipts via email or digital record. These will likely work the same as physical receipts for support. Sometimes an email may serve as proof of a transaction you reported on your tax return. Gather and store any email records that could be applicable.
5. Use Calendars and Logs
You may have recorded business transactions or occurrences on a business calendar, log, or diary. These records may be enough proof for the IRS to verify an expense or income amount you provided on your tax return. Evaluate and gather any of these documents that could help support your case.
6. Gather Mileage and Travel Records
Travel expenses may be a major part of your tax return deductions. Look for any mileage records or documentation of travel bookings you can provide. It’s wise to record the number of miles you travel for your business when writing off that expense.
7. Use Photographs
Photographs can be helpful, especially if you reported instances of theft or loss. Show images or videos of property damage to back up your claims. You can also use photos and digital reproductions of receipts when applicable.
8. Understand the Cohan Rule
There have been audits where the taxpayer didn’t have certain documentation, and one such instance is the important court case, Cohan v. Commissioner. In this case, a taxpayer couldn’t provide expenditure records but could provide reasonable estimates based on factual basis. The Cohan rule allows taxpayers to claim deductions using similar estimates without having records of the transactions. This rule may help you in some cases if you don’t have records in an audit.
These steps can help you comply with requirements if you’re worried you don’t have the right receipts or documentation to support what you reported on your tax return. Guidelines can be tricky in an audit, and you never want to make a mistake, so reach out to a tax expert who can help guide you through it.
Recordkeeping Best Practices for Business Owners
The good news is that with the right preparation tactics, you’ll be ready in the event of an IRS audit. Here are some recordkeeping best practices for business owners to stay ahead of audits:
Create a Method to Keep a Business Transaction Summary
Track all of your expenses and income with a set method. The IRS page on recordkeeping states, “For most small businesses, the business checking account is the main source for entries in the business books.”
Use an Accounting Software
Software programs help you automatically record transactions and categorize purchases so a lot of the work is done for you. This system helps you stay accountable and accurate.
Understand and Follow the Burden of Proof
The burden of proof refers to your responsibility to prove statements, deductions, and entries provided on your tax return. You are required to be able to substantiate information about expenses in order to deduct them.
Update Your Receipt-Keeping Process
Create a system for keeping receipts, whether a physical file, a folder in your email inbox, or a folder on your computer for digital receipts and photographs of receipts.
Retain Other Documents You May Need in an Audit
Keep additional records like invoices, paid bill confirmations, canceled checks, deposit slips, sales slips, and other documents that summarize transactions and support the information you report on your tax return.
Be Diligent With Employment Records
The IRS says that all employment records should be kept for at least four years, including employment tax records, so you’ll want to keep these in a safe place.
Understand Periods of Limitation With the IRS
A period of limitation is the time you have to amend your tax return and claim a refund or credit. You should keep records for three years from the date you filed your return, in most cases. Also keep records for three years after filing, or for two years from the date you paid the tax, whichever is later, in the event you’re filing to claim a credit or refund after you sent in your return. You should maintain records for seven years if you file a claim for worthless securities or a bad debt deduction loss. You should keep records indefinitely if you don’t file a tax return, according to the IRS.
Keeping accurate, updated records does a lot more than prepare you for an IRS audit. Creating an effective system also helps you monitor business performance, run financial reports, manage your cash flow, and keep track of expenses versus income. Planning for an audit ensures you will never be in a situation where you don’t have proper documentation for the IRS.
Contact the Experts at Silver Tax Group for Audit Assistance
No matter what kind of records you have, facing a tax audit can be stressful and alarming. You never want your business to be in hot water with the IRS, which can lead to high penalties or even legal issues down the road.
Fortunately, preparing records in advance or using other forms of proof outside of receipts can support your claims and comply with laws and regulations. Sometimes bank statements or even email records can be enough to substantiate your claims. Gathering the right documentation can help you meet IRS audit requirements.
Work with the tax experts at Silver Tax Group when you have questions about an audit. Our professionals can help with tax planning, consulting, litigation, emergency tax services, audit defense, and much more. We will make sure you follow all applicable steps required by the IRS and support your claims.
Reach out to Silver Tax Group to speak to a tax expert about being audited by the IRS with no receipts.
