Each year, there are about 6 million taxpayers who have their tax return questioned by the IRS, either by audit or by a verification notice from the IRS.
If you are faced with proving items reported on your tax return, you may find it difficult or impossible to find proof for every item the IRS is questioning. It may be smarter to hire a professional to sort out the details and work directly with the IRS.
But what happens if you don’t have all the information to prove items on your return?
For example, if you deducted medical expenses and no longer have receipts or even the list of medical providers, prescriptions, and other medical costs – what should you do? Well, you could retrace your steps. Determine your medical expenses for the year and get receipts from doctors and pharmacies. Your bank statements and cancelled checks are a good starting point, if you still have access to these documents.
If you’re a business that deducted expenses and you no longer have receipts, it may be logical that you would have expenses that the IRS should allow even though you don’t have a receipt. The IRS provides some flexibility and can take your word that you had allowable expenses. (This is known as the Cohan Rule based on a tax court case that may give you flexibility with your records when proving expenses to the IRS.)
Items you probably can’t recreate
The tax code requires some expenses to be documented at the same time the expense occurs, such as:
- Travel/entertainment expenses: These expenses are required to be recorded by receipts made at the time the expense is incurred.
- Charitable contributions: All charitable contributions need receipts that accurately reflect the value of the contribution.
- Mileage records: You are required to record the mileage, date, place, and business purpose.
- Gambling losses: If you are going to deduct gambling losses, you must have receipts, tickets, statements and documentation such as a diary or similar record of your losses and winnings.
Technically, if you do not have these records, the IRS can disallow your deduction. Practically, IRS auditors may allow some reconstruction of these expenses if it seems reasonable.
Reconstructing records for the IRS
Most importantly, get to work immediately to reconstruct the items. It can take awhile to put all or part of the pieces together, so start right away to meet your IRS response deadline.
You may have to reconstruct your records or just simply provide a valid explanation of a deduction instead of the original receipts to support the expense. If the IRS disagrees, you can appeal the decision. You may also have to argue against penalties during the audit by providing facts on how you made your best effort to comply. Lack of records often leads to a 20% IRS negligence penalty.
Tips to reconstruct your records:
- Review bank statements and credit card statements. They are usually a good list of what you paid. They may also be a good substitute if you don’t have a receipt.
- Vendors and suppliers may have duplicate records. Reach out to them if you need a copy.
- Appointment books can provide back-up information about travel, number of clients and frequency of service.
- Cell phone records can help establish dates of service or assist in reconstructing expenses.
- You may be able to reconstruct a reasonable mileage argument with online map tools. Don’t just estimate miles per week x 52 = miles to deduct. Consider periods of no travel.
If you reconstruct or estimate expenses in a way other than what the IRS requires, create a declaration, and sign it under penalty of perjury.
A tax pro can help
Filing taxes is difficult. Dealing with tax problems can be very difficult. Tax professionals can help when you can’t get access to all the records the IRS may be asking for.
Experienced tax pros know your options and the likelihood of an IRS agent accepting your reconstructions. They can also get you back on track and get your record-keeping in tip-top shape.