| A few months ago, one of my clients (let's call him Mr. | | | | etc.), then you run the risk of losing that deduction in |
| Jones) got one of those IRS "love letters" requesting | | | | the event of an audit. |
| more information about his return, and the IRS wanted | | | | One of the most common questions I am asked by |
| to meet with Mr. Jones in person to discuss the | | | | clients is this: "I know I paid for something, but I don't |
| situation. | | | | have a receipt. Should I still report the deduction." My |
| Mr. Jones (a small business owner) was required to | | | | response is usually this: "You only need a receipt if you |
| show up at the local IRS office with all his records. The | | | | get audited." |
| IRS was questioning the legitimacy of several business | | | | At first, people don't know if I am joking or not. Well, I |
| deductions. The IRS was doing what it is allowed by | | | | do make that comment with my tongue planted firmly |
| law to do -- demand that the taxpayer prove that | | | | in cheek, but there really is a lot of truth to it. If you |
| those deductions were valid. | | | | don't have the documentation to prove a deduction, |
| Turns out that Mr. Jones lost the audit and ended up | | | | you can still report the deduction (if you want), |
| owing the IRS a significant amount of money -- the | | | | because you only have to prove the deduction if you |
| additional tax, plus penalty and interest for late | | | | get audited. |
| payment of that tax. Why did Mr. Jones' lose the | | | | But if you do get audited, knowing that there are |
| audit? Mr. Jones made two "classic" taxpayer | | | | undocumented deductions on the return, be prepared |
| mistakes: | | | | to lose the deduction. Fair enough? |
| MISTAKE #1: "NO RECEIPT, NO DEDUCTION" | | | | And here's the other major mistake that Mr. Jones |
| Mr. Jones lost several deductions simply because he | | | | made: |
| didn't have the proper documentation to prove the | | | | MISTAKE #2: BOGUS DEDUCTIONS |
| deductions. What do I mean by "documentation"? | | | | It turns out that Mr. Jones wasn't completely honest |
| Well, if the IRS requires you to substantiate a | | | | with me about some of his deductions. He reported |
| deduction on your tax return, you must be able to | | | | deductions that simply were not real deductions. Here's |
| provide written proof that the deduction really | | | | one example: Mr. Jones owned several rental houses. |
| happened. The easiest way to prove a deduction is to | | | | These rental houses, of course, required maintenance |
| hang on to: a) The receipt or invoice, and b) Proof of | | | | and repair work. Many times Mr. Jones would do the |
| payment, which can be a canceled check, cash | | | | work himself rather than pay someone else to do the |
| receipt, or credit card statement. | | | | work. |
| Mr. Jones reported numerous deductions for which he | | | | Well, Mr. Jones would estimate what he would have |
| simply didn't have the documentation. No receipts, no | | | | had to pay someone else to do the work that he did |
| canceled checks, no nothing. Turns out that Mr. Jones | | | | himself, and then he would report that amount as a |
| was one of those "cash guys". Maybe you know | | | | deduction, even though he didn't actually pay anybody |
| what kind of guy I'm talking about -- he never wrote a | | | | to do the work. |
| check in his life, just carried a wad of cash around in | | | | In other words, Mr. Jones deducted the value of his |
| his pocket. He paid for everything with cash, and never | | | | time -- which is non-deductible. This is an important |
| kept any of his receipts. | | | | point -- you can never legitimately deduct the value of |
| Every year he'd sit down with his wife and | | | | your time for work you did. You have to actually pay |
| "remember" how much he spent on different things. No | | | | someone else to do the labor. |
| way to prove any of this, of course. He just had a | | | | If you ever get a letter from the IRS demanding |
| "feel" for how much cash he had spent, and he had | | | | additional information, you'll have nothing to worry about |
| run his business for so many years that he just "knew" | | | | if you do exactly the opposite of what Mr. Jones did. If |
| how much it cost to purchase certain things. | | | | you can properly document your deductions and |
| Well, this is the kind of taxpayer that the IRS loves! It | | | | assuming you have no bogus information, you'll pass |
| really is true -- if you can't prove that you paid for | | | | the audit with flying colors. |
| something (with receipts, invoices, canceled checks, | | | | |