In today’s paperless world, whenever most people are asked if they want a receipt after a purchase, the typical answer is “No”. Business owners should be the exception. I for one hate working with paper in general so I totally get that; however, to be an astute business owner you need to know how to properly keep receipts and other proper documentation on file, if not, your tax return filings could be in jeopardy.
Your receipts essentially serve as your tax return audit protection so you need to be intentional about keeping them in an organized and easily accessible manner at all times. Let’s discuss the why and the how.
If you are a business owner who deducts hundreds or thousands of dollars for meals, entertainment, travel, vehicle expenses, etc. you MUST keep your receipts and follow the strict substantiation requirements laid out by the IRS. The issue is that even though your books and records may show that the expense actually occurred, if you do not have the required notes, receipt copies and documentation in support of those expenses to prove that they are business related, the books and records alone would not hold up in an audit. Without the support required, the only thing you have left is your word, and unfortunately this is not enough for the IRS. The burden of proof rests on you, and without the required documentation, you can quickly become a casualty of the tax court. When you lose to the tax court due to insufficient documentation, even though you are genuinely entitled to the deductions you take, you end up losing the deduction and having to pay the taxes and associated interest and penalties as a result of losing the deduction. Here are some record keeping tips to help you prevent that.
- Keep all of your receipts – Resolve that there is always the possibility that you will have to provide every single receipt to support your deductions. Receipts for things like travel expenses, meals and entertainment are usually the expenses that business owners tend to neglect. There are arguments you can raise with the tax court concerning this (e.g. receipts may not be required for expenses under $75.00) but is it worth the trouble and time it will take to argue this with the IRS? It is just better to have the receipts on file so it serves as audit protection rather than spend the time and money to fight your case with the IRS.
- Write down the business purpose for each receipt – This is especially important for meals and entertainment expenses as well. For office expenses like telephone or copier paper it is easy to determine the business purpose but it is difficult to recall who you went to dinner with years ago and what the business purpose for meeting with them was. Make sure you document this information.
- Snap a pic of the receipts with your phone – Take advantage of today’s technology by writing your notes on the receipt and then taking a picture. There are tons of smartphone apps that can help you keep track in this manner.
- Save electronic copies of your receipts for six years minimum – The IRS can audit you for as many as six years after your tax return has been filed. The print on most paper receipts fade within weeks of your purchase and a faded receipt will not help you in an audit. It is far better to scan them and save them electronically right away. You can still keep the paper version for additional back-up just in case for some reason your electronic docs become inaccessible due to a crashed hard drive or loss of electronic data for whatever reason.
- Keep cash purchases at zero – The issue with cash purchases is that they are easy to make but they can become a NIGHTMARE to keep track of and VERY TIME-CONSUMING to reconcile with your receipts. I stay away from them at all costs in my business. Credit and debit card purchases along with electronic copies of your receipts is your most efficient audit-proof course of action for IRS documentation.
There is a misconception that once you can show the expense hitting your statements it will be sufficient. The truth is that bank and credit card statements and canceled checks are NOT sufficient by itself in an audit– All the statement does is show that the expense actually occurred but it does not tell you what was bought. For deduction purposes the IRS is additionally concerned with what was bought. For example, a purchase at Walmart shown on your statement could be for anything ranging from a computer to groceries or personal items. Only your receipt will prove what was actually bought, your statement will not. The statement is great for recordkeeping and bookkeeping purposes etc. but the receipt detail is what the IRS will be looking for to substantiate the nature of your purchases. The nature of your purchase is what determines whether you are eligible for the deductions you take or not.
IRS audits will always exist. The key is to be prepared at all times by staying ahead of the game. To do so efficiently and effectively, make sure you make purchases preferably on debit cards, credit cards or by check, stay away from cash purchases if not entirely, then as much as possible, remember to document the business purpose and other required detail surrounding all travel expenses, meals and entertainment, dining expenses etc. and keep receipts for ALL… YES… ALL expenses.
Written by: Natasha Dornbush, CPA