If you’re running a small business, you’re already more likely to be audited by the Internal Revenue Service than those simply claiming income from an employer’s W-2. Add to that a bit of messy paperwork on your end, and you can find yourself in a situation that goes well beyond a bit stressful.
So what happens if you get that audit notice and you don’t have all of your receipts? Is it game over?
The basics of being audited
If you’ve received an IRS letter requesting a tax audit, your first reaction might be full-blown panic, especially if you have a rather haphazard system of bookkeeping.
But before panic sets in, take a moment. First, be sure that you are holding an authentic letter from the IRS. Some scammers count on emotions running high with a potential audit and use fake IRS audit letters to steal from distraught business owners.
Once you’ve determined you’re holding a real letter from the IRS, remind yourself what an audit is—and is not.
An IRS audit is not a trial. It’s not an inquisition. It’s simply a review. The IRS wants to match the numbers on your financial statements with evidence of your income and spending. It’s a double-check of your numbers.
An IRS visit for an audit doesn’t end in jail time for honest mistakes or oversights. Your audit is going to end in one of the following ways:
You’ll show that your numbers are solid, and you don’t owe the IRS any extra money. They say thankyouverymuch and leave you alone.
You and the IRS learn together that there was a mistake, and you owe them a bit more in taxes. They have you sign a paper that says that, and you write a check.
The IRS decides you owe them more money and you disagree. You work with an enrolled agent to double-check things on your end and file a dispute with the IRS. Your CPA or enrolled agent helps you resolve the dispute, and you pay what you wind up owing, which may be nothing at all.
In a perfect world, you’d have a business receipt organizer with your charitable contributions and travel expenses color-coded and filed properly. That way when you get an audit notification letter, you simply hand the documents to the IRS and go on about your business.
But the real world of small business can be messy at times, and the IRS knows it. The IRS routinely handles audits with no receipts. That’s why there are other ways to prove your business expenses.
Why did I get audited?
Audits are not equally distributed among taxpayers. While small business owners are always audited more than typical employee households, the IRS still audits less than 1 percent of all tax returns.
The IRS does do a certain number of random audits every year using a computerized algorithm only they are privy to, but there are also IRS audit triggers that seem to make you more likely to catch the eye of the IRS. Simply having a small business is one of these audit red flags. That one is rather unavoidable in your present circumstances.
Other IRS audit red flags include:
Not reporting all your income, especially if you overlooked a 1099 or W-2 when you filed.
Claiming too many charitable deductions.
Reporting too many losses.
Making large cash transactions.
Home office tax deductions.
Writing off a lot of entertainment expenses.
Making a large amount of money.
Failing to make any (or much) money.
Using round numbers that look artificial.
Making math mistakes on your tax forms.
The more audit triggers your tax return throws up, the more the IRS is likely to notice. A small business owner who deducts lots of concert and sports venues, has a home office, donates a substantial amount to charity, and fails to make very much money (and therefore pays very little in taxes) each year looks a bit suspicious to the tax authorities.
They might think this business owner is playing fast and loose with the numbers to avoid a tax obligation. So, the IRS will send an audit letter and tell the business owner they want to take a peek to be sure everything is on the up and up. If it is, there’s nothing to worry about.
What does an audit without receipts look like?
A tax audit with receipts is straightforward. The IRS sends a letter, you turn over your receipts and financial documents either by mail or in an office, they match up all the numbers, and the audit is complete.
When you don’t have the receipts to immediately turn over for matching purposes, you will likely have some additional steps. Remember, the IRS isn’t trying to destroy your business or send you to jail. They just want to see that your numbers match.
If you’re audited and you don’t have receipts, here’s a step-by-step look at what you can expect.
Step 1: You’re contacted by the IRS.
Remember that the IRS will only contact you through the mail. If you’re worried about a scam letter, call the IRS phone number to confirm the audit.
Step 2: Gather the information you do have.
You won’t know what’s missing until you see the paperwork you do have. Before turning over the records you’ve got to the IRS, double-check the numbers yourself. (Presumably, you checked them the first time you filed your taxes.)
Step 3: Look for alternate means to justify your reported expenses.
If you don’t have the receipt for an expense, you may still be able to claim some of all of the expenses by using alternative means.
The Cohan Rule was outlined by the federal court system for just these circumstances. In a 1930 court case, Broadway legend George M. Cohan filed his taxes using estimates of his expenses and told the court (when the IRS didn’t agree with his methods) that he was too busy to keep track of all the documentation.
The court system agreed that Cohan had incurred expenses for his business, and since he couldn’t provide exact amounts with his receipts, he could still claim the expense if it was “reasonable and credible.”
Since the Cohan Rule was introduced, it has become an expectation that business owners be able to show other types of information to support their claimed expenses if they can’t find the receipts. Also, business owners can only deduct the minimum standard amount for a service or item as calculated by the IRS without the receipt in hand.
This means you will still need to find as much evidence as you can to support the expenses you’ve deducted on your tax forms.
For the items you can’t document with receipts, try to find records of the expense and purpose in other ways. The IRS auditors might accept evidence gained by some or all of the following methods:
Request new copies of invoices and receipts from suppliers or service providers. Simply contact the venue or supplier and ask for another copy of the invoice or receipt. You may wind up paying a small fee for the second copy.
Use your bank statements, credit card statements, canceled checks, and your check register for your bank account to show the date you made a payment, who your check was written to, and who received that payment. This will at least show amounts you paid, although it may not prove why the payment was made.
Use your business calendar and correspondence to gather information about travel and entertainment dates and expenses.
Dig through your emails to find communication about purchases for a business purpose and emailed receipts.
Log into your various travel accounts (like your flight, food, or hotel rewards accounts) and find evidence of your travel or purchases through those accounts.
Use your phone information. Use your phone location records to show where your phone has traveled over the time periods in question. Social media apps and your phone carrier may be able to provide specific location data.
Step 4: Explain your information to the IRS.
The more organized your financial records are, the easier the audit process will be. The IRS agents are simply looking for numbers to match. They may have even communicated to you the areas of concern in your forms so you can work specifically on gathering data for those areas.
If you’ve been asked to mail documentation to the IRS, consider organizing it and pulling records together with explanations before you send it off. If you’ve been asked to meet with the IRS agent, you will have a chance to go through your records and explain the supporting information you do have for each of the areas in question.
Organize that information ahead of time and consider working with a CPA or another enrolled agent who understands tax processes and tax law if you’re not confident in your documents and explanations.
Step 5: Answer any additional questions from the IRS.
Since you’re trying to use other documents to explain charges and expenses, the IRS office may ask you for additional support for certain expenses. Work to acquire this information as quickly as possible.
Step 6: Examine the IRS audit findings.
Without specific receipts, the Cohan Rule says you can claim expenses if they are reasonable and credible, and you have attempted to show this to the IRS, using other documents as your audit defense tools.
But remember that the Cohan Rule also says that you may only deduct the minimum standard amount, set by the IRS, for a service or item purchased without the receipt. The IRS can also disallow certain expenses if they find your alternative evidence lacking.
The IRS will use the information you’ve provided and their own calculations for the minimum standard amounts and tally up what they believe you can deduct, and more importantly, what they think you should have paid in your taxes. You can expect to have the audit findings within 30 days.
Step 7: Pay the amount owed or appeal the audit findings.
Once you receive the IRS findings, you’ll have some choices on how to handle the outcome.
The potential outcomes of an IRS audit
After an audit, the IRS will either be satisfied, or they will require payment of back taxes and potential fees.
In some cases, the IRS may be completely satisfied with your documents and explanations. They might do the math, double-check the documents, and then go on their way, leaving you relieved and ready to reinvent your bookkeeping and accounting system for the future.
In other cases, you may find yourself with a new tax bill. If the IRS decides that you deducted too much for expenses, they may tell you that you owe back taxes and expect payment. The IRS may also include fees for failing to pay what they consider the correct amount by the filing date. You have some options on how to manage back taxes.
If the IRS presents you with a new tax bill you can:
Pay the additional taxes and be done.
Set up an IRS payment plan for the back taxes and pay them over time.
Ask for a delay in paying the taxes.
Appeal the back taxes and work with a tax resolution specialist, like a tax lawyer or CPA, to fight the IRS audit ruling.
In some cases, the IRS may decide to check into additional years of your income tax returns. Typically, the IRS only goes back about three years for audits. But, if they feel it is warranted, the IRS may go back up to six years to check for issues in your previous tax returns, although this is very rare.
If the thought of anyone looking into your bookkeeping from past years is panic-inducing, it might be worth investing a bit in some retroactive bookkeeping. If you don’t have time to go back through and clean up your old bookkeeping, it may give you tremendous peace of mind to hire some experts like accountants or professional bookkeepers to do it for you.
How Bench can help
Being audited without receipts generates an additional outcome for self-employed business owners: new attention to tax filings and record keeping. Of course, knowing you need to do something doesn’t always give you the time and inclination to get it done. That’s where Bench can help.
Bench is America’s largest professional bookkeeping service for small businesses. When you outsource your bookkeeping and tax filing to Bench, you can be confident that your financial documentation is in good hands while you focus on running your business.
That way, if you ever find yourself being audited, you’ll have everything you need in an organized system, ready for inspection. Best of all, you’ll have a team of tax professionals available every step of the way.
Being audited is at best nerve-wracking, at worst, terrifying. The best way to prevent—or prepare for—an audit is a system of clean, accurate records and receipts. If you’ve struggled to keep up a good system in the past, today might be the perfect day to make a change. Feel like you can’t move forward with a new system until you’ve cleaned up the past? Bench Retro specializes in helping business owners get caught up when their books get behind. Why not let Bench help?