Help! I'm being audited, but I don't have any receipts. This phrase is something that tax professionals hear regularly. If you're in this situation, don't despair. With the right approach, you can get through an IRS tax audit without receipts.
The process will be more complicated if you're facing an IRS audit and don't have any receipts. Worst of all, the IRS may deny the business expenses or itemized deductions you claimed on your tax return, and you may end up with a new tax bill.
To help you minimize your losses, this post explains what to expect when you go through a tax audit without receipts. To get help now, use TaxCure to search for a tax professional who provides audit representation in your area.
Why Does the IRS Ask for Receipts?
The IRS asks for receipts during a tax audit as a verification of your expenses. For instance, if you itemized medical bills or wrote off business expenses, the IRS will request receipts to verify those deductions.
Why Receipts Are Important During an IRS Tax Audit
Receipts are important during an audit because they are one of the easiest, most effective ways to back up the business expenses claimed as deductions on your return. However, as discussed in the following sections, IRS auditors may be willing to accept a variety of alternatives to receipts.
Keep in mind that a tax audit is when the Internal Revenue Service asks for verification of the information on your income tax returns. Typically, this applies to business filers, including sole proprietors and freelancers who file a schedule C, partnerships, S-corps, and c-corps. But the IRS also audits individual income tax returns -- generally, if you're not a business owner, this only comes into play if you itemize your tax deductions, sell a home, or have other complicated tax situations.
With a business tax audit, you may have to validate both your income and expenses. For personal income tax audits, you generally only have to back up your itemized deductions or expenses used to reduce capital gains when you sell a property. The traditional way to back up these expenses is with a receipt.
What to Do If You Don't Have Receipts for a Tax Audit
So, what should you do if the Internal Revenue Service has contacted you about an audit and you don't have any receipts? First, take a deep breath. You're not the only taxpayer in this situation. Many business owners forget to keep their receipts when they file their tax returns.
Organized records make the IRS audit process a lot easier, but every day, people survive tax audits even though they have missing or incomplete records. You're just going to have to spend some extra time recreating your expenses or finding alternatives to receipts. This is where the Cahan rule comes into play.
What Is the Cohan Rule?
The Cohan rule makes it possible to get through a tax audit without receipts. This rule allows taxpayers to claim reasonable expenses even if they don't have supporting documents.
In 1930, the Court of Appeals for the Second Circuit ruled that taxpayers can claim business expenses without receipts as long as the expenses are reasonable and credible.
The case involved the Broadway showman George M. Cohan. When the IRS tried to audit his tax returns, he had no receipts, and the IRS auditors disallowed all of his business expenses. This drastically increased his tax due.
Cohan took the issue to Tax Court, claiming that he was too busy to keep organized records about his expenses. The Court decided that Cohan had clearly incurred some legitimate expenses, and it allowed him to keep some of the disallowed expenses.
Nearly 100 years later, this ruling continues to help taxpayers who have missing receipts and incomplete records.
If the IRS is auditing you and you don't have receipts, you can invoke the Cohan rule. Unfortunately, the Cohan rule doesn't mean you can claim any expense without backing it up. It makes it possible to substantiate certain business expenses or itemized personal expenses without receipts.
What Receipts Do You Need for an IRS Audit?
Depending on the scope of the audit, you may only need to back up certain expenses, or you may need to substantiate every claim on your return. The IRS audit notice you received should outline the type of tax audit you're facing.
In some cases, the IRS may ask for verification of a few things on your return. In this case, you just need to find financial documents related to those items. In other cases, you may face a line-by-line audit that requires you to verify every detail on your return.
How to Reconstruct Your Records
Once you figure out what you need, start reconstructing the records for your expense deductions using the following tips:
- Contact vendors to see if they have copies of invoices or receipts.
- Talk to charities to get receipts for charitable contributions.
- Sign in to utility accounts and download records from their automated payment systems.
- Look at credit card statements, bank account statements, and canceled checks.
- Review your business calendar and social media history to track your activities.
- Find mileage records for your business vehicles.
- Use cell phone records to back up expenses.
You may have to take some or all of these steps to verify your expenses. However, the exact process will depend on the nature of your expense.
Let's say you pay your business's utility bills monthly from your checking account. You can easily use your bank statements to back up those expenses.
However, if you try backing up travel or entertainment expenses with bank statements, the auditor will most likely want more information. For example, imagine that your bank statements show that you bought a ticket to Vegas and wrote that off as a business expense.
With just that record, the IRS agents cannot know if that is a business or personal expense. However, you can substantiate that expense with a note from your business calendar or appointment book, a post from your business's social media page, or even just some documents from the conference you attended.
Can You Use Fake Receipts During an Audit?
Undergoing a corporate or Schedule C audit with no receipts can be stressful. But you should never create IRS audit fake receipts. This may sound tempting when you're not sure what to do, but this is illegal. You can reconstruct financial records, but you should never generate fake receipts.
What Happens When Expenses Are Disallowed Due to Missing Receipts During an Audit?
If claimed deductions are disallowed, you will end up with a tax bill. Here's how that works on both business and personal returns.
Disallowed business expenses -- With a business return, you report your revenue, and then, you claim expenses. The difference is your business profit, and that's the amount that you pay tax on. If the auditor doesn't allow you to claim some of your business purchases as deductions, that increases your business profits and drives up your tax liability.
Disallowed personal deductions -- On a personal income tax return, you get to claim a deduction that gets subtracted from your income and you get taxed on the difference. Most taxpayers claim the standard deduction which is a set amount, but some itemize their deductions.
When you itemize, you add up all of the allowed deductions, and then, you subtract the total from your income. If you itemize, you can claim tax deductions such as mortgage interest, medical bills over a certain threshold, state and local taxes up to a certain limit, and a few other expenses. If you don't have financial records to back up your claimed deductions, the auditor will disallow them. This will reduce your deduction and increase your taxable income. The Internal Revenue Service will send you a new bill.
How to Respond to the Audit Report If IRS Disallowed Deductions Without Receipts
At the end of the audit, the auditor will send you a copy of the audit findings. The audit letter will also outline what to do if you disagree with the findings. If the IRS has disallowed every expense that didn't have a receipt, you should reach out to a tax pro. They can help you figure out how to appeal the audit and avoid paying unnecessary additional taxes.
When you reach out to an enrolled agent, a CPA, or a tax attorney, they will help you respond to the audit. They will help you invoke the Cahan rule and reconstruct your expenses. They will represent you in front of the IRS appeals agent or in Tax Court if necessary. Most importantly, they will also ensure that you follow the right protocols and don't miss any deadlines.
Once you get to this point in the audit process, it's critical to meet all of the deadlines, or you may lose your chance to appeal the IRS audit ruling.
FAQs About Audits and Receipts
Here are answers to some commonly asked questions about tax audits.
What happens if you don't have receipts for taxes?
For tax filing, you are not required to have receipts. The Internal Revenue Service does not require taxpayers to back up their deductions when they file a tax return. However, although receipts aren't required for filing taxes, they can be critical during IRS audits.
What if I sold a property and don't have receipts for capital improvements?
Contact the company that performed the capital improvements and see if they can generate a backdated invoice for you. Otherwise, look for bank or credit card statements that show what you spent.
If you sell a property, the tax code requires you to pay tax on the capital gains -- note that there are generous exemptions for personal residences that meet certain criteria. To calculate the capital gains, you subtract the basis from the sale price. The basis consists of the purchase price of the property plus any capital improvements or amounts spent while buying or selling the property.
This is why it's important to keep receipts from capital expenses -- they could help reduce your future tax liability.
Does IRS ask for receipts?
The Internal Revenue Service only asks for receipts if you're being audited. Other than that, the tax law doesn't require individuals, self-employed taxpayers, small business owners, or corporations to provide receipts.
Does the IRS verify receipts during an audit?
During an audit, the IRS may take some receipts at face value, but in other cases, they may want additional information to verify that the expense on the receipt was for a business purpose. For instance, the IRs may want to see the expense in your business bank statement, or the agency may want you to explain why these are allowable expenses.
What happens if you lost receipts for taxes?
If you claim expenses but don't have receipts, the IRS may assess a negligence penalty against you. The IRS expects small business owners to operate with financial integrity, and maintaining accurate records is part of that process.
The good news is that the negligence penalty is 20% of the underreported tax. So, as long as you can invoke the Cohan rule and find other ways to back up the expenses that you claimed, you can minimize this penalty.
No Receipts and Tax Evasion or Fraud
If the IRS auditor believes that you made up deductions, they may charge you with tax fraud. There are civil and criminal penalties for tax fraud, and they can be very severe. If you are worried about this happening or if the IRS agent has mentioned the possibility of fraud, reach out to a tax lawyer as soon as you can.
How to Avoid Getting Audited Without Receipts
No one wants to be in this situation. Luckily, there are steps you can take to reduce your risk of facing an audit without receipts:
- Be diligent about your bookkeeping -- Set aside time regularly to organize receipts and update bookkeeping records.
- Create a system to track your receipts -- Whether you throw them all in a shoe box or download them to an app, it's important to be consistent. Whenever possible, sign up to get receipts emailed to you, and then keep those emails in a folder or at least don't delete them.
- Use the same account for deductible expenses -- This makes it easier to stay on top of your expenses.
- Make notes on receipts to explain why the purchase was deductible -- These notes can be invaluable if you get audited, and the IRS raises a question about any of your receipts.
- Create a process for organizing receipts from anyone who makes business purchases -- If your employees, business partners, or others make business purchases from their own accounts, make sure you have a process in place to keep their receipts and track the expenses.
Whenever possible, try to avoid doing anything that creates an audit red flag on your tax return. If you know that you inherently have a higher audit risk than other taxpayers, you need to be more diligent about your recordkeeping.
Get Help Surviving an Audit With No Receipts
IRS audits are almost always stressful. No one gets excited when the IRS notifies them that they have been selected for an audit, but audits are even more stressful if you don't have the right records.
Have you received an audit notice? Are you worried that you don't have receipts or other financial records? Then, you should reach out for help. An enrolled agent, CPA, or tax attorney can help you through this process. To find a local tax pro experienced with audits, use TaxCure to search for tax pros in your area. Then, filter your search results to look specifically for pros with audit experience.
