By far the most common reason small business owners lose tax write-offs like the mileage deduction when they are audited by the IRS is lack of proper tax deduction records backing up the claimed deductions. The IRS requires that you have documents to support the deductions you claim on your tax return. In the absence of a supporting document, an IRS auditor will likely conclude that an item you claim as a business expense is really a personal expense and refuse to allow the deduction. If you’re in the midlevel income, 25% tax bracket, every $100 in disallowed deductions will cost you $25 in federal taxes.
The supporting documents you need depend on the type of deduction involved. However, at a minimum, every deduction should be supported by documentation showing what, how much, and who. That is, your supporting documents should show:
- What you purchased for your business
- How much you paid for it
- Whom (or what company) you bought it from, and
- The business purpose for the expense.
You can meet the what, how much, and who requirements by keeping the following types of documentation:
- Canceled checks
- Sales receipts
- Account statements
- credit card sales slips
- Invoices, or
- Petty cash slips for small cash payments.
Some people believe the only documentation they need to prove that an expense was for their business is a sales receipt. This is not the case. A sales receipt only proves that somebody purchased the item listed in the receipt. It does not show who purchased it. You could write a note on the receipt stating that you bought the item, but you could easily lie.
Likewise, a canceled check is not adequate documentation for a business expense. All a canceled check proves is that you spent money on something. It does not show what you bought. Of course, you can write a note on your check stating what you purchased, but why should the IRS believe what you write on your checks yourself?
However, when you put a canceled check together with a sales receipt (or an invoice, a cash register tape, or a similar document), you have concrete proof that you purchased the item listed in the receipt. The check proves that you bought something, and the receipt proves what that something was.
Using a credit card is a great way to pay business expenses. The credit card slip will prove that you bought the item listed on the slip (or form). You’ll also have a monthly statement to back up your credit card slips. You should use a separate credit card for your business.
Sometimes, you’ll need to use an account statement to prove an expense. Some banks no longer return canceled checks, or you may pay for something with an ATM card or other electronic funds transfer method. Moreover, you may not always have a credit card slip when you pay by credit card—for example, when you buy an item over the Internet. In these events, the IRS will accept an account statement as proof that you purchased the item.
Save supporting documents to prove to the IRS that an expense was related to your business. Sometimes it will be clear from the face of a receipt, sales slip, or the payee’s name on your canceled check that the item you purchased was for your business. But if it’s not clear, note what the purchase was for on the document.
Entertainment, Meal, and Travel Expense Records
Deductions for business-related entertainment, meals, and travel are a hot-button item for the IRS because they have been greatly abused by many taxpayers. You need to have more records for these expenses than for almost any others, and they will be closely scrutinized if you’re audited.
Whenever you incur an expense for business-related entertainment, meals, or travel, you must document:
- The date the expense was incurred
- Amount of the expense
- The place
- Business purpose for the expense, and
- If entertainment or meals are involved, the business relationship of the people at the event, including their names, occupations, and any other information needed to establish their business relationship to you.
All this record keeping is not as hard as it sounds. Your receipts will ordinarily indicate the date, amount, and place in which you incurred the expense. You just need to describe the business purpose and business relationship if entertainment or meals are involved. You can write this directly on your receipt.
The IRS does not require you to keep receipts or any other supporting documents for entertainment, meal, gift, or travel expenses that cost less than $75. However, you must still document the five facts listed above. Usually, the easiest way to do this is to keep your receipts, even though it is not technically required.
How Long to Keep Records
You need to keep copies of your tax returns and supporting documents in case you are audited by the IRS or another taxing agency. You might also need them for other purposes—for example, to get a loan, mortgage, or insurance.
You should keep your records for as long as the IRS has to audit you after you file your returns for the year. This is usually six years after you file your return. However, to be on the safe side, you should keep your tax returns indefinitely. They usually don’t take up much space, so this is not a big hardship. Your supporting documents probably take up more space. You should keep these for at least six years.
MileIQ’s blog does not constitute professional tax advice. You should contact your own tax professional to discuss your situation.