Learn what auditors will look for when trying to prove your deductions so you are prepared

download (3)Tax audits still remain relatively rare, but should you face one, be prepared for questions. Tax authorities tend to deny everything and then make you prove that your deductions are valid. Here are some suggestions.

 
To prove your deduction most auditors are looking for two required documents.

 
Receipts. The receipt should clearly show the company or entity, the date, the value of the activity, and a clear description of the activity. In the case of donations, the receipt should also have a statement that confirms you received no benefit in return for your donation. It should also state that you are not retaining part ownership of the donation.

 
Proof of payment. You will need a canceled check, a bank statement, or a credit card receipt and related statement.

 
Other proof. In addition to the above, there are certain deductions that require additional documentation. Here are the most common:

 
Contemporaneous. Any proof of payment and receipts should generally match the date of the activity. The IRS and state agencies are quick to dismiss receipts that are obtained after the fact. A good rule of thumb is to ensure receipts and proof of payment are received at the time of the activity. If not, at least make sure you have receipts and payment proof within the tax year the deduction is taken.

 
Mileage logs. You will need to show properly maintained mileage logs for business miles, charitable miles, and any medical mile deductions.
Business records. You will need financial statements for any business-related activity with supporting documentation.

 
Residency. If you live in multiple states or multiple countries, you may have to prove where you lived during the year. Keep records that show your physical presence to support your tax filings.

 
Proof of non-reimbursement. If you claim any unreimbursed business expenses, many states are asking you to prove that you were not able to get these expenses reimbursed from your employer. The easiest ways to do this are to show a denied expense report or to get your employer to write a letter that confirms your expenses were not reimbursed. Those most impacted by this are musicians, barbers/hairstylists, construction workers, and anyone who uses their own tools to do their job for their employer.

 
While you can never be completely sure you won’t face an audit in your lifetime, you now know which documents an auditor will want.

#Documentation is the key to #business #expense #deductions

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If you have incomplete or missing records and get audited by the IRS, your business will likely lose out on valuable deductions. Here are two recent U.S. Tax Court cases that help illustrate the rules for documenting deductions.

 
Case 1: Insufficient records
In the first case, the court found that a taxpayer with a consulting business provided no proof to substantiate more than $52,000 in advertising expenses and $12,000 in travel expenses for the two years in question.

 
The business owner said the travel expenses were incurred ”caring for his business.“ That isn’t enough. ”The taxpayer bears the burden of proving that claimed business expenses were actually incurred and were ordinary and necessary,“ the court stated. In addition, businesses must keep and produce ”records sufficient to enable the IRS to determine the correct tax liability.” (TC Memo 2016-158)

 
Case 2: Documents destroyed
In another case, a taxpayer was denied many of the deductions claimed for his company. He traveled frequently for the business, which developed machine parts. In addition to travel, meals and entertainment, he also claimed printing and consulting deductions.

 
The taxpayer recorded expenses in a spiral notebook and day planner and kept his records in a leased storage unit. While on a business trip to China, his documents were destroyed after the city where the storage unit was located acquired it by eminent domain.

 
There’s a way for taxpayers to claim expenses if substantiating documents are lost through circumstances beyond their control (for example, in a fire or flood). However, the court noted that a taxpayer still has to ”undertake a ‘reasonable reconstruction,’ which includes substantiation through secondary evidence.”

 
The court allowed 40% of the taxpayer’s travel, meals and entertainment expenses, but denied the remainder as well as the consulting and printing expenses. The reason? The taxpayer didn’t reconstruct those expenses through third-party sources or testimony from individuals whom he’d paid. (TC Memo 2016-135)

 
Be prepared
Keep detailed, accurate records to protect your business deductions. Record details about expenses as soon as possible after they’re incurred (for example, the date, place, business purpose, etc.). Keep more than just proof of payment. Also keep other documents, such as receipts, credit card slips and invoices. If you’re unsure of what you need, check with us.

Unexpected retirement plan disqualification can trigger serious tax problems

umbrella-1163700_960_720It’s not unusual for the IRS to conduct audits of qualified employee benefit plans, including 401(k)s. Plan sponsors are expected to stay in compliance with numerous, frequently changing federal laws and regulations.

 
For example, have you identified all employees eligible for your 401(k) plan and given them the opportunity to make deferral elections? Are employee contributions limited to the amounts allowed under tax law for the calendar year? Does your 401(k) plan pass nondiscrimination tests? Traditional 401(k) plans must be regularly tested to ensure that the contributions don’t discriminate in favor of highly compensated employees.
If the IRS uncovers compliance errors and the plan sponsor doesn’t fix them, the plan could be disqualified.

 
What happens if qualified status is lost?
Tax law and administrative details that may seem trivial or irrelevant may actually be critical to maintaining a plan’s qualified status. If a plan loses its tax-exempt status, each participant is taxed on the value of his or her vested benefits as of the disqualification date. That can result in large (and completely unexpected) tax liabilities for participants.
In addition, contributions and earnings that occur after the disqualification date aren’t tax-free. They must be included in participants’ taxable incomes. The employer’s tax deductions for plan contributions are also at risk. There are also penalties and fees that can be devastating to a business.
Finally, withdrawals made after the disqualification date cannot be rolled over into other tax-favored retirement plans or accounts (such as IRAs).

 
Voluntary corrections
The good news is that 401(k) plan errors can often be voluntarily corrected. We can help determine if changes should be made to your company’s qualified plan to achieve and maintain compliance. Contact us for more information.