The words IRS audit can summon incredible anxiety for many self-employed taxpayers. Not everyone even knows what an "audit" actually entails, but they are certain they don't want any part of that action, whatever it is.
Getting audited and not having all your receipts for taxes in order is even more fear-inducing. After all, receipts are considered primary evidence in proving qualifying tax write-off expenses.
Note: If you want an easy way to record and organize all of your tax receipts, try Bonsai Tax. Our freelancer tax software could help you store all your receipts on the cloud so you'll have them if you ever get audited. Try a 14 day free trial today.
Keeping track of receipts is not easy for anyone, but freelancers are notoriously bad at archiving their financial documents, as they are usually juggling multiple tasks at a time and often lack the business administration background to keep well-organized financial records. So, it is not surprising that some freelancers attract the negative attention of the IRS: their tax returns are a mess!
Certainly, freelancers who struggle with book-keeping and taxes would benefit tremendously from utilizing the Bonsai Tax receipt organizer app -- software that helps with receipt scanning, importing, organizing and tracking for tax purposes. But, suppose you are already in "hot water" with an upcoming IRS audit -- and you don't have all (or any) of your receipts in order -- what do you do?
Firstly, don't panic. True, audits from the U.S. Internal Revenue Service are nothing to rejoice about -- but they do not have to be disasters of apocalyptic proportions either if you are ready for them. Let's take a closer look at what happens when you are audited and your original receipts are missing.
Before we can talk about how to "survive" an audit -- let's define it.
It is the taxpayer's responsibility to annually pay taxes to the IRS on their income, and it is their prerogative to declare work-related expenses as write-offs to offset some of those taxes. When the IRS reviews those declarations (and the subsequent taxes paid) in the form of tax returns, they might find some unclear / missing income reporting or questionable itemized deductions they need to follow up on, and this formal inquiry is called an "audit".
The taxpayer receives the IRS audit notice typically within seven months of filing (though the statute of limitations allows for three years), in the form of a letter by mail (never a phone call). The letter states the intention to conduct an audit and requests specific documentation from the taxpayer, to be provided usually within 30 days of receiving the audit notice.
The person being audited can request an extension of time to help them organize related materials if they are struggling with getting it done in a timely manner.
Ignoring the audit letter and the subsequent "notice of deficiency" and failing to be available and forthcoming with answers/requested documentation will result in being served with the bill for taxes owed as re-calculated by the IRS in accordance with its audit conclusions. The lack of cooperation with the audit constitutes the waiving of one's right to appeal the final sum/decision in tax court.
Not every IRS audit happens due to violations on the taxpayers' part. Occasional taxpayer accounts are selected for a tax audit at random, while others are reviewed in relation to tax returns of a different person (such as a business partner or investor) being audited.
However, the majority of IRS audits do have to do with investigating certain "red flags" in taxpayers' tax returns, such as:
Self-employed workers are more likely to get audited by the IRS than W-2 employees working for someone else. The IRS has, unfortunately, seen quite a bit of sloppiness as well as straight-up cheating from this category of the taxpayer: as the result, freelancers do attract extra scrutiny (which is why it's so important to use Bonsai Tax software to organize/track business expenses!)
Note: In fact, try a 14-day free trial of our software to organize your receipts and store them on the cloud (in case you get audited!). On average, users save $5,600 from their tax bill. Don't be audited and caught with no receipts again!
Original receipts are the golden standard with the IRA, as they are seen as the most indisputable evidence of a given expense. However, in the face of incomplete records, and assuming that the taxpayer is being honest and reasonable, the IRS auditors will allow them to recreate/reconstruct/prove their expenses through "other credible evidence".
For freelancers with lost/missing tax receipts for work expenses, there is a legal precedent for cutting them a bit of a break, known as the Cohan Rule. The Cohan Rule law hails from a 1930 court case that was fought by a famous Broadway entertainer, George M. Cohan, who was fond of paying for business expenses with cash and neglected to hold on to any of his receipts.
When Cohan found himself subject of an IRA audit that ended up disallowing any of his undocumented travel and entertainment expenses, he took the matter to tax court. Cohan lost the first court case but persevered and took the case to the Appeals court which ended up ruling in his favor.
Thanks to the Cohan Rule, self-employed workers with incomplete business expense records could still prove each of their deductions with a reasonable/credible estimate based on materials or information other than receipts.
Here are some of the ways for the taxpayer to hunt down relevant expense materials that would recreate and substantiate these estimates:
In the complete absence of a paper trail, you can take a photo of the item you've claimed as a deduction and accompany it with as much detailed description as you can recall about when, where, and to what business purpose the item was purchased.
In cases when no receipts are available whatsoever, the IRS is not likely to take the taxpayer's word for every itemized expense but will, instead, apply a minimum standard calculation for the cost of the qualifying goods/services in question, depending on the deduction category. While this may not cover the exact cost incurred, it is certainly much better than nothing.
The IRS notifies taxpayers of its audit decision within 30 days of making it. The person can accept the decision -- or request an appeals hearing and, if the matter is not settled in appeals, to pursue the dispute in tax court.
If you experience an IRS audit without the necessary receipts -- get through it the best you can with the Cohan Rule this time -- but consider it a wake-up call and a lesson learned.
You can avoid being audited in the future by committing to keeping a record of your business tax info and by utilizing the right digital tax management tool to make the process much simpler and faster.
For self-employed workers, the best app to track tax receipts is Bonsai Tax: a cloud-based computer software / phone app designed specifically for freelancers in anticipation of the tax "paperwork" applicable to their needs.
The Bonsai Tax software provides an easy, streamlined way to maintain thorough records of your business expenses -- by scanning cash receipts and importing bank and credit card statements into an online account which, in turn, organizes/sorts them into different categories of potential deductibles for tax filing. You won't have to worry about how long to keep receipts for taxes, because it would be stored on the cloud.
Based on the enrolled income and expenses data, the app generates a tax estimate every calendar quarter, so that you always have an idea of how much you will owe at the end of the year. And when that time comes, the software takes over the bulk of filling out of the tax return on your behalf.
How much easier would your life be if you let Bonsai Tax guide you through the tax process, while keeping your data on track and your mind on the prize?
The answer is: so much easier!
When you have well-organized records, you have a well-organized business. Knowing that your tax return is backed up by solid documentation gives you a peace of mind and allows you to focus your effort on doing your best professional work and making your clients happy. Sign up for a free trial with Bonsai Tax and experience the difference (and the relief) for yourself!
A verbal contract (formally called an oral contract) refers to an agreement between two parties that's made —you guessed it— verbally.
Formal contracts, like those between an employee and an employer, are typically written down. However, some professional transactions take place based on verbally agreed terms.
Freelancers are a good example of this. Often, freelancers will take on projects having agreed on the terms and payment via the phone, or an email. Unfortunately, sometimes clients don't pull through on their agreements, and hardworking freelancers can find themselves out of pocket and wondering whether a legal battle is worth all the hassle.
The main differences between written and oral contracts are that the former is signed and documented, whereas the latter is solely attributed to verbal communication.
Verbal contracts are a bit of a gray area for most people unfamiliar with contract law —which is most of us, right?— due to the fact that there's no physical evidence to support the claims made by the implemented parties.
For any contract (written or verbal) to be binding, there are four major elements which need to be in place. The crucial elements of a contract are as follows:
Therefore, an oral agreement has legal validity if all of these elements are present. However, verbal contracts can be difficult to enforce in a court of law. In the next section, we take a look at how oral agreements hold up in court.
Most business professionals are wary of entering into contracts orally because they can difficult to enforce in the face of the law.
If an oral contract is brought in front of a court of law, there is increased risk of one party (or both!) lying about the initial terms of the agreement. This is problematic for the court, as there's no unbiased way to conclude the case; often, this will result in the case being disregarded. Moreover, it can be difficult to outline contract defects if it's not in writing.
That being said, there are plenty of situations where enforceable contracts do not need to be written or spoken, they're simply implied. For instance, when you buy milk from a store, you give something in exchange for something else and enter into an implied contract, in this case - money is exchanged for goods.
There are some types of contracts which must be in writing.
The Statute of Frauds is a legal statute which states that certain kinds of contracts must be executed in writing and signed by the parties involved. The Statute of Frauds has been adopted in almost all U.S states, and requires a written contract for the following purposes:
Typically, a court of law won't enforce an oral agreement in any of these circumstances under the statute. Instead, a written document is required to make the contract enforceable.
Contract law is generally doesn't favor contracts agreed upon verbally. A verbal agreement is difficult to prove, and can be used by those intent on committing fraud. For that reason, it's always best to put any agreements in writing and ensure all parties have fully understood and consented to signing.
Verbal agreements can be proven with actions in the absence of physical documentation. Any oral promise to provide the sale of goods or perform a service that you agreed to counts as a valid contract. So, when facing a court of law, what evidence can you provide to enforce a verbal agreement?
Unfortunately, without solid proof, it may be difficult to convince a court of the legality of an oral contract. Without witnesses to testify to the oral agreement taking place or other forms of evidence, oral contracts won't stand up in court. Instead, it becomes a matter of "he-said-she-said" - which legal professionals definitely don't have time for!
If you were to enter into a verbal contract, it's recommended to follow up with an email or a letter confirming the offer, the terms of the agreement , and payment conditions. The more you can document the elements of a contract, the better your chances of legally enforcing a oral contract.
Another option is to make a recording of the conversation where the agreement is verbalized. This can be used to support your claims in the absence of a written agreement. However, it's always best to gain the permission of the other involved parties before hitting record.
Fundamentally, most verbal agreements are legally valid as long as they meet all the requirements for a contract. However, if you were to go to court over one party not fulfilling the terms of the contract, proving that the interaction took place can be extremely taxing.
So, ultimately, the question is: written or verbal agreements?
Any good lawyer, contract law firm, or legal professional would advise you to make sure you formalize any professional agreement with a written agreement. Written contracts provide a secure testament to the conditions that were agreed and signed by the two parties involved. If it comes to it, a physical contract is much easier to eviden in legal circumstances.
Freelancers, in particular, should be aware of the extra security that digital contracts may provide. Many people choose to stick to executing contracts verbally because they're not sure how to write a contract, or they think writing out the contract terms is too complicated or requires expensive legal advice. However, this is no longer the case.
Today, we have a world of resources available at our fingertips. The internet is a treasure trove of invaluable information, platforms, and software that simplifies our lives. Creating, signing, and sending contracts has never been easier. What's more, you don't have to rely on a hiring a lawyer to explain all that legal jargon anymore.
There are plenty of tools available online for freelancers to use for guidance when drafting digital contracts. Tools like Bonsai provide a range of customizable, vetted contract templates for all kinds of freelance professionals. No matter what industry you're operating in, Bonsai has a professional template to offer.
A written contract makes the agreement much easier to prove the terms of the agreement in case something were to go awry. The two parties involved can rest assured that they're legal rights are protected, and the terms of the contract are sufficiently documented. Plus, it provides both parties with peace of mind to focus on the tasks at hand.
Bonsai's product suite for freelancers allows users to make contracts from scratch, or using professional templates, and sign them using an online signature maker.
With Bonsai, you can streamline and automate all of the boring back-office tasks that come with being a freelancer. From creating proposals that clients can't say no to, to sealing the deal with a professional contract - Bonsai will revolutionize the way you do business as a freelancer.
Why not secure your business today and sign up for a free trial?