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.
Freelancers Are Prone To IRS Audits
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.
What Is An IRS Audit?
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.
Failing To Comply With An IRS Tax Audit Is Not Recommended
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.
Does A Tax Audit Mean You're In Trouble With The IRS?
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:
- Not reporting (all of) income
- Too many / excessive itemized deductions (extra "generous" charitable contributions could set off alarms as well)
- Personal expenses claimed as business expense deductions (and the other way around)
- A mismatch between claimed income (low) and lifestyle (expensive)
- Failure to mention all foreign financial accounts
- Claiming false dependents (children who are not one's own)
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 7-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!
Going Through A Tax Audit Without Receipts
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".
Invoking The Cohan Rule
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.
The Cohan V Commissioner U.S. Tax Court Ruling
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:
- Comb through your bank account/credit card statements: they are not as detailed as original receipts but they may still offer some evidence of expenses. Canceled checks may also help in this capacity.
- Try to locate copies of receipts or invoices by reaching out to past vendors/suppliers, as some businesses hold on to their transactional materials for a while (though they might charge a fee for retrieving these records).
- Your calendar/appointment book may offer clues about the number of clients served and when business purchases were made.
- Social media history and cell phone records/location data may be useful in retracing some of your business travel history/mileage (the Bonsai Tax receipt scanner app is an excellent tool for logging travel expenses!)
Zero Receipts To Speak Of
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.
Completing The Audit
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.
Preventing an IRS Audit From Happening In The First Place
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.
Bonsai Tax Keeps Your Receipts Safe, Accounted For, And Sorted For Maximum Deductions
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. No need to manually record deductions with a template for expense tracking, just push some buttons and have all your receipts organized.
Do Yourself And Your Business A Favor...
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!
