One question I get asked frequently is, “What business receipts, records and documents should I keep for my business?”

The answer I give is always the same. The Internal Revenue Code (IRC) requires a taxpayer to maintain books and records that substantiate income, deductions, and credits, including adequate records to substantiate deductions claimed as trade or business expense. This includes but is not limited to invoices, paid bills, canceled checks, etc.

Think of the documentation as telling the story about the expenditure – what you bought, where you bought it, how much you paid for it, proof that you actually paid for it, how this purchase relates to your trade or business. This last item is especially important for purchase that can have personal uses as well as business uses. A debit card entry in a contractor’s bank account records for a purchase at Home Depot or Lowe’s is more likely for a legitimate business expense than is a similar entry in an attorney’s bank account records. So, the attorney would likely need more documentation of the business use than the contractor might need.

What If You Don’t Have All of Your Records?

But, sometimes a taxpayer doesn’t think about this or ask this question until he has been contacted by the IRS with a “friendly” notice that he is being audited. So, what can he do then if he does not have all his receipts and invoices? What if some unforeseen event, such as a fire or flood destroyed some of the records? What if they got misplaced or lost in a move? What if they were purged by the taxpayer? Does this mean that all is lost – that all expenses will be denied by the auditor? Or, is there some salvation for the taxpayer?

Well, if the expense is for 1) travel; 2) entertainment, amusement, or recreation; 3) gifts; or 4) certain “listed property,” the taxpayer MUST comply with strict substantiation rules to take a deduction for the expense. Without the required supporting documentation, the taxpayer does not get the deduction allowance. For those who can’t sleep, you can check this out in the Internal Revenue Code, § 274(d).

The Cohan Rule

However, for other expenses not in one of the categories covered in IRC § 274(d), you may get some other relief. If you cannot substantiate the exact amounts of deductions by documentary evidence of the types described above but you can establish that you had some business expenditures, the courts may employ what is known as the Cohan rule to grant you a reasonable amount of deductions.

What is the Cohan rule?” you ask. Stay tuned for a future article. Meanwhile, organize and maintain your documentation as though everything you do is covered by the strict substantiation requirements of §274(d).