Dealing With Missing Receipts

After (or along with) reconstructing a taxpayer's income in order to complete a delinquent taxreturn, comes the task of asserting all the deductions and adjustments to income to which thetaxpayer is legally entitled.

The IRS, in its process of filing substitute returns, knows most taxpayers have adjustments toincome, especially the self-employed. The self-employed can have office rent, utilities, merchandise,merchant account charges, advertising, payroll, all kinds of expenses the IRS knows they likely have.However, the IRS is not going to arbitrarily assign numbers to these expenses or use any kind ofindustry average. For one, two businesses in the same industry may operate in totally divergentways, such that one has high expenses for advertising and the other low expenses for advertising.

What the IRS Can Provide and Partly Ignores

A Wage and Income Transcript can be obtained through the local IRS office, the Taxpayer AdvocatesOffice or any tax professional (EA, CPA or attorney) authorized to practice before the IRS. For self-employed individuals and other businesses, the interest on loans relating to the business is oftenreported to the IRS, sometimes as mortgage interest. (Note: Any taxpayer filing jointly for thesubject tax year should also secure a Wage and Income Transcript for his or her spouse.)

The IRS frequently ignores any tax credits of which they have record (such as foreign taxes paidthrough investment funds). The IRS has records of tuition fees and/or payments made, student loaninterest reported as paid, mortgage interest and, often, real estate taxes. (While most of these arenot business expenses, part of the mortgage interest and real estate taxes might be.)

Reconstructing the Business Expenses

After (or as) the income is determined, the business expenses need to be identified. The rule ofthumb regarding business deductions is: Are they reasonable, necessary, ordinary and/orcustomary? This is refined by anything unique in a taxpayer's business operations. For example, notall farmers use creamery wastes to feed their animals. However, those that do may have higher autoexpenses than others because they travel daily to get the fresh nutrients for their animals. By thesame token, their feed expenses might be much less than those of other farmers raising the sametype of animal.

The bank and credit card statements will contain charges for various purposes of services, suppliesand equipment. Categorize them, log them and find receipts when possible. A multi-faceted exampleof this would be a self-employed individual's contributions to the Little League. On the surface, theycould appear to be charitable donations only deductible on Schedule A (itemized deductions). Inreality, they may reflect payments required to sponsor a team in the business's name. The businessname was on all the uniforms and published in the programs and newsletters. This is advertising,and a legitimate business deduction. After recalling all of this, it is possible the taxpayer can getduplicate receipts from the Little League secretary!

Inherent in the dates presented in bank and credit card statements is the structure of recreatingmileage logs, if applicable. If the taxpayer drives a diesel-fueled vehicle and can document his or heraverage miles per gallon, then get the local average diesel fuel price and the vehicle's total milesduring the subject tax year, the taxpayer can divide and multiply these, as logical, to arrive at fuelexpense.

The bank and credit card statements used to reconstruct the income are just as important in

reconstructing the expenses. They are documentation in themselves for bank service charges andfees paid by the business. (Note, however, without a separate business bank account, no more thanone-half of the total fees is likely to be allowed in an IRS examination.)

Does the Taxpayer Owe That Much Money?

Probably not. A taxpayer logically working through what secondary records are available canreconstruct both income and expenses for a tax year for which the business records have been lostor destroyed. The bottom line is every business has expenses and those claimed must be ordinary,reasonable and necessary.