“If I don’t have good records, will I really pay more tax than I could/would/should have?”
“If I don’t have receipts, does it really matter?”
“If I get audited, will the IRS nail me for not substantiating my deductions?”
The answer to every one of those questions is an emphatic “Yes!” Here is the proof: Michael Robert Cottrell was self-employed and made about $5,700 in self-employment income one year. He didn’t report that income because he thought, “I have at least that much in expenses, so my expenses offset my income and I really didn’t make any profit. So there’s really no need to report the income or the expenses.”
Mike got audited by the IRS, and when the IRS told him to “prove” those deductions with a paper trail, Mike was unable to do so. He literally had no records whatsoever to document his claim that his net profit was zero. He admitted to receiving the $5,700 in income, but then proceeded to claim that about 50% of that income was spent on materials, 25% went toward subcontracted labor, and the rest went to pay other miscellaneous expenses and debts. The IRS said, “Prove those deductions.” Mike said, “I don’t have any records. They were lost when I moved.” The IRS said, “Sorry, Mike. No receipt, no deduction.”
End result: Mike was assessed by the IRS with a tax bill of $1,625. Because he didn’t have any written record or proof of his deductions, his deductions were disallowed.
NOTE: The information about Mr. Cottrell is a matter of public record — Michael Robert Cottrell T.C. Summary Opinion 2003-162. The Burden of Proof is on the taxpayer to prove a business deduction. Therefore, cultivate the habit of keeping your original business receipts and filing them in a well-organized record-keeping system