Recordkeeping requirements and the consequences of lost, destroyed or stolen records.

• Author: Christensen, Anne L.

EXECUTIVE SUMMARY

* Taxpayers' books and records must be sufficient to establish gross income, deductions, credits and other items shown on a return.

* In certain circumstances, a taxpayer who claims that records are lost or destroyed can substantiate a deduction by reconstructing the expenditures.

* Some deductions, such as travel, entertainment, gambling and charitable contributions, require specific and more strict recordkeeping than others.

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Taxpayers have to substantiate the accuracy of their returns with appropriate books and records. This article discusses the general and specific recording requirements that apply to most taxpayers.

In filing tax returns or other documents with the IRS, taxpayers are under a duty to keep and maintain books and records that will substantiate the accuracy of their filed documents. Tax law includes both general and specific recordkeeping responsibilities. A failure to adhere to these can result in the loss of favorable tax treatment, the disallowance of deductions, tax deficiencies and, often, penalties. When records are lost, destroyed in a casualty or stolen, some relief is possible, but only after satisfying tough burden-of-proof and reconstruction requirements. This article discusses recordkeeping requirements, the taxpayer's burdens of proof at examination or in litigation, and the administrative and judicial policies that have evolved to deal with defective records.

Books and Records

Regs. Sec. 1.6001-1 sets forth the general requirement that all persons required to file income tax returns must keep books of account or records (including inventories) to sufficiently establish gross income, deductions, credits and other matters shown on the return. The regulation goes on to require retaining records and making them available for inspection by the IRS, for as long as their contents may be material to the administration of the tax. Other regulations under Sec. 6001 list similar requirements for estate tax, gift tax, payroll taxes, excise taxes and information returns.

Accounting Periods and Methods

According to Kegs. Sec. 1.441-1(b)(7), books should consist of records that clearly and adequately reflect income on an annual basis. To that end, Sec. 446 specifies using the cash receipts and disbursement method of accounting, the accrual method, or some combination of methods approved by the Service, as long as it clearly reflects income. Inventory requires use of the accrual method for purchases and sales, although there are some small business exceptions. A hybrid method can use elements of both methods, provided it clearly reflects income and is used consistently from year to year. Special transactional accounting methods are also available, such as the installment and completed-contract methods. Whatever the method, it must clearly reflect income and accurately represent the taxpayer's income, expenses and credits.

While wage-earners have to keep accurate records, they do not have to keep formal accounting books, under Regs. Sec. 1.6001-1(b). Whether or not required to keep books, all taxpayers must be able to substantiate the accuracy of their returns.

Definition

What are "books and records"? According to IRS Pub. 583, Starting a Business and Keeping Records, appropriate records should be of two types--supporting documents of specific transactions, and summaries of those transactions. Examples of supporting documents are cash register tapes, purchase orders, sales invoices, payroll records, bank deposit slips, cancelled checks, credit card receipts, information returns (Forms 1099), bank statements and similar documents. Summaries of transactions are kept and recorded in accounting journals and ledgers (e.g., sales registers, check registers, depreciation schedules, payroll reports and bank reconciliations).

Recordkeeping Requirements

Sec. 274 imparts strict recordkeeping requirements for specific expenditures. When applicable, it requires taxpayers to have expense records; otherwise, they cannot take the deduction, even if otherwise eligible.

Temp. Regs. Sec. 1.274-5T(b)(2) applies to the following expenditures:

1. Business travel away from home, including meals and lodging;

2. Any business expenditure for entertainment, amusement or recreation, or for a facility used in such an activity;

3. Business gifts; and

4. The use of listed property (e.g., cell phones, cameras, computers and automobiles). Similar rules apply under Sec. 280F for home office deductions.

   Taxpayers meet the Sec. 274 substantiation requirement when they maintain adequate records. The term "adequate records" has two components--a diary, log of expenses or similar record--corroborated by documentary evidence, which generally includes receipts for all items over $75 and for lodging. Exhibit 1 on p. 466 shows the substantiation elements. They can be described as follows:

1. Amount. This is the amount of each separate expense, such as transportation, lodging or meals. However, the daily cost of meals and incidentals can be compiled into general categories, such as meals, taxi fares and laundry. Entertainment is treated similarly; the daily cost of taxi fares and telephone calls is aggregated. The amount spent on gifts or listed property (including acquisition costs and capital improvements) must be documented.

2. Time. This is the exact dates the traveler is away from home; the number of days spent on business while away from home and the dates of entertainment, gifts and acquisition of listed property.

3. Place/Destination. This is the specific cities, towns or places the traveler visited while on business away from home, and includes the name, address, and/or location of entertainment or place of business discussion.

4. Description of item. This is a description of the specific gift given.

5. Business purpose. This is the business reason for traveling or the type of benefit the individual expects to result from traveling or the use of listed property. It includes the business reason and the nature of the business discussion, as well as the business reason or anticipated benefit for entertainment and gifts.

6. Business use. This is the amount of business or investment use, such as miles driven for automobiles or minutes of conversation for cell phones. This component supports the allocation of business and nonbusiness use of an item of property.

7. Business relationship. This is the identification of the people entertained or the recipients of gifts and their occupations, to establish a business relationship.

   What Constitutes Substantiation?

   Adequate records: In general, Temp. Regs. Sec. 1.274-5T(c) requires that taxpayers have adequate records to substantiate each required element for the expenses described above. Taxpayers should maintain an account book, diary, log, statement of expense, trip sheet or similar record, along with documentary evidence (e.g., receipts, cancelled checks) that supports entries in the account book, etc. The substantiation requirement can best be met with written records made at or near the time of the expenditure or the use of business property. Weekly entries in a log meet the "at or near the time" requirement. It is particularly important for written records or documentary...