Tax Court did not find a disorganized "shoebox" compelling which leads to a big liability
San Mateo, CA:
In a recent US Tax Court case, the Wrights' (owners of a couple of small businesses--catering and construction) learned a very important lesson in document organization.
The Wrights were audited by the IRS for their 2014-2016 tax returns. A substantial portion of their business expenses were disallowed by the IRS for lack of substantiation. A total of $46,680 in tax and $9,335 in accuracy-related penalties were charged by the IRS.
The Wrights, feeling that their case was worthy of an appeal, petitioned the US Tax Court to hear their case.
The Wrights presented the Tax Court with 44 exhibits and almost 2,000 pages of documents (receipts, invoices, etc). So far so good....except, many of the receipts and adding machine tapes did not add up to the amounts claimed on their returns. In addition, an additional $58,473 in income was "found" on the catering business bank records of deposits. The documents presented to the court were disorganized, with handwritten notes in the margins, and double entries in the documents (a credit card record showing meal expense and a restaurant bill showing the same expense counted twice). There were multiple instances of inconsistences in the documents, leading the court to question the genuineness of the evidence offered--even noting that some entries appeared to be fabricated.
The Wrights were warned by the judge beforehand that a clear and concise spreadsheet of expenses being claimed would be necessary to present as evidence. Essentially, a "shoebox" of disorganized and jumbled documents were not acceptable. Unfortunately for the Wrights, they did not take that advice.
In the end, after reviewing the mess that he was presented, the judge found the Wrights did not meet their burden of proof. Because of the finding by the court of fabrication and questioning the genuineness of some of the records, the court further found that the Wrights' credibility was so damaged, that their uncorroborated testimony was essentially disregarded. The Wrights' lost their appeal.
Running a business is really no different than an individual tax return. The numbers on the tax return must be "backed up" to substantiate any expense deduction. An organized, clear, and complete record of those substantiations are necessary----putting them in "messy shoebox" and expecting the IRS or Tax Court to fix your organizational deficiency will lead to a bad result for you.
Kevin Rego
www.regotaxlaw.com
