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Every year he would just sit down with his wife and "remember" how much he spent on different things. No way to prove any of this, of course. He just had a "feel" for how much cash he had spent, and he had run his business for so many years that he just "knew" how much it cost to purchase certain things.
Well, this is
kind of taxpayer that IRS loves! It really is true -- if you can't prove that you paid for something (with receipts, invoices, canceled checks, etc.), then you run risk of losing that deduction in event of an audit.
One of most common questions I am asked by clients is this: "I know I paid for something, but I don't have a receipt. Should I still report deduction."
My response is usually this: "You only need a receipt if you get audited!"
Think about that for a minute! At first, many clients don't know if I am joking or not. Well, I do make that comment with my tongue planted firmly in cheek, but there really is a lot of truth to it. If you don't have documentation to prove a deduction, you can still report deduction (if you want), because you only have to prove deduction if you get audited.
But if you do get audited, knowing that there are undocumented deductions on return, be prepared to lose deduction!
And here's second major mistake that Mr. Jones made:
MISTAKE #2: BOGUS DEDUCTIONS!
It turns out that Mr. Jones wasn't completely honest with me about some of his deductions. He reported deductions that simply were not real deductions. Here's one example: Mr. Jones owned several rental houses. These rental houses, of course, required maintenance and repair work. Many times Mr. Jones would do work himself rather than pay someone else to do work.
Well, Mr. Jones would estimate what he would have had to pay someone else to do work that he did himself, and then he would report that amount as a deduction, even though he didn't actually pay anybody to do work!
In other words, Mr. Jones deducted value of his time -- a big No-No!
This is an important point -- you can never legitimately deduct value of your time for work you did. You have to actually pay someone else to do labor.
Well, that's what happened to Mr. Jones. He made a couple classic mistakes and paid consequences.
I hope you benefited by learning what can happen in a real audit. If you ever get a letter from IRS that demands additional information, you'll have nothing to worry about if you do exactly opposite of what Mr. Jones did. If you can properly document your deductions and assuming you have no bogus information, you'll pass audit with flying colors!
Wayne M. Davies is author of the new eBook, "The Tax Reduction Toolkit: 29 Little-Known Legal Loopholes That Will Reduce Your Taxes By Thousands (For Small Business Owners and Self-Employed People Only!) Don't file another tax return until you visit: http://www.YouSaveOnTaxes.com/toolkit.html
