Substantiation of Business Expenses 

 

Taxpayers bear the burden of substantiating every deduction claimed on their tax return.  The information presented here is aimed specifically at business deductions.   

 

I just bought toner for my printer on Amazon.  The expense will be shown on the statement for my business debit card.  Will this be sufficient evidence of this business expense if the IRS takes a look at it?  The answer is no. In an audit, the IRS will disallow any business expense for which you don’t have a receipt to match to the deduction in your bank or credit card statement. 

 

Further, the IRS says the purpose of the expense must be ordinary and necessary to the operation of your trade or business.  However, the Internal Revenue Code does not define “ordinary and necessary”.

   

The Supreme Court has said that “ordinary” does not mean habitual or normal.  They have indicated that an expense may be considered “necessary” if it is “appropriate and helpful” for the development of the taxpayer’s business.   

 

An expense does not need to be essential to be considered necessary.  A reasonable expectation that the business will benefit from an expense is enough for it to be considered necessary.   

 

IRS regulations promulgate that all taxpayers are required to keep an accounting of income and expense.  No uniform method of accounting applies to all taxpayers.  The adoption of specific forms and systems of accounting are left to the taxpayers’ judgement.  Permissible methods of accounting include the following: 

 

Cash receipts and disbursements: Under this method of tracking income and expenses, all items of income are included in the tax year in which the payment is actually received.  Likewise, expenditures are counted as expenses during the tax year in which they are actually paid.   

 

Accrual Method: Under this method of accounting, income is accounted for when earned rather than when the cash is actually collected.  For example, I have delivered product to a customer and sent them an invoice as of the end of the year.  Under the accrual method this is counted in income even though I haven’t received payment yet.  Similarly, expenses are accounted for at the time I have incurred the liability by my vendor having delivered product to me.  This is counted as an expense even though I have not paid for the product as of year-end.   

 

Other Methods:  A combination of the above methods of accounting is permitted if it clearly reflects income and is consistently used.