The case is David and Gail Vigil v. Commissioner (TC Summary Opinion 2008-6).
Vigil had deducted $3,463 for meals and entertainment, $12,347 for travel expenses, $7,862 for supplies, and $17,199 for car and truck expenses. In audit the IRS disallowed all of these deductions because Virgil failed to provide any substantiation.
You are allowed to deduct “all ordinary and necessary business expenses paid or incurred during the taxable year in carrying on any trade or business” under Internal Revenue Code Section 162(a). However taxpayers are also required under IRC Section 274(d) to maintain and substantiate records for such deductions claimed.
In this situation Vigil claimed that he kept a record of the various locations where he conducted his business and also of the mileage driven. He used credit cards for business expenses and kept the receipts. However he gave the original receipts and documentation to his tax preparer, a CPA, but did not keep any copies. The CPA developed a drug problem and later died. The CPA’s wife, who took over the business, also developed a drug problem. Even with the help of the local sheriff Mr. Vigil was unable to get any of his documentation back from her.
In a situation where receipts and documentation are not available you can “estimate” deductible expenses if you can produce sufficient evidence and establish a rational basis on which the estimate can be made under the famous “Cohan Rule” (Cohan v. Commissioner, 50 TC 823, 827-828). In addition you can substantiate deductions through reconstruction of expenditures through other credible evidence if your records are lost or destroyed through circumstances beyond your control (Smith v. Commissioner, TC Memo 1998-33).
The Tax Court decided for the IRS because Virgil was not able to adequately reconstruct his records and he did not provide sufficient evidence for the court to estimate the amount of his expenses.
There are two morals to this story –
(1) Make sure you have receipts and documentation (i.e. a travel diary) for all business expenses.
(2) If you give original receipts to your tax professional make sure you get them all back with the completed return. You may want to make copies just in case before handing the receipts over to your preparer.
A possible third moral – beware if your tax preparer has traces of a white powder around his nose!
Whatever you do also never give or send original receipts or documents to the IRS. Give the IRS, or state tax auditor, photocopies of your receipts and documentation - always keep the originals for yourself in a safe and secure place. You can show the IRS or state auditor originals, but do not let him/her keep them.
As an aside, in this case Virgil deducted both actual auto expenses and the standard mileage allowance. You can’t do both – it is one or the other. And there are special rules as to which you can deduct.