Good records will help the taxpayer do the following:
A system of books and records may be as simple as a calendar showing business income earned each day and business expenses paid each day or they may be a detailed accounting system. The system of records should include enough information to correctly determine gross receipts, business expenses incurred and the purchase price of assets acquired for use in the business. These records should also include inventory purchases, payroll, and other transactions occurring in the course of operating the business.
The taxpayer's books and records should include supporting documents. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. These documents are important to support the entries in the books and the tax return. These records will also help the taxpayer determine the value of inventory at the end of the year.
Schedule C should include current operating costs of running the business. To be deductible, a business expense must be both ordinary and necessary.
To be correct and complete, the Schedule C should include all allowable business expenses. The taxpayer's records should not include any personal expenses. The following is a brief list of some common business expenses. See the Schedule C instructions and IRS Publication 535, Business Expenses, Publication 946, How to Depreciate Property, and Publication 587, Business Use of the Home, for more information. Common business expenses include the following:
To comply with their EITC due diligence requirements, a paid preparer should make adequate inquiries to be satisfied that the taxpayer is carrying on a business and that the income and expenses reported on the tax return are substantially correct and complete.
In the event of a loss of client records or due to poor recordkeeping, a paid preparer may need to help his client reconstruct the records. The reconstruction will demonstrate that the paid preparer exercised due diligence and it will also teach the client about recordkeeping.
The goal of record reconstruction is to use available documentation to develop a sound and reasonable estimate of the taxpayer's business income and expenses to support the Schedule C prepared. Although the taxpayer may not have formal books and records with supporting documentation, they may have partial records that can be used as a basis for reconstruction.
The knowledgeable tax preparer can guide their client on how to use these partial records to develop support for the Schedule C. This reconstruction can also provide support for the return in the case of an audit. Numerous court cases exist that support the use of reasonable estimates and reconstruction of income and expenses to determine a taxpayer's correct tax liability. However, if the tax preparer is not satisfied with the accuracy of the reconstructed records, he has the right to refuse to prepare the return.
The following is a table of helpful example options and tools to use in reconstructing records:
|Example source||How to use to reconstruct records|
|Appointment books or calendars||
An appointment book could be used to develop:
Using summary counts of the number of each kind of service rendered, the taxpayer could apply an average or standard cost to come up with an estimate of total receipts. The number of trips made and the locations traveled to could be combined with online map tools data to support total business miles driven.
|Online map tools||Online map tools can be used to reconstruct mileage calculations.|
|IRS standard allowances||The IRS provides standard expense allowances including per diem expenses for truck drivers and standard mileage rates.|
|Checkbook, cancelled checks, bank statements or credit card statements||These documents can be used to gain information about expenses incurred and what types of services were performed for clients. Using summary counts of the number of each kind of service rendered, the taxpayer could apply an average or standard cost to come up with an estimate of total costs and receipts.|
|List of regular clients||Using a list of regular clients, a taxpayer could reconstruct a reasonable calendar of services. Regular expenses could be extrapolated from that information. The taxpayer could apply an average or standard cost to come up with an estimate of total receipts.|
|Partial receipts or sales tax records||Partial receipts can lend information regarding what expenses were incurred for services. The taxpayer could apply an average or standard cost to come up with an estimate of total receipts.|
|Cell phone records and call history or computer logs||Cell phone records and call history can be used to develop a list of clients served during specific timeframes.|
|Prior year returns||Prior year returns can provide the basis for records if activities are similar from year to year.|
As a preparer you must make a decision whether you are comfortable that the information presented by your client is substantially correct.
If you are not satisfied with the taxpayer's records, you may:
You have a professional responsibility to prepare returns that are accurate. The taxpayer is ultimately responsible for the figures computed through record reconstruction, and you should inform the taxpayer of possible repercussions of filing a false EITC claim whether with or without your assistance. However, as a tax preparer you must exercise due diligence and apply reasonableness as you may be subject to penalties and additional consequences.