Howard's IRS and the Law Blog

Everyday, I see how the IRS is responding to people hurt by the economy. The Journal of Tax Practice and Procedure asked me to write an article about it  – “IRS Collections in Troubled Times.”

Current IRS enforcement is centered on recovering government money that was spent to stabilize the economy.  As a result, the IRS is increasing its collection enforcement activities, with lien and levy filings hitting levels not seen since the mid-1990s.

The IRS has sought to soften the impact with public statements that it will attempt to be compassionate to taxpayers.  To their credit, the IRS is trying to be sensitive to those who have had job losses and income reductions.  But much of what the IRS is offering – like flexibility for missed installment payments – were available even in better times.

The reality is that fairness often comes down to individual situations and the IRS employee on the other end of the phone.  I have seen compassion and indifference.  There is some flexibility from the top; the essential question is how it is exercised.

IRS audits – how can you prove expenses without receipts?

by Howard S. Levy, Esq. on November 9, 2009

in IRS Audits, Tax Court

Can you prove expenses in an IRS audit without receipts and checks?

Thanks to the tax case of Cohan v. Commissioner,39 F. 2d 540 (2d Cir. 1930), the IRS will allow expenses even if receipts and checks are missing.

All you need is a reasonable basis to recreate the expense and credible testimony that you actually spent the money.

The Cohan case is law, and is followed by the IRS and the U.S. Tax Court.

Examples of using the Cohan rule:

A mileage log can be recreated if the basis for it is reasaonable – a calendar, for example, showing appointments.  Ever hear of a realtor who sells houses without travel?  A reasonable basis exists for the expense.  A realtor would make a log book from a review of her calendar showing open houses, supplemented by an affidavit providing an overview of how business is conducted.

For a flooring contractor to his subs, for example – labor expenses can be proven by recreating the jobs performed and the manpower used.  Carpet and flooring does not get laid by itself – a statement as to how the business was conducted supports the expenses.  No reciepts, but there is a basis to recreate and prove the expense.

In many cases, your testimony is valuable support for the reconstructed evidence.  In IRS audits, your testimony can be given in the form of an affidavit (a sworn written statement) of facts reciting how you paid the money.

Audit Reconsideration for missing records.

If your audit has already been completed and you are looking at a bill that is too high, the audit can be reopened to allow you to recreate expenses.  This is called audit reconsideration.

The Cohan rule, as it is known, is almost 70 years old, but it has withstood the test of time.  The decision still stands – direct records are not needed to verify an IRS expense deduction.  If you can reconstruct the evidence, you can use that to make an reasonable estimate for the deduction.

You are not a professional record-keeper.  Fortunately, thanks to the Cohan rule, you can overcome holes in your recordkeeping.

“I know I filed it, but the IRS tells me they never received it.”

Tax returns – lost.  Collection appeals – misplaced.  Innocent spouse claims – never processed.

The reality is that the IRS does lose incoming mail.  It is the exception, not the rule, but it happens.

And when it happens, it can be difficult to convince the IRS they are at fault without compelling evidence of filing.

The very best, indisputable way to file with the IRS:

Hand-file it.  Take your return, or your appeal or request, and drive it over to an IRS walk-in center.  Bring a copy with you.  When you file the original, ask the IRS to date stamp the copy as received.

I almost always recommend this for a series of unfiled returns.  Avoid mailing all the returns in the same envelope.  Putting each one in a separate envelope can result in 4 out of 5 being processed. You need 5 out of 5.

Lately, I have been hand-filing collection due process appeals by hand as well.  I have been challenged on more than one occasion by an IRS  Revenue Officer or Appeals Officer as to the timeliness of an appeal. Undisputed proof – a copy with an IRS date stamp – puts an end to these issues.

If you file with a post office proof of mailing certificate, be prepared:  On occasion, the IRS may question what was in the envelope.  Sometimes, I have seen the IRS take the unreasonable position that your mailing reciept only proves you mailed something to the IRS, not what you mailed.

When it is your word against the IRS records, you lose.  If it is important, hand-file it.

I will be on a panel seminar in Cincinnati on November 6 to address taxes and bankruptcy. My co-panelists include Bankruptcy Judge Jeffrey Hopkins and Bankruptcy Trustees Henry Menninger and Tom Geygan.

In addtion to IRS and bankruptcy, other topics that will be discussed include bankruptcy’s impact on divorce, real estate and understanding means testing.

The seminar is “Bankruptcy Forum: What Judges and Trustees Want You to Know.”   Take a look at the program brochure or register online.

What to expect from the IRS collection division in 2010:

1.     More aggressive IRS tax lien filing practices.

IRS Revenue Officers have been instructed to make decisions on the filing of Federal tax liens within 10 days of case assignment.   The IRS hit an all-time low for lien filings in 1999 of 167,000.  That has rebounded to 867,000 in 2008, still off the mark from of 1,400,000 in 1992.  Expect the IRS to continue to improve on securing its claims.

2.     Quick issuance of levies from Automated Collection Service.

The IRS Automated Collection Service has been issuing levies immediately upon expiration of their mandatory 30 day waiting period.  (The IRS cannot take levy action until 30 days after it mails you a Final Notice of Intent to Levy.  You have the right to stop this by filing a collection appeal during this waiting period).

This has caught many who have filed timely collection appeals off guard.  The IRS seems to be making quick matches on levy sources immediately upon expiration of the 30 day period, acting before it completes processing of the appeal.  This aggressiveness has resulted in clients who have timely filed a collection appeal receiving a wage or bank levy.  Be careful – file your collection appeal as soon as possible.

3.     Increased collection of the trust fund recovery penalty.

The IRS Taxpayer Advocate reports that between 2002 and 2007 the IRS collected only 13.5% on trust fund recovery penalty assessments. The IRS knows this has been a problem, and indications are it is being fixed.

In the past, I would often be retained by clients who are 7, 8 and 9 years past assessment of the trust fund penalty and have never heard from the IRS on collection. (This is important  – the IRS only has 10 years to collect after assessment).  That is changing.  Expect IRS Revenue Officers to seek collection of the trust fund penalty after they assess it.

4.     “Pyramiding” tax cases, owing year after year.

IRS will continue its focus on those that “pyramid” tax liabilities – that is, owe the IRS year after year.  This is especially true for nonfilers and employment taxes.  IRS Goal #1 is to stop the problem of not paying every year, every quarter.  Expect these cases to be high priority in the IRS collection queue.

5.     Areas involving fraud, including fraudulent 1099 OID.

An evolving issue the IRS is working to immediately clamp down on is the fraudulent use of 1099 OIDs (original issue discount).  Known as “OID Redemption” schemes, false forms are being filed claiming bogus 1099 OID credits and false withholding.  The Justice Department reports that a total of $3.3 trillion in false claims have been filed.

The IRS is now catching those claims before issuing the refunds, but millions have already gone out the door. High level IRS Revenue Officers are being assigned these cases as priorities.  They are receiving approval to issue immediate jeopardy levies to recoup the credits illegaly claimed.

With the tax gap at $300 billion and the budget deficit at 1.45 trillion, expect the IRS to continue its efforts to bring money back into the Treasury.

It can be tempting to use payroll tax withholdings as a source of operating capital for your business, especially in troubled times.  But this is dangerous – the IRS can penalize anyone in your business who took part in this decision with personal liabilty for the unpaid taxes.

This is known as the trust fund recovery penalty.  The amount of the penalty is equal to the amount of money deducted from employees paychecks but not paid to the IRS.

But there are time limitations on the IRS pursuit of the trust fund recovery penalty.  If the IRS does not assign a Revenue Officer to your case and investigate you in a timely manner, they lose the right to do so.   Here’s an overview of when time is up on a trust fund recovery assessment:

Statute of Limitations Expiration Date  – Trust Fund Recovery Penalty.

The IRS timeframe for assessment of the trust fund recovery penalty against you is based on the filing date of your company’s employment tax returns (Form 941).

The IRS has three years from the filing date of the employment tax returns to come to you with the trust fund penalty.  The term “filing date” is important here – it is defined by Internal Revenue Code 6501(b)(2), which states that employment tax returns filed for any period ending within a calendar year are considered filed on April 15 of the succeeding year.


941 return timely filed for quarter ended June 30, 2007.  The clock starts ticking on April 15, 2008, the date the return is deemed filed for trust fund assessment purposes.  Final assessment of the trust fund recovery penalty must be made before April 15, 2011, three years later.

941 return timely filed for quarter ended December 31, 2007.  The clock starts tickong on April 15, 2008, the date the return is deemed filed for trust fund assessment purposes.  Final assessment of the trust fund recovery penalty must be made before April 15, 2011, three years later.

If an employment tax return (Form 941) is filed late, the statute of limitations on assessment of the trust fund penalty expires three years from the late filing date, provided it is later than the statute expiration date if the return had been filed on time.

Once or twice a year I see time pass for clients without the IRS pursuing trust fund assessments.  It does happen, although the IRS is trying to close the gap.

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