Tax Receipts

It is important to save your receipts in the event the IRS or FTB audits your tax return.   There is a general rule that taxpayers should keep receipts for seven years for tax audit purposes.  However, every general rule has its exceptions, and some taxpayers may need to keep some receipts longer than seven years.  A recent Office of Tax Appeals (OTA) Case illustrates what happens at an IRS or FTB tax audit when you do not have tax receipts and how one of the exceptions to the seven year rule came into play. 

In the Sediqui case, the Taxpayers purchased real estate in 1982.  In 2009, the Taxpayers made improvements to the property which they used to increase the cost basis of their property.  In 2017 the Taxpayers sold the property and reported the gain from the sale on their tax return.  The Taxpayers increased their cost basis (and reported less taxable gain) by the cost of the improvements they paid for in 2009.

The FTB audited the Taxpayer’s 2017 return and determined the Taxpayer lacked sufficient receipts to substantiate the improvements.  Ultimately, the Franchise Tax Board allowed some of the improvement costs but did not allow the full cost of the claimed improvements as the Taxpayer lacked receipts.

When a taxpayer lacks receipts at audit, the IRS and FTB will often employ the Cohan rule.  Under the Cohan rule, a reasonable estimate is made of a taxpayer’s expenses, but the estimate bears heavily against the taxpayer.  In short, under the Cohan rule, a taxpayer without receipts will get a low-ball estimate of the costs they are claiming on their return.  The taxpayer generally does not get the full amount claimed, but they will get something. 

This case also illustrates one of the many exceptions to the seven-year rule.  People who own real estate should keep receipts and other records related to improvements made to their real estate for much longer than seven years.  A property owner may make improvements that increase the tax basis of their property and subsequently sell the property decades after the improvements are completed.  As such, the property owner may need to substantiate the costs of the improvement decades after the improvements occurred if a property owner’s return is audited. 

The Seven Year rule for receipts is a general rule with many exceptions.  You should always consult with a tax advisor before discarding or destroying any receipts or other tax related documents.  When in doubt, keep the document.  Electronically storing documents is a potential option if you are concerned about storing voluminous paper records. 

Taxpayers missing receipts are not always doomed; however, they are generally not going to be as well off as a taxpayer who has maintained all of the records required to substantiate their position.  Again, there are work- arounds like the Cohan rule that can potentially reduce an audit bill.

The experienced tax attorneys at RJS LAW provide a wide range of tax services including helping clients with IRS, FTB, CDTFA, and EDD audits.  If you are under audit (or have concerns about being audited), please contact our firm at 619-595-1655 or via the web at RJS LAW for a no cost consultation. 

Written by Joseph Cole, Esq., LL.M.