When it comes to maximizing deductions and minimizing tax liabilities, inadequate records can be your worst enemy. More often than not, taxpayers miss out on deductions not due to complex tax laws, but due to a lack of proper documentation. If you’re a business owner, especially one who utilizes vehicles for your operations, understanding the essentials of recordkeeping can save you substantial amounts of money.

The Crucial Role of Documentation

Documenting your expenses isn’t just a suggestion; it’s a necessity. In most cases, proving the business purpose and payment is essential to claim deductions. This typically involves maintaining invoices and checks. However, for smaller expenses where obtaining a receipt might be challenging, an alternative like a diary can come to the rescue. This practice becomes invaluable when dealing with expenses that don’t have strict substantiation requirements.

The Power of the Cohan Rule

The Cohan Rule is a saving grace for taxpayers who can’t provide precise documentation for various expenses. Under the Cohan Rule, when taxpayers are unable to produce records of actual expenditures, they may rely on reasonable estimates, provided there is some factual basis for it. The rule is based on a tax case involving entertainer, composer and playwright George M. Cohan, who claimed a deduction for entertainment expenses but had no documentation. While its applicability has narrowed over time, understanding its roots can shed light on the importance of maintaining comprehensive records for your expenses.

Five Essential Elements of Car and Truck Expense Documentation

For meals, entertainment and listed property usage (cars, trucks, etc.), the requirements are more specific and the Cohan Rule isn’t available. For vehicles, you must document the:

  1. Cost and date of each expense;
  2. Mileage for each business use;
  3. Date of vehicle use;
  4. Business destination, and
  5. Business purpose of the trip.

Each of these applies to each trip. Don’t forget to also record the date when you started using the vehicle for business purposes and the total miles driven throughout the year. While it might sound daunting, using a diary or a mobile app to document these details can significantly simplify the process. The recording should be made as close as possible to the time of the trip. That could be the same day, or within the week. The longer you delay, the less credible the record.

The Case of Lee Baker: A Lesson in Recordkeeping

Lee Baker worked as a self-employed truck driver. He owned a 1995 Mack Truck tractor which he used to haul tank trailers. He did not own the trailers. The taxpayer claimed approximately $63,638 of expenses related to his truck business for the year at issue.

Of the total, he claimed $38,516 for fuel, $12,200 for truck maintenance, and the remainder for other expenses. But he provided no documentation to support any of the expenses claimed.

Because the property use didn’t have to meet the strict substantiation requirements, the court could estimate the taxpayer’s expenses under the “Cohan Rule.” The court estimated his deduction on the rationale he must have incurred some expenses. Ironically, the rule can no longer be used for travel and entertainment or expenses related to listed property such as cars and trucks.

Timeliness Is Key

Remember, the more immediate your recordkeeping, the more reliable your documentation becomes. Whether it’s the same day or within a week, recording your trips and expenses soon after they occur adds credibility to your records. A delay can introduce doubts about the accuracy of your claims, potentially putting your deductions at risk.

Employees and Vehicle-Expense Reimbursement

If you’re an employee seeking reimbursement for vehicle expenses, the same rules apply. Whether your company uses the actual expense method or the standard mileage method, meticulous recordkeeping is essential. This applies not only to businesses but also to employees using company vehicles. Neglecting documentation can lead to including undocumented mileage as income on your W-2.

In Conclusion

Navigating the realm of tax deductions and expenses can be intricate, but having a firm grasp on proper documentation can be your saving grace. Don’t let valuable deductions slip through the cracks due to inadequate records. Embrace the power of accurate recordkeeping to ensure that your business and vehicle-related expenses are fully substantiated, keeping your finances on the right track. Remember, the investment you make in meticulous documentation today can yield substantial savings in the long run.

LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.