Small businessmen who are not engaged in a partnership use Schedule C in computing taxable profits. Provided that they keep decent books and records, the process is supposedly straightforward. They simply record the appropriate expense from his records onto the appropriate line of the Schedule. For example, Insurance Expense is recorded on Line 15; Office expense is recorded on Line 18. Yet, in our audit work we find that it is Car and Truck Expenses (Line 9) that cause a great deal of pain. Why is this so? In this article we will address the why and how typical taxpayers will get themselves into trouble when an IRS small business audit begins to examine car and truck expenses.
The two methods of calculating car & truck expenses can often lead to unforeseen tax increases.
In the first place, the IRS allows two methods of computing expenses. That alone introduces complexity and confusion.
One is the standard mileage rate, the other is actual car expenses. The methodology for each is deceptively simple. The trap is this: the IRS looks for additional information that you may not know nor can you substantiate.
So what happens? A plumbing contractor decides that he wants to use the standard mileage rate in computing his mileage expenses. He looks up the instructions and finds that for 2011 the mileage rate for January 1 through June 30 is $.51 per mile and from July 1 through December 31 is $.55 per mile. Thus he computes: 20,000 miles at $.51 per mile or $10,200 20,000 miles at $.55 per mile or $11,000 Total 40,000 miles $21,200 He plugs this figure into line 9 and finds that the business has made only a small profit.
If he used the alternative method he would have been to record his actual expenses which amounted to $6,592. Moreover, he sees that a lot of his gas charges were from Vermont stations where he had filled up before trailering his snowmobile back to Connecticut. He may have been bothered by Part 4 line 33 of the schedule in which the IRS asks how many miles he drove and how much for commuting or other. He cheerfully inserts 40,000 for business and zero for both commuting and other miles.
He files his return and is surprised when three years later he is audited. The Auditor has disallows the mileage in its entirety, the Taxpayer is assessed for the extra income and self-employment tax. He also gets hit with penalties and interest. If he engaged an attorney or CPA to assist him with his tax audit, he also paid a substantial professional fee.
How to avoid an uncomfortable audit; an uncomfortable bill
So…what should he have done? He should have gotten some tax help. He would have learned that he could deduct and he could have set up his books to insure that he had recorded every deductible expense. He may not be aware that he can deduct depreciation on his vehicle.
His best line of defense would have been to keep a daily mileage log and to have recorded all mileage honestly. As a minimum, he would have avoided entering an even amount of mileage 40,000 which is a tip off to the IRS that the mileage is at best an estimate. DO NOT enter mileage estimates. If you really did travel 40,000 exactly, then really, forget about a few of those miles and claim 39,936.
And, if he elects to take the actual expenses, he needs a record that will prove what percentage of those expenses. Second, he should never, ever pay for gas with cash. An auditor’s first question is where he got the cash. If he has $2,312 in cash receipts, the presumption is that he made unrecorded cash sales. But note that even credit card statements and receipts are not considered conclusive. A taxpayer’s wife could have easily filled up her personal car and of course the snowmobiles need gas as well.
Third, auto repair receipts are important because they often show the mileage on the date of service. It is helpful when the ending mileage for June 26th is 72,135 and the oil change receipt for that day shows 72, 127. The receipt also identifies the car that was serviced.
Honest and substantiated records will get you the deduction. A small businessman wants to be out plying his trade and making a living. He may view proper record keeping as an unwanted distraction but it is essential for making sure that his return is honest and that he has taken every allowable deduction.
Conclusion
Car and travel expenses are an area the IRS loves to focus an in a small business audit. Because the rules are usually not followed, and when they aren't they are easy to detect, this give huge clues to other deductions (and revenue) that may have not been properly reported.
If you find yourself being audited and need assistance, contact us. We can help. Call us at 888-727-8796 or email info@irsmedic.com.
