Updated: Aug 2, 2019
Since most of our clients know, I began my professional accounting work doing IRS Audits and I have been doing Business and Personal audits for over 25 years. I have found these 3 important words to keep the IRS at bay during many in-depth audits, please review and keep in mind these words often made the difference of the IRS allowing the deduction or paying the IRS back taxes, penalties and additional interest.
Ordinary, Reasonable and Necessary
A. Ordinary: Is the deduction “Ordinary” in your line of business or your type of business (do others in your type of business have the same deductions as a cost of operations)? Is it ordinary in this part of country or state, and is it ordinary for other similar types of business or in other states but in the same line of business. You might need to proof this from a trade publication (for a similar business).
Example: High Mileage Deductions might be consider Ordinary if you need to visit customers or clients, and need to do it often (keeping a good calendar with a mileage log will help support higher than average miles for other business), plus I keep receipts for all oil changes since the oil center notes (on my receipt the mileage) for each time I change my oil (you also could keep the receipt from the Auto Parts store or Walmart for proof of oil purchases, if you change your oil).
B. Reasonable: Do you have “Reasonable Deduction/s” which is normal for all other comparable businesses. Reasonable means that the cost is totally realistic and is unconditionally needed to keep business ongoing.
Example: We provide each of our staff with cell phones to contact clients after hours, and do not want them to use their personal phone for that reason. This would be a sensible cost of operations, and since many other accounting firms have done this for years (taken from Accounting Staff Publication).
C. Necessary: This word is used during audits to explain that without this deduction the business could not operate (and that’s is why it is required).
Example: One client had three locations and IRS was questioning them on the high rent expense and why they needed three locations and two storage units. The explanation was that they needed locations to meet customers in different counties (due to distance) and the two storage units were needed due the high cost of rent in each location. They often needed to expand inventory and did not have the space to store all the essential stock at the stores.
Look for trade magazines, books and publication for examples to support your deductions.
These Three Tax Words have helped us win numerous IRS Audits over many years, I have used many trade publications to explain the Ordinary, Reasonable and Necessary cost of a client’s deduction/s (to keep the deduction as a deduction).
Warning: If the IRS dis-allows the deduction there will be times they will make you amend the Tax Return without the deductions (which could affect your personal return) along with penalties and additional interest (which in many audits might be required for several years at a huge cost to you).
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