You deducted business expenses on your tax return. Maybe your accountant prepared the return, and you believed everything was correct. Now the IRS wants proof of those deductions. What happens if you cannot find the receipts?

The IRS can disallow business costs that you cannot adequately substantiate, even when you believe the purchases were legitimate. That can mean additional taxes, penalties, and interest. For New Jersey business owners, an audit can also take valuable time away from running the business.

What business expenses does the IRS examine?

An auditor may question vehicle costs, travel, meals, supplies, advertising, equipment, subcontractor payments, and cash purchases. The IRS generally looks at whether an expense was actually paid or incurred, whether it was connected to the business, and whether it qualifies under the tax rules. Some expenses, including vehicle use and travel, have stricter documentation requirements.

What happens if you do not have receipts?

A missing paper receipt does not always mean the expense is lost. Depending on the facts, bank and credit card statements, vendor invoices, canceled checks, purchase histories, and other reliable records may help establish a transaction. But a payment alone does not necessarily prove its business purpose. For some expenses, estimates cannot replace the specific records required by law.

A real example: Rachel, the online reseller

Rachel ran an online resale business. She regularly bought discounted merchandise at retail stores and resold it online. Those purchases were central to how she made money, but she did not save the purchase receipts.

During an IRS audit, Rachel could not adequately support the inventory purchases she had reported. The IRS disallowed the unsupported costs. The issue was not necessarily whether she had bought products for resale. It was that she could not prove the amounts claimed.

Rachel’s experience illustrates a costly lesson: buying something for your business and proving the purchase to the IRS are two different things.

Are inventory purchases different from ordinary business expenses?

Yes. A reseller’s merchandise purchases are generally part of the cost of goods sold, which is used to calculate gross profit, rather than an ordinary operating expense such as advertising or office supplies. The exact accounting treatment depends on the business and its applicable accounting method. Either way, you need reliable records showing what you purchased and what it cost.

Resellers should keep itemized receipts, purchase logs, payment records, inventory information, and sales reports. That is especially important when purchases are frequent, small, or made with cash.

Can you reconstruct missing records during an audit?

Sometimes. A qualified representative may be able to help collect duplicate receipts, online order histories, bank records, supplier statements, shipping information, or consistent inventory and sales records. These materials can help explain transactions that were poorly documented at the time.

However, reconstruction takes time and does not guarantee that the IRS will allow the costs. It is much easier to preserve records as purchases occur than to rebuild years of transactions after an audit begins.

What if you paid workers or suppliers in cash?

Cash payments can be legitimate business transactions, but cash withdrawals alone often prove very little. If you withdraw $2,000 from an ATM, the statement shows that you took out cash. It does not establish who received it or what the payment was for.

Maintain invoices, dated payment records, names of payees, and other proof. Payments to workers may also raise separate questions about worker classification, employment taxes, and required information returns.

Can the IRS look at personal bank accounts?

Yes, when those records are relevant to examining a return. Transferring money between personal and business accounts does not, by itself, create taxable income or a deductible expense. But commingled transactions can be difficult to explain and may lead to more questions. Keeping separate accounts makes an audit easier to manage.

What if your accountant prepared the return?

Hiring a tax preparer does not eliminate the business owner’s obligation to maintain accurate records. An accountant often prepares the return using the figures and documents the owner supplies. Your accountant may have prepared your tax return, but you are still responsible for keeping the records that support the numbers on it.

Can disallowed deductions lead to penalties and interest?

Yes. When the IRS disallows expenses or inventory costs, reported taxable income may increase, producing additional income tax and, in some situations, self-employment tax. Interest generally accrues on unpaid tax. An accuracy-related penalty, commonly 20% of the relevant underpayment, may also apply if statutory requirements are met. That penalty is not automatic in every audit, and defenses may be available.

Can an IRS business audit expand?

It can. Information discovered during the examination may cause the IRS to look more closely at other transactions, tax issues, or years, subject to applicable rules and limitations. Careless explanations, disorganized responses, and missed deadlines can complicate an already stressful process.

Why hire a tax audit attorney instead of handling it yourself?

Business owners know their companies, but they may not know what an auditor is legally entitled to request or how best to substantiate a disputed deduction. A tax audit attorney can review the proposed adjustments, identify supporting evidence, organize responses, communicate with the IRS, and challenge conclusions that are not supported by the facts or law.

Complex audits can last months. Having a representative manage the process can allow you to spend more time operating your business and less time responding to document requests.

Can you challenge an IRS decision to disallow expenses?

Often, yes. Depending on the stage of the examination and the notices issued, you may submit additional records, dispute proposed changes, seek consideration by IRS Appeals, or pursue available court review. Deadlines matter. Do not ignore an IRS letter because you disagree with its findings.

How long should you keep business receipts?

The IRS generally advises keeping records until the period of limitations for the return expires. That is often at least three years, but longer periods may apply. Records relating to assets, inventory, basis, and other items that affect later returns may need to be kept much longer. An organized electronic recordkeeping system can work well if the records are accurate, complete, and accessible.

What can you do now to protect your business?

Do not wait for an audit notice. Set up a simple system to capture receipts as you make purchases, log cash transactions, reconcile bank and credit card accounts, track inventory, and separate personal transactions from business spending. Save digital copies in an organized folder or accounting system, and periodically review whether your records actually support the amounts on your returns.

Frequently asked questions

Can the IRS disallow a business expense paid in cash?

Yes. Cash purchases can qualify, but you still need enough evidence to prove the amount, date, recipient, and business purpose, as applicable.

Can I use a bank statement instead of a receipt?

Sometimes a bank statement helps, but it often does not identify what was purchased or whether it was business-related. Other documentation may be necessary, and special substantiation rules apply to certain deductions.

Can I appeal if the IRS disallows my deductions?

In many cases, yes. Your options depend on the notice and stage of the case. Promptly review the deadline before taking action.

Facing an IRS business expense audit in New Jersey?

At Tomes Law Firm, we represent New Jersey business owners in IRS audits and tax disputes. We help clients organize the evidence, address disputed deductions, respond to IRS requests, and work toward a fair resolution. You should not have to put your business on hold to handle a complicated audit alone.

Contact Tomes Law Firm to discuss your IRS audit and how we can help protect your business. Call the tax audit attorneys and accountants at 732-333-0681 or 833-4IRS-TAX to schedule your confidential free consultation.

We Solve Tax Problems. You Get Peace of Mind.

IRS resources

IRS: Recordkeeping https://www.irs.gov/businesses/small-businesses-self-employed/recordkeeping

IRS Publication 583: Starting a Business and Keeping Records https://www.irs.gov/publications/p583

IRS Publication 463: Travel, Gift, and Car Expenses https://www.irs.gov/publications/p463

IRS Publication 535: Business Expenses https://www.irs.gov/publications/p535