Disaster Strikes: Next Trouble, an IRS AuditTax Planning
Your office burns to the ground in a fire.
You barely escape with your life. Everything in your office is destroyed, including all of your paper records and computer systems.
You need to reconstruct your accounting and tax records not only to file your taxes (including claims for casualty losses), but also to file insurance claims, bill clients, pay bills, obtain loans, deal with federal and state audits, determine business cash flow and solvency, and otherwise continue in business.
The first income tax reason for re-creating your records right away is that you can qualify to claim the casualty loss on a prior-year tax return and obtain a quick tax refund.
The second tax reason is that you have to file a tax return.
And because you lost your business records in the fire, your prior tax returns and the one you’re about to file are in serious trouble, because the fire destroyed your proof.
The IRS requires documentation for every deduction. Disasters do not change the documentation requirement.
But we are here to help—to make your record reconstruction a little easier with some helpful tips.
Check Your Online Backups
Unless you keep everything on paper and never use accounting software, it’s likely that much of your critical tax and financial data is already backed up online in the “cloud.” For example, your accounting software may perform online backups automatically without you even being aware of it.
Indeed, everything stored on your business computer (and home computer) may be backed up online.
Online data backups are impervious to local and even national disasters because the data is stored electronically in many locations on the internet.
Of course, not everything you need may be backed up online, particularly older items. But even data on damaged or destroyed computer hard drives, including the hard-drive backup in the office, may be recoverable by experts.
Planning. You should have an off-site online backup system for all of your personal and business records, both tax and otherwise.
Replacing Important Business Records
If you don’t have online or paper copies of the following types of records, you’ll have to obtain copies from whoever has them. Some of these (your business insurance policy, for example) may be easily available online. Other records may take more effort to replace.
You may have electronic copies of your tax returns stored in the cloud, ready to download. If not, contact the tax professional who prepares your returns. He or she should have copies of the returns prepared on your behalf.
You can also get copies of your previous tax returns and transcripts from the IRS.
IRS tax transcripts. IRS tax transcripts are not copies of your filed returns. Rather, they contain data from the key parts of the return. IRS transcripts are free, and you can get them anytime by using the IRS Get Transcript online tool; by postal mail with IRS Form 4506-T, Request for Transcript of Tax Return; by calling the IRS at 800-908-9946; or through the IRS2Go mobile phone app.
There are four types of IRS tax transcripts:
- Your tax account transcript provides an overview of your account, including such basic data as return type, marital status, adjusted gross income, taxable income, and all payment types. It also shows changes made after you filed your original return, including penalties, assessments, IRS inquiries, and other account activity. This transcript is available for the current tax year and up to 10 prior years.
- Your tax return transcript includes income reports from sources such as banks and employers. It also shows that you filed (or didn’t file) a tax return for a specific year. It doesn’t show changes after you filed your return. This transcript is available only for the current tax year and returns processed during the prior three years.
- Your record of account transcript combines the tax return and tax account transcripts into one complete transcript. It is available for the current tax year and returns processed during the prior three years.
- Your wage and income transcript shows data from IRS information returns such as Forms W-2 and 1099 that report how much you were paid by employers, banks, and the like. Current tax year information may not be complete until July. This data is helpful if you are missing W-2 or 1099 forms and need to prepare a tax return. This transcript is available for up to 10 prior years.
IRS transcripts contain three-digit transaction codes the IRS uses to identify all the actions posted to your account. To decipher these codes, refer to the Transaction Codes Pocket Guide (Document 11734).
Tax returns. If you want a complete photocopy of an old tax return instead of a transcript, use IRS Form 4506, Request for Copy of Tax Return, and make a payment of $43 for each year you need a copy.
If you use accounting software or an integrated app to track your inventory, your records may be backed up online. Alternatively, they may be retrievable from a computer hard drive.
If not, you can begin to rebuild your lost inventories by getting copies of invoices from suppliers. Whenever possible, the invoices should date back at least one calendar year.
If you use a payroll service, contact it to get copies of your payroll records. If not, request copies of your payroll tax deposits from the IRS and your state income tax and unemployment insurance agencies.
You can get copies of payroll checks from your bank. You can also ask your employees for copies of their pay stubs.
This can be one of the hard parts of reconstructing your books, because ordinarily there’s no single place showing all the customers or clients you’ve done business with.
You’ll have to create a list of your customers or clients and ask them for copies of the invoices you sent them and/or the checks they sent you. You can use cell phone records and emails to develop a customer list.
Business Mileage Records
Ideally, you have an electronic mileage log (there are many mileage apps), so a record of your business mileage is online.
If not, and if your paper mileage log was destroyed, you can use your appointment book or calendar and online map tools to reconstruct your business mileage.
The mileage log is another difficult record to reconstruct, because you need not only the mileage number but also the business purpose for each trip (something that is often missing from the online apps).
For information about income, get copies of bank statements. The deposits should closely reflect your sales for any given time period.
Documenting Business Casualty Losses
To claim a business casualty loss, you need to (1) know your damaged or destroyed property’s adjusted basis, and (2) determine its decline in value due to the casualty event. Your deductible business casualty loss is the lesser of the two, reduced by insurance recoveries.
Adjusted basis is usually the property’s original cost, plus the value of any improvements, minus all deductions you took for the property. This information should be in your tax returns and/or accounting records. If not, here are some tips:
- If the business was a pre-existing property, go back to the broker for a copy of the purchase agreement. This should describe what property you acquired.
- If the building was newly constructed, contact the contractor or a planning commission for building plans.
- Check with lenders for copies of any appraisals or other information they may have about cost or fair market value.
- For capital expense items, office equipment, and supplies, old credit card receipts and retailers’ current price lists can help verify value.
- If you have no record of the cost of a vehicle, call the dealer where the car was purchased and ask for a copy of the contract. If this is not available, give the dealer all the facts and details, and ask for a comparable price figure. If making payments on the car, check with the lien holder.
Business owners should take the following steps after a disaster to help document their property losses:
- Take photographs or videos as soon after the disaster as possible. This helps establish the extent of the damage.
- Check smartphones or other cameras for pictures and videos taken of buildings, equipment, and inventory before the disaster occurred.
- If there are no photographs or videos available, sketch an outline of the inside and outside of the business location. Then start to fill in the details of the sketches. For example, for the inside of the building, record where equipment and inventory were located. For the outside of the building, map out the locations of elements such as shrubs, parking areas, signs, and awnings.
Disasters are not one-off events. In fact, lightning can strike the same place twice.
Be prepared for the next disaster. Back up and safely store online in the cloud your most critical data: major contracts and legal documents, tax returns and financial statements, and other critical business and customer documents.
When thinking of how to back up your data, keep in mind that to prove a tax deduction you generally need both (a) proof of payment and (b) invoice or receipt showing what you purchased.
Here are five takeaways from this article:
- Disasters can happen at any time. You’ll be most equipped for one if you’ve backed up and stored your most critical data online.
- To the extent you lack online backups, you’ll have to get copies of vital records from your bank, clients and customers, landlord, and insurer, and from government agencies.
- You can replace lost tax returns by contacting the IRS.
- The IRS recommends you document a disaster loss by taking photographs or videos as soon after the disaster as possible. Also, check smartphones or other cameras for pictures and videos from before the disaster occurred.
- To calculate your deductible casualty losses, use your tax and accounting records to document your business property’s adjusted basis.