1040 Audit Without Records

[Uncle Sam]

How would you deal with this? This is factual - not made up.

Client is being audited for a prior year for Schedule C expenses, and Schedule A
expenses.

His documentation proof was stored (scanned) in a computer, and paper records
(from business) were stored in a storage facility.

On two subsequent, distinct, and documented occasions, his computer was stolen,
and the storage facility flooded, that destroyed his records. This was NOT a Presid-
entially Declared Disaster area event - not a result of a hurricane or anything like that

He's got proof of insurance claims (that have yet to be settled) regarding both.

Audit is coming up shortly. I know the Cohan Rule WON'T work, as it doesn't apply.

[JohnH]

I'd gather what can be gathered by requesting copies:
1) Business bank statements
2) Business credit card statements
3) Business vendor summary statements
4) Request major customers to provide copies of invoices issued to them, if there were any

5) Mortgage statements
6) Property tax info from public records
7) Contribution receipts (if any)

Then work up a rough analysis that (hopefully) supports the numbers on the return, show it to the auditor, and see what they say. If you can prove 75% or so of the big numbers, maybe they will close it out.

I've found you can do a lot of analysis with nothing more than bank statements and an Excel spreadsheet if the business owner didn't play games with cash.

[New York Enrolled Agent]

Sam

In addition to JohnH's suggestions, I would consult the Internal Revenue Manual regarding oral testimony in an audit. I'll just paste a small piece.

4.10.7.3.2 Oral Testimony
The Internal Revenue Code requires all taxpayers to keep adequate records. There are times, due to unusual circumstances, when records do not exist. In such cases, oral testimony may be the only evidence available.

[New York Enrolled Agent]

Sam

The Tax Court released an opinion today (10/17) in a TCS case called Bonds. The last sentence in this snip should offer a bit of direction.


At trial, petitioner testified that she kept her tax records in the basement of her home in Minnesota and that the basement was flooded on three separate occasions, once when a sump pump failed, once when her hot water tank failed, and once after “a big storm”, which “soaked” certain of her records, prompting her to throw them out.
However, it remains unclear why petitioner could not have reconstructed at least some of her records by contacting third-party payees, such as insurance and utility companies.

[Uncle Sam]

1040 Audit Without Records

This helps.
Thank you New York Enrolled Agent.