ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – ARE QUICKBOOKS RECORDS SUFFICIENT TO PROVE DEDUCTIBLE BUSINESS EXPENSES? – PART 1
By Robert S. Schriebman
This is Part 1 of a 2 Part series. Are QuickBooks records, standing alone, sufficient to prove deductible business expenses? In the Kouza case, the US District Court, E.D. Michigan, held that deductible business expenses cannot be substantiated by QuickBooks alone. In this article, I will discuss the Kouza case and the law relating to the ability to deduct IRC § 162, ordinary, necessary, and reasonable business expenses. Something more than QuickBooks is needed.
The Kouza Case
US District Court, E.D. Michigan, So. Div., 21-12790, Oct. 30, 2023.
Mr. Kouza was quite an entrepreneur. He had many different businesses. His record keeping left much to be desired. He was audited by the IRS for the years 2013 through 2015. He informed the IRS that he was “not sure whether he had sufficient basis in the businesses to cover losses.” In 2017, he submitted to the IRS a claim for refund for the year 2015 on Form 1040X. The refund claim was based on losses from three businesses in the amount of almost $230,000. During an administrative hearing to attempt to resolve the refund claim, Mr. Kouza testified that his business records were lost or probably dumped because he scraped everything. He could not produce original source documentation such as invoices and cancelled checks. He also testified that he had no personal knowledge concerning how the businesses’ profit and loss and payroll information was prepared. The IRS took the position that Kouza had not produced any original source documentation to substantiate claimed businesses expenses and losses. Rather Kouza’s sole documentation supporting his claim for refund consisted of profit and loss statements produced by the accountant for the three businesses in issue and that these statements were generated by QuickBooks, a software product.
Kouza relied on QuickBooks summaries prepared by the tax return preparer for the three businesses that went under. Kouza further argued that if his QuickBooks records were not sufficient to prove deductible business expenses, both the Court and the IRS should still give him deductions based upon an old court doctrine known as the “Cohan Rule.”
What is the “Cohan Rule?”
The Cohan Rule was a doctrine established in Cohan v. Commissioner 39 F.2d 540 (1930). The Cohan Rule is still used today. The doctrine allows taxpayers to estimate certain deductible expenses when a taxpayer does not have adequate records to document such expenses. The Cohan Rule is applicable if the taxpayer can prove that he/she is entitled to some deduction, but it does not apply to travel, entertainment, and business gift expenses per IRC § 274.
My Dog Ate My Homework
Mr. Kouza sought to be excused from producing original invoices and cancelled checks because these records were either lost or may have been trashed when his businesses went under. In my practice, I have heard excuses such as the inability to produce books and records due to flooding in a basement or the more frequent excuse that someone broke into the client’s car and stole his books and records but left the car standing. These sad tales of woe have little influence on the IRS and even less on the FTB. When perspective clients come up with these excuses, I show them the door.
Having said the above, there are legitimate excuses when books and records have been destroyed by natural disasters, such as flooding, landslides and wildfires. Looters and thieves can take documentation in an attempt to steal identity records. There are legitimate excuses that the IRS will accept for not only audit purposes, but also the abatement of late filing and late payment penalties.
In Part 2, I will discuss the Court’s position regarding the legal sufficiency of QuickBooks as the equivalent of original source documentation. I will also set forth the Court’s opinion on how long a taxpayer should keep books and records for tax purposes.
Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 50 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD, and he is not employed by the EDD or any other agency of the State of California.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
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