What an election year, huh? Come to think of it, make that two election years that this endurance march leading up to the 2008 presidential election has now spanned. As Sen. Barack Obama recently quipped, babies born at the start of his run for the Democratic nomination are walking and talking by now.

Among the recent dramatic turns in this protracted primary was the release of the presumptive candidates’ 2007 tax returns. Obama’s 2007 income of $4.2 million was largely due to the $3.9 million he earned from his bestseller “The Audacity of Hope.” Republican Sen. John McCain’s 2007 income of $405,409 raised few eyebrows. He files separately from wife Cindy, whose family fortune is estimated at $100 million plus.

Such campaign-year public scrutiny of candidates’ federal income tax returns raises an interesting question: How would your tax records stand up to the presidential sniff test?

If you’re like most traders, you shudder at the thought. Sure, you probably keep a daybook. You collect receipts when you travel for business. You use a dedicated business credit card and keep the statements to corroborate your expense report.

Unfortunately, your record keeping would probably fall short of the mark in the event of an IRS audit, resulting in disallowed deductions and penalties.

Your quasi-businesslike approach may generate the numbers you or your accountant need to file a completed tax return, but if the IRS wants a closer look, the burden of proof is fully upon you the taxpayer to turn up the records with correct documentation to justify your write-offs.

Recognize IRS Danger Zones

The IRS tax code requires that “adequate records” be kept to support all deductions. “Adequate records” include two components: a daybook, log, trip sheet or journal in which each expense is noted “at or near the time” it was incurred, and corroborating receipts for all lodging and items costing more than $75. You can tally your daybook on a weekly basis and still fall within the IRS timeliness guidelines.

But not all tax deductions are considered equal in the eyes of the IRS. It’s fairly easy to spot unreasonable deductions in categories like office supplies or dues and subscriptions, hence they’re not typically red-flag areas.

The IRS is much more vigilant when it comes to business travel and entertainment (T&E), business gifts, and listed property such as cars, computers and cell phones. Here’s what your daybook must include to safely pass inspection in these red-flag zones:

• Travel and entertainment: date, time, place, amount and business purpose of the expenditure. In the case of business entertainment, you must also note your business relationship to those in attendance.
• Business gifts: date, time, amount, description, business purpose and your business relationship to the recipient of the gift.
• Listed property: date, time, amount and business purpose of the purchase.

Documentary corroboration of these expenses in the form of receipts or credit card statements is permissible if it contains date, place, amount and nature/classification of the expenditure.

Tighter Rules on Charitable Giving

Beginning in 2007, if you donate money to charity, the IRS wants to see either a bank record or a written receipt from the recipient showing the name of the organization and the date and amount of the donation before it will allow your deduction. Previously, taxpayers were only required to note the contribution in their records.
The IRS is taking a harder line on non-cash charitable donations as well. For non-cash donations of less than $250, you will need a receipt from the recipient listing the organization name, date, location and description of item(s) donated. You also are required to keep a written record of each donated item that includes: organization name and address, date and location of donation, the fair market value of the item and method used to obtain it, basis cost and any additional terms attached to the gift.

Additional record keeping requirements apply to non-cash donations of between $250-$500, more than $500, and more than $5,000 in value. For more details, see Publication 526 (2007 Charitable Contributions).

Easy Gambling Deductions? Don’t Bet On It!

Gambling deductions are another hot spot with the IRS these days, so prepare to be extra diligent if you frequent the casino or off-track betting parlor.

To substantiate your gambling losses, your daybook must include the date and type of wager, the name and location of the gambling establishment, the amount you lost and the names of those present with you to verify that you bet the wrong horse, number or team.

Now the paperwork. Substantiation documents to be filed with your IRS return include, but may not be limited to, Form W-2G (Certain Gambling Winnings), Form 5754 (Statement by Person Receiving Gambling Winnings), wagering tickets, statements of actual winnings or payment slips from the gambling establishment, bank withdrawals, canceled checks and credit card records.

This Just In: The IRS Does Have a Heart

Contrary to popular opinion, the taxman does have a heart – at least when it comes to certain circumstances that might prevent you from producing the necessary records to defend your return.

For instance, where a natural disaster such as flood, fire, tornado, hurricane, avalanche or mudslide has rendered your records irretrievable, the tax court will accept a reasonable reconstruction of your expenditures. It will be up to you, of course, to dig up the actual (not approximate) amounts and prove that the loss was beyond your control and that adequate records really did exist.

Should the IRS lose your records however, the courts have ruled that your now-lost records shall be considered accurate, regardless of what the IRS may think.

Why all the fuss about record keeping? Because the penalties for inadequate records can be steep: in addition to losing the deduction, you could be slammed for 20% of what the IRS figures as your understatement. To appeal its decision, you must prove that your record keeping was adequate, or alternatively that your failure to keep adequate records was do to a reasonable cause (think coma) and that you acted in good faith.

Keeping poor records just isn’t worth it. Fortunately, there’s a great alternative. Contact Traders Accounting, your trader tax experts, today. We can help you tame the paper tiger and make sure your records can withstand the heat, whether it’s an IRS audit or a run for the presidency!