Shifting the Burden of Proof

by Stephen Kass on July 22, 2012

Keeping good tax records has always been important, but the IRS Restructuring and Reform Act of 1998 made it even more so. One of the act’s boldest initiatives was
shifting the burden of proof from the taxpayer to the IRS in civil tax matters. The burden shift applies to both individuals and businesses. It does not, however,
cover all situations. It applies only in court proceedings on civil tax matters. It does apply to a partnership, corporation or trust with a net worth over $7 million. The burden
shift is not automatic; instead it occurs only if the taxpayer fulfills the following three requirements:

1. Introduces credible evidence relevant to determining taxpayer income or estate or gift tax liability.

2. Cooperates with reasonable requests from the IRS in its investigation.

3. Complies with the substantiation and record-keeping requirements in the code
and regulations.

To substantiate a deduction by adequate records, a taxpayer – either an employee or a self-employed individual – must maintain:

1. An account book, diary, statement of expense or similar log in which the taxpayer lists each element of an expenditure at or near the time it was made.

2. Documentary evidence (for example receipts or paid bills) for away-from home lodging and other expenditures of $75 or more.

An accurate record must include a written statement of business purpose unless it is evident from the surrounding facts and circumstances. The documentary evidence should
establish the expenditure amount, date, place and character.

Specific record keeping and substantiation requirements apply to listed property, charitable contributions and employee expenses. Specific rules also apply to taxpayers
using electronic storage and ADP systems to maintain books and records.

Even without the new burden of proof rules, a taxpayer failing to maintain adequate records faces serious consequences. The IRS may disallow a deduction, impose
penalties for negligence or fraud or require the taxpayer to use an IRS-prescribed method to determine income.

The IRS permits a taxpayer who can prove records were destroyed by fire, flood or earthquake – or even in a non-natural casualty such as theft or loss – to reconstruct
those records under most circumstances. If the taxpayer fails to keep adequate books and records, the IRS has several methods as its disposal to reconstruct the taxpayer’s income.

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