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Professional Gamblers need to be aware of their responsibilities under the law to
maintain adequate books and records and document their activities.
"But I have a friend who says (or my accountant says) that this is "too
conservative" and there's no reason for keeping all these records, it's
a waste of time!" What these people are invoking, whether they are
aware of it or not, is the "Cohan rule" [Cohan v. Comr., 39 F.2d
540 (2d Cir. 1930)] . The Cohan rule allows a taxpayer to
approximate the amount at issue despite inadequate records, if it is
clear that an expenditure was incurred.
An example of this might be - you have solid documentation that 50% of
your car mileage is valid business mileage, but you lost all of your
gasoline purchase receipts in a fire. The gasoline purchased can
be approximated based on the documented miles, the average MPG of your
vehicle and the average cost of gasoline at the pump.
As such, the Cohan rule lowers the requirements for substantiation of
valid business expenses if the IRS finds the taxpayer to be credible.
If, after considering the taxpayer's other records and everything
else, the IRS does not feel comfortable with the credibility of the
taxpayer - then the deductions are disallowed. Why take the
chance? Laziness on the part of a taxpayer? Because a tax
preparer can earn twice as much by fluffing off the work of documenting
substantiation, so he can bill full price for doing two client's tax
returns in the time it otherwise might take for doing one?
The danger here is that when it comes to an Individual's
Professional Gambler
Status and Professional Gambler Status Entities, the lack of credible
substantiation can lead to a revocation of Professional Gambler Status in its entirety
and thus reverting the taxpayer to Casual Gambler Status [Higgins v. Comr.,
312 U.S. 212 (1941)]. When doing this, the Cohan rule is not
helpful. True, without substantiation the deductions may still be
allowed under the Cohan rule, but only as an Investor's expenses.
All Professional Gamblers:
- treat your trading business
professionally and apart from your personal activities.
- avoid commingling business
and non-business assets and activities.
- save all invoices for
expenses and equipment for several years.
- also save all canceled
checks, bank statements,
credit card statements and loan paperwork
to support payment of invoices. (also see
electronic records below)
- save all 12 monthly
brokerage statements. If saving in electronic format, maintain
multiple backup copies.
- save all confirmations and
other evidence to show the amount of time and effort spend pursuing
your trading activities.
- reconcile your casino W-2G
and 5754 sales to your records.
- reconcile your annual net
gain or loss to other verifiable records.
- verify that your downloaded
trading records are correctly based on transaction date as required
for IRS, and not by settlement date as per the SEC rules (usually
just the activity between December 25 and January 7 needs to be
reviewed).
- keep copy of any form 2848
power of attorney and show it to IRS if the need arises.
- never speak with the IRS
about your tax return or your trading activity, refer them to your
CPA.
- avoid using any busch league
"net change in broker account value" as your primary method of computing
net gains or losses for the year. we've seen as many errors with
professional gamblers erroneously overpaying their taxes as illegally underpaying their taxes using this
foolhardy, unprofessional approach.
- .
Corporations and Multi Member LLCs:
- keep copy of form SS-4 and
the IRS acknowledgement of your federal identification number.
- keep copy of form 2553 and
the IRS acknowledgement of your s-corp election.
- issue stock certificates or
member certificates to shareholders/members and assure that they are
"fully paid for," preferably with a separate payment made by check
from the shareholder/member to the entity.
- maintain a minute book to
document what happened at annual meetings and special meetings.
- maintain an LLC operating
agreement
- maintain an owners' buy-sell
agreement funded with disability insurance or life insurance, as
desired.
- establish your retirement
plan before December 31st.
- fund your retirement plan
before the initial due date of your tax return or...
- if you will absolutely be
filing timely, fund your retirement plan before the extended due
date of your return.
A Recommended Chart of Accounts:
Chart of
Accounts
Earned Income is required for Retirement
Plans and Medical Insurance Plans:
Employee
or "self-employed" Independent Contractor
Why Retain Documents and Records?
Your business records and your personal financial records must be
retained for as long as they may be relevant for any tax purpose.
Generally, you will need to keep all records that support items on your
tax return for at least four years, since the IRS may challenge your
return for three years after its due date. (Even longer in certain
cases)
Records for long-term assets,
such as real estate, business equipment, and investments, should be
maintained as long as you own the assets plus several years
afterwards, since you will need them in order to determine your
taxable gain or loss upon sale of disposition of the asset, and you
may need them to support depreciation or casualty loss deductions
along the way. If you rolled over a gain in the asset, as was
permitted under the old rollover replacement rule for personal
residences, or because you traded some business or investment property
in a tax-free exchange, you must keep records of the original asset
until you dispose of the asset that took its place.
Be sure to keep copies of your
income tax return itself. If you have ever made any nondeductible IRA
contributions, you must retain the Forms 8606 from each year you made a
contribution or received a distribution from any IRAs. But more
generally, if your return is ever challenged for something serious such
as fraud or not filing a tax return, the IRS can go back in time to
examine your returns for as many years as it thinks necessary. The
problem is that the IRS computer system might not have accessible copies
of your returns from, say, 10 or 15 years ago. Therefore it is very
important that you keep copies of your own tax records indefinitely, and
preferably forever.
What Tax Records to Keep and For How Long:
The general rule under federal
income tax regulations requires you to keep your records so long as they
may be material to administration of the income tax law.
- Income Tax Returns: Keep all federal and state income tax returns
permanently along with copy of and forms W-2 and 1099-MISC for
compensation earned.
- Income Tax Return Related
Items: Keep all federal and state income tax return supporting documents (i.e., those items confirming your income
and/or deductions) for a minimum of three years after the return's
filing date. The more prudent route is to keep these returns and
documents for six years. Why? The IRS can assess additional taxes
within three years of its filing date, but has up to six years in
which to make a tax assessment if the IRS determines that a
substantial amount of income has been omitted from the return.
In certain cases, including when fraud is suspected, the IRS can go
back even further.
- Property Taxes: The
Statute Of Limitations on personal property taxes are fifteen (15)
years of more after the due date of the tax. The sale of
long-ago forgotten tax liens on personal property you no longer own,
or real property you still own can come back to haunt you a decade
later unless you have canceled checks and stamp receipted tax bills
to prove that you already paid.
- Mailing Receipts:
Keep with your file copy of each tax return the U.S. Postal Service
receipt -- i.e., the registered mail receipt --showing the date the
return was mailed. If your return is filed electronically, keep a
copy of the electronic filing confirmation with a printed copy of
the return. In the event the return is misplaced or lost, this
documentation will save you from penalties.
- Residential Property
Records: Keep settlement records from all of your home purchases
and sales in a safe place. This will help you determine basis for
any future sale and gain determination. In addition, keep records of
the amounts that you spend for home improvements with this file.
These records will provide documentation of your basis in the house
if and when it comes time to compute your taxable gain.
- Stock and Bond Records:
Keep records of your investment and trading purchases (e.g., stocks,
options, futures, mutual funds, and bonds). Besides providing
you with a date for determining the type of gain -- long term versus
short term -- these records establish your basis in the investment
and help to compute the gain/loss when you sell. In addition, keep
records that show a return of capital on your investments.
- Depreciation Records:
For any rental real estate or depreciable business property that you
own, keep records of the property's cost, the purchase date, the
method used to calculate depreciation, and a schedule of all
depreciation claimed on the property in previous years. Maintain
these records until you sell or dispose of the property. Once you
sell the property, keep these records with the tax return on which
you report the sale.
- Personal Records:
Keep a permanent file of personal records -- such as divorce
agreements, copies of estate and gift tax returns under which you
received property, etc. - - since they can provide a basis for
determining your tax liability when you dispose of the property.
- Other Records: There
are other situations in which you will benefit from keeping records.
For example, if you have made nondeductible contributions to an IRA
or Roth IRA, maintaining records of these contributions will
facilitate proving your tax liability when funds are withdrawn from
the IRA.
Guidelines for Paper Records:
Three Years*
- Auto mileage logs (three years
or life of vehicle)
- Bank deposit slips
- Cancelled checks
- Daily sales records
- Entertainment records
- Expense reports
- Paid vendor invoices
- Written acknowledgment from
charity for contributions of $250 or more
*From date of filing return or
due date of return, whichever is later
Six Years
- Bank statements
- Contracts (after expiration)
Permanent
- Annual financial statements
- Corporate stock records
- General ledger & journals
- Real estate records
- Tax returns
- Copy C of Form W-2
- LIFO inventory record
Other
- Depreciation schedules (life
of asset, plus three years)
- Meeting minutes (life of
company)
- IRA contribution and
distribution records (three years after final distribution)
Here's another records retention list:
IRS typically has three years to audit tax returns. But it is six
years if it suspects that the return understates income by more than
25%. There is no statute of limitations if tax fraud is involved
or if the tax return was not filed.
Copies of tax returns including corrections and amended tax filings -
Keep Forever
Tax / Legal correspondence - Keep Forever
Audit Reports - Keep Forever
Contracts and leases - Keep Forever
Real Estate Records - Keep Forever
Mortgages and Notes - Keep Forever
Corporate Minutes and Stock records - Keep Forever
General Ledger and Journals - Keep Forever
Bank Statements - Six Years
Sales Records and supporting journals - Six Years
Personal Investment Records - Six Years after final taxable sales to a
3rd party
IRA Records - Six Years after final taxable withdrawals
Canceled Checks - Three Years
Paid Vendor invoices - Three Years
Employee Payroll Records - Three Years
Employee Expense Records - Three Years
Depreciation Schedules - Life of asset plus Three Years
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FAQ: Do I need
to retain original business expense receipts if I scan them into my
computer?
Many taxpayers maintain books and
records by using an electronic storage system that either images their
hardcopy books and records to an electronic stage media, such as an
optical disk. Records maintained in an electronic storage system that
complies with certain requirements will constitute records under Code
Sec. 6001.
Code requirements
Code Sec. 6001
provides that every person liable for any tax imposed by the Code, or
for the collection, must retain records. Any person subject to income
tax, or a person required to file an information return, must maintain
books and records, including inventories sufficient to establish the
amount of gross income, deductions, credits, or other matters required
to be shown.
A taxpayer’s electronic storage
system that meets certain requirements will be treated as being in
compliance with the recordkeeping requirements of Code Sec. 6001.
Special Rules
The definition of books and records goes beyond the typical hard
copy items when you maintain all or part of your accounting records on a
computer. In general, record-retention periods are the same for
“machine-sensible” records as they are for their hard-copy counterparts.
Machine-sensible records include magnetic tapes, punched cards and
computer disks.
Where machine-sensible records are concerned, however, retrievability is
important. Not only must certain records be maintained, but the IRS must
have access to those records. This becomes especially burdensome when
computer systems are upgraded.
If you or your business have
more than $10 million in assets*, and you maintain all or a portion
of your accounting records on a computer, the IRS requires that your
machine-sensible records be in a retrievable format and provide the
information necessary to determine the correct tax liability. This
requirement applies even if your accounting system is maintained by an
outside service bureau. To comply with this requirement, you must retain
the following specific documentation for all data files:
- Record formats (including the
meaning of all the codes used to represent information)
- System and program flowcharts
- Label descriptions
- Source program listings of
programs that created the files retained
- Detailed charts of accounts
- Evidence that periodic tests
are performed on the retained records to ensure they can produce the
data stored in the records
- Evidence that the retained
records reconcile to the taxpayer’s books and the tax return
If you or your business have
less than $10 million in assets, but you nevertheless maintain all
or a portion of your accounting records on a computer, the IRS requires
you to conform to the above standards if (1) your books and records are
only available in machine-sensible format, (2) machine-sensible records
were used for complex computations (such as LIFO) or (3) you are
notified by the IRS that your machine-sensible records must be
maintained.
* Members of a controlled group of corporations are combined for this
purpose.
Taxpayers’ responsibilities
The IRS permits the
destruction of the original hardcopy books and records and the deletion
of the original computerized records once the taxpayer has:
- Completed its own testing of
the electronic storage systems that establishes that hardcopy or
computerized books and records are being reproduced in compliance with
certain requirements; and
- Instituted procedures that
ensured its continued compliance with these requirements.
Click
here for more information on
electronic records.
Relevant IRS Procedures and Rulings Pertaining to Records:
http://www.uiowa.edu/~fusrmp/irsprocedures.htm
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