The term “alternate accounting methods” is usually associated with cash, accrual, or IFRS. When I plan the accounting work behind a tax return, however, I use the term more loosely to cover a wider range of tools for reconstructing income and expenses when the records are incomplete.
Why would a CPA need these tools at all? In a perfect world, preparing a tax return means matching data from third-party sources and fitting it into the forms. That description fits few of the returns I prepare. I am more often involved when the usual records are not available. The cause might be a natural disaster (my own office landed upside down in the water after Superstorm Sandy), a technology failure, a serious bookkeeping error, absentmindedness, substance abuse, depression or another mental health issue, or incarceration. In recent years, general stress has become the fastest-growing reason a taxpayer cannot produce records. A person worried about a utility shutoff or a property tax lien foreclosure is not focused on bookkeeping. Whatever the cause, the taxpayer is still required to file.
The goal in these cases is to meet the taxpayer’s legal obligation by filing a timely, defensible return at the lowest possible cost and tax liability that the available facts support. Few of these taxpayers expect 100% accuracy, and the professional standards do not demand it. Treasury Department Circular 230 and the AICPA Statements on Standards for Tax Services both permit a preparer to use reasonable estimates when records are unavailable, provided the estimates are not presented in a way that implies more precision than exists. The courts have accepted reasonable estimates for nearly a century under what tax professionals call the Cohan rule.
There is one firm limit. The tax code does not allow estimates for vehicle, travel, gift, and certain listed-property expenses. Those deductions require specific substantiation, and no amount of statistical skill replaces it.
Once the reason and the goal are clear, I may propose one or a combination of these methods:
- Estimating
- Statistical sampling
- Trend analysis
- Ratio analysis
- Industry analysis
Each method depends on understanding the data and applying sound statistical principles. The IRS itself uses many of these same techniques when it reconstructs income during an examination, so a return built on them speaks the examiner’s language. It is not enough, for example, to use random estimates. Those numbers must be based on sound logic and mathematics. The worksheets documenting the methodology should be preserved with the other tax return data.
When the work is based on a legal theory, it is equally important to document those details as the basis for our work.
Finally, it makes sense to conclude the tax return work by developing and adapting a plan to ensure that the same problem does not happen again. I consider that to be the very important coaching aspect of my work.
If you are behind on a return because your records are lost, incomplete, or simply too much to face right now, that is not a reason to stay stuck. It is a common starting point for the work I do.
To arrange a private call to discuss your situation, send a short introduction text message to 856-314-5625. Do not include any private personal information in the text. We will establish a secure way to share information later if needed.
