Can You Write Off Business Cash Purchases?

Business owners frequently use cash for transactions, leading to questions about whether these purchases can be claimed as tax deductions. The answer is yes, cash purchases are deductible if they meet standards set by the Internal Revenue Service (IRS) and are substantiated with proper proof. A deductible business expense is a cost incurred in the course of running a trade or business. The payment method, whether cash, credit, or check, does not determine deductibility; the nature of the expense and the ability to prove it are the deciding factors.

Establishing the Deductibility of an Expense

For any expense to be deductible, it must meet the “ordinary and necessary” rule established by the Internal Revenue Code. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your business and does not have to be indispensable.

For example, a freelance graphic designer buying new software is an ordinary and necessary expense. The same is true if a contractor pays a laborer in cash for a day’s work on a job site. The purpose of this rule is to ensure deductions are directly related to business activities, as personal or family expenses are not deductible.

Required Documentation for Cash Purchases

While cash expenses are deductible, they often receive closer scrutiny during an IRS audit because they lack the inherent paper trail of a check or credit card transaction. Therefore, maintaining meticulous records is important. The most reliable documentation is a receipt or invoice that contains the name of the payee, the transaction date, the amount paid, and a clear description of the goods or service purchased.

The IRS has a specific rule regarding documentation: you must have a receipt for any lodging expense while traveling, and for any other single expense of $75 or more. This means that for smaller cash purchases under $75, a detailed log entry may suffice without a receipt. However, a receipt is always the best evidence.

It is a common misconception that a bank statement showing a cash withdrawal is sufficient proof of a business expense. A bank statement only proves that you withdrew cash; it does not show how that cash was spent. For example, withdrawing $100 from an ATM does not prove you spent that $100 on fuel for a business trip; you need the fuel receipt to properly document the expense.

The IRS provides specific guidelines on how long to keep records.

• Keep records for three years from the date you filed your tax return or the return’s due date, whichever is later.
• Extend this period to six years if you have underreported your gross income by more than 25%.
• Keep records related to employment taxes for at least four years.
• Keep records that support the basis of your property, such as deeds and receipts for improvements, as long as you own the property and until the period of limitations expires for the year you sell it.

Reconstructing Records for Missing Receipts

In some cases where receipts have been lost or were never obtained, it may be possible to reconstruct an expense record. Historically, a legal precedent known as the Cohan Rule allowed for deducting business expenses based on reasonable estimates. However, this rule has been significantly restricted by law for certain types of expenses.

The Cohan Rule cannot be used for expenses related to travel, meals, gifts, or “listed property” such as passenger cars and computers. For these categories, the IRS requires strict documentary evidence, and estimates are not permitted. For other expense types where the Cohan Rule may still apply, you must provide credible supporting evidence created at or near the time of the transaction.

Acceptable forms of secondary evidence include detailed logs, account books, or digital calendar entries that you maintain regularly. The more detailed and consistent your log-keeping is, the more credible your reconstructed records will be.

For instance, imagine a consultant who paid cash for parking while meeting a client and lost the receipt. To reconstruct this, the consultant could point to a calendar entry for the client meeting on that date. If they also had a bank statement showing a small cash withdrawal from an ATM near the meeting location, these pieces of secondary evidence would create a credible record of the parking expense.

Recording and Reporting Cash Expenses

Once you have determined an expense is deductible and have the documentation, you must properly record it in your bookkeeping system. A common method for small outlays is to use a petty cash system, tracking each payment from a set fund in a log. For larger cash expenses, you should record them directly in your primary accounting ledger, debiting an expense category and crediting a “Cash on Hand” account.

When it is time to file your federal income tax return, this information is transferred to the appropriate form. For sole proprietors and single-member LLCs, business expenses are reported on IRS Form 1040, Schedule C. For example, the total from your log of cash purchases for office supplies would be included in the total for the “Supplies” line on the form.