IRS notices

The documentation that turns a strategy into a position

You did the thing. You took the advice, made the change, and kept every receipt in a folder with the year on it. So you are covered.

Possibly. Receipts prove that money moved. Most tax positions do not fall apart because nobody could prove money moved. They fall apart on the question of why it moved, and what it was for.

The gap between having done something and being able to show you did it correctly is where most of the risk in planning sits. Not in the strategy. In the file behind it.

The misconception

That receipts are documentation. A receipt is evidence of a payment. It says an amount left an account on a date and went to a named party.

It says nothing about business purpose, nothing about whether the arrangement was real, and nothing about whether the thing you claimed matches the thing that happened. Those are the questions that get asked.

What a position is made of

Three things, and all three have to be present.

The business purpose, recorded at the time. Why this cost, for this business, in this amount. Written when the decision was made rather than remembered later. A short note on the day beats a long explanation two years afterwards, every time.

The transaction actually happening the way it was described. If the arrangement says rent is paid monthly, rent is paid monthly. If it says a salary is taken, the payroll runs. If a company owns something, the company bought it and the company pays for it. A structure that exists only on paper, with the real behaviour unchanged underneath, is the most common failure in the whole field.

The paperwork a third party would expect to exist. An agreement between related parties, in writing, with terms a stranger would have accepted. Minutes where a decision required a decision. A valuation where a value was needed. The test is not whether you and the other party understood each other. It is whether the file looks like the file of two parties dealing at arm's length.

There is a real difference between a position you can defend and one you are hoping nobody asks about.

You can usually tell which one you have by asking a simple question. If somebody sat down with the file and no explanation from you, would they reach the same conclusion the return reached? If the answer depends on you being in the room, you do not yet have a position.

What this is worth

Hard to quantify, and any number attached to it would be invented, so here is the qualitative version.

A well documented position that is questioned usually ends with the position standing. Time is spent, the file is produced, the matter closes. A poorly documented version of the same position, taken by the same person for the same legitimate reasons, can be adjusted, and the adjustment can carry interest and potentially more.

The two cases are identical in substance. The difference is entirely the file. That is why documentation is not administrative work sitting next to the strategy. It is part of the strategy.

What this requires

• Contemporaneous records, written at the time, in whatever form you will actually maintain.
• Real payments, on the dates the agreements say, moving between the accounts they should move between.
• Agreements in writing for anything between related parties, with terms that are commercially recognisable.
• Consistency between what the return says and what the file shows, including across entities and across years.

The system matters less than people think. A shared folder with dated notes works. What does not work is the intention to write it up later, because later is the week somebody asks, and by then it is reconstruction.

Who this is not for

Nobody is exempt from this, so use this section for the three things people skip most often.

First, the contemporaneous log for anything that turns on time or use. Mileage, business use of a vehicle, hours of participation in an activity. These are the claims most often reduced, and always for the same reason. The claim was probably accurate and there was no record made as it happened.

Second, agreements between entities the same person owns. It feels absurd to write a lease between two things you control. It is exactly the situation where the absence of one is fatal, because there is no negotiation to point at as evidence that the terms were real.

Third, the minutes and resolutions behind decisions in an entity. Nobody enjoys this. It takes minutes a few times a year, and it is often the only evidence that a decision was made by the entity rather than by a person who happens to own one.

When this happens

Contemporaneous is the whole point. The word is doing all the work in this article. A record made on the day carries weight precisely because it could not have been shaped by knowing what was coming.

December reconstruction is the failure mode. Sitting down at year end to recreate a log from a calendar and a memory produces something that reads exactly like what it is. It is better than nothing and it is not the same thing, and an honest advisor will tell you so.

The point

A strategy without documentation is an intention. The file is what converts it into something that holds when it is examined.

That is planning work, done while the year happens. Your Charter team sets out what the file needs to contain at the point the strategy is chosen, rather than looking for it at filing.

This is general information, not advice on your own situation. Whether any of it applies to you depends on facts this article does not know.