Can you even remember the last time a bank sent back your cancelled checks? That’s because banking law known as the Check 21 Act went into effect late 2004. This allowed bank to provide their checking account customers bank statements that include either the original cancelled check, or a “substitute check”, “or by agreement, information relating to the original check…with or without subsequent delivery of the original paper check”.
The Act was a boon for banks, as they could now process more checks quicker and cheaper. When a paper check is deposited or cashed, the bank takes an electronic picture of the front and back of the document. The banks are then generally allowed to destroy the original check. What you now get back is either a scanned copy of the check, or, if part of your customer agreement, just data taken from the magnetic ink line at the bottom of the original check (i.e. no copy at all).
Banking customers didn’t seem to mind the new policy: less paper to deal with! It all seems good – until the IRS conducts an examination and asks for a cancelled check to prove an expense deduction. The IRS will usually accept a copy of the cancelled check from the bank statement – assuming you held on to your past bank statements! But if you can’t produce the check or the IRS examiner suspects the validity of the copy you supply, you will have to order a substitute copy of the check from the bank. We’ve seen those bank charges for check copies get very, very costly.
So what should you do to prepare for the possibility of an IRS inquiry? The easiest (but granted, time consuming) suggestion is to get online access to your bank statements, then download and save electronic copies of monthly statements and checks as a backup. If the bank doesn’t include scanned cancelled check copies in the bank statement, you can most likely access recent activity online, click on each cancelled check, and save a copy of each check on your computer. You would have to be very diligent, as banks keep customer detail activity online for a limited period of time.
This situation can cause an added headache with audits, as most IRS inquiries occur 1-2 years after a tax return is filed – long after most taxpayers have easy access to their banking records. In addition, with bank mergers as a way of life in the United States, taxpayers will have an even harder time getting prior bank records.
Gary Kaplan has experience dealing with the IRS on a vast range of issues, including producing adequate documentation. It will be more important than ever to be working with a tax professional. Give us a call today.
