Tax Article - Check 21 – Proving Tax Deductions Without Cancelled Checks

The Check Clearing for the 21st Century Act (Check 21) became effective on October 28, 2004. The bottom line on what this means for most consumers is that in time you won’t be seeing any of your checks ever again after you send them off as payment. Instead, Check 21 allows your bank to truncate each of your checks and create a new electronic negotiable instrument called a substitute check. After doing this, your bank generally will be allowed to destroy your original check as long as it has updated its "customer agreement" to do so.

How does Check 21 change the way I am able to prove an expense to the IRS to be entitled to a tax deduction or credit?

The short answer is that, for most taxpayers, Check 21 means you will need to keep your past bank statements in good order. The IRS reports it will accept bank statements that contain images of cancelled checks and/or substitute checks. To be used as proof, an account statement must show the check number, amount, payee’s name, and the date the check was posted. A check image isn’t required if the account statement itself includes all of these items.

To keep track of your payments more easily for tax purposes, you should also maintain a careful check register. That way, you’ll know where to look if audited.

Important Details

If you receive canceled checks with your account statement, Check 21 for the time being will mean that you might begin to receive a mixture of canceled original and substitute checks. If you receive image statements (pictures of several checks on a single page), you also may notice that some of the pictures are of substitute checks.

Check 21 says you can use a substitute check as proof of payment because it is legally the same as the original check. The IRS, therefore, must accept your substitute check as proof of payment.

The IRS has indicated that it generally will accept image statements of substitute checks as proof of payment. However, as has been IRS policy for image statements of canceled original checks, if an IRS auditor is suspicious that the image statement is not genuine, you may be requested to order the actual substitute check from your bank. This should be rare, however, and only if you are audited. Your record keeping obligations under the tax law are satisfied in the meantime by keeping your bank statements.

Of course, dealing with bank statements instead of canceled checks is not as easy. Instead of separating your cancelled checks that involve a tax-return matter in a neat pile each month, you will need to devise other ways of keeping track. Some people circle tax-related payments in their check register, then review the entire register for the year at tax time (while making sure they have all bank statements in one place, too). Others circle tax items directly on their monthly bank statement; still others record tax payments in a separate notepad or computer file.

Online Banking

As a precaution, it is suggested that you download and print out your bank statements at the end of the year. That way, even if audited several years from now, you’ll have a record that is easy to access.

Please contact Feeley & Driscoll's international tax experts by Email or call us at 1 (888) 875-9770.

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