Initially, Taxpayer and spouse started business five years ago in 2015, selling sandwiches out of a truck. Business is treated as a pass-through entity for purposes of state income tax. Business quickly took off and eventually hired additional cooks and drivers to keep up with the ever-increasing profits. Of course, that also meant purchasing additional trucks and portable kitchen equipment. Taxpayer received a notice from the state tax Collector that they have been selected for an audit for their personal income tax.
The bookkeeping was done by spouse. Spouse shows excel worksheets used to keep track of expenses and revenues. The Excel sheets list ingredients purchased, payroll, equipment, and other expenses, but not taxes. Excel worksheets only cover back to Fiscal Year 2019. All records were kept by hand in notebooks prior to June 2018.
Income and expenses from Sandwich shop were included in their jointly filed state individual income tax returns. The client claims to have filed returns for every relevant year. However, copies of returns cannot be found before Fiscal Year 2019. The auditor has stated that they do not have records of any returns filed before FY 2019. The client believes that they had no taxable income after accounting for business expenses for those years.

The auditor has requested all documents, records, and information relating to your client’s income for every year that Sandwich shop was in business. What potential issues do you see in the above facts for the upcoming audit? What advice would you give your clients? How would you respond to the auditor’s request?