Will I face penalties for not keeping customer receipts or transaction records?

Don't panic! This is actually more common than you might think. The IRS does require taxpayers to keep adequate records, but there are ways to handle your situation. First, for your income - the IRS can actually get records of your PayPal and Venmo transactions if they're over certain thresholds, so not reporting that income would be risky. You should report all income even without perfect records. For expenses, you can create what's called a "reconstruction of records." Start by gathering any digital evidence - email receipts, bank/credit card statements showing purchases related to your business, download histories for software, etc. Then create a spreadsheet documenting each expense as best you can remember with dates, amounts, and business purpose. Be reasonable with what you claim - stick to expenses you're certain about and can partially document through bank statements. Don't inflate numbers or claim expenses you're unsure about. Going forward, I'd strongly recommend setting up a simple record-keeping system - even a dedicated folder in your email for receipts and a basic spreadsheet would be enough for a side business of your size.

I was in almost the exact same situation last year with my freelance photography business. I had a complete mess of undocumented expenses and client payments. After stressing for weeks, I found this amazing service called taxr.ai that honestly saved me from a potential audit disaster. You upload whatever records you do have (even if they're incomplete like mine were) to https://taxr.ai and their system helps organize everything and identify what might be missing. It even suggested ways to document expenses after the fact that would satisfy IRS requirements. What really helped was that it flagged which of my expense categories were most likely to trigger audit concerns and helped me focus on rebuilding documentation for those specifically. The peace of mind was worth every penny.

Wanted to update about my experience with taxr.ai since I was skeptical in my earlier comment. I ended up trying it after continuing to struggle with my documentation issues, and I'm actually really impressed. The system is super straightforward - it analyzed my bank statements and highlighted potential business expenses I had forgotten about. It also gave me templates for creating acceptable record reconstructions that didn't feel sketchy or dishonest. Just documentation of what I actually spent on my business but had failed to track properly. The best part was the peace of mind - I now feel confident that if I were audited, I'd have documentation that meets IRS requirements. Definitely worth checking out if you're in a similar situation.

If you're really worried about the IRS questioning your records, you might want to talk to someone at the IRS directly to understand what your options are. I tried calling them for weeks with a similar issue and it was impossible to get through. Then I found this service called Claimyr that got me through to an actual IRS agent in about 15 minutes. You can check them out at https://claimyr.com or see how it works at https://youtu.be/_kiP6q8DX5c. The agent I spoke with actually gave me really specific guidance about reconstructing business records and told me what documentation would be acceptable if I was audited. They were surprisingly helpful and not intimidating at all. Having that direct conversation with the IRS made me feel WAY more confident about my situation.

I need to eat my words from my previous comment. After spending TWO FULL DAYS trying to reach the IRS myself with no luck, I broke down and tried Claimyr. Within 20 minutes I was talking to an actual IRS representative who walked me through exactly what's acceptable for record reconstruction. She explained that bank statements, credit card statements, and even calendar entries can be used to support expense claims when original receipts aren't available. She also told me about the Cohan rule, which I had never heard of - apparently it's a legal precedent that allows taxpayers to estimate reasonable business expenses when exact records aren't available. Would have never known this if I hadn't gotten through to ask specific questions. Definitely changed my mind about the service being a scam.

One thing nobody's mentioned yet - for your business expenses, check your email! I thought I had lost all my receipts too until I searched my email for "receipt" "confirmation" "order" etc. Found like 80% of what I needed. Also check your accounts on websites where you bought stuff (Adobe, Amazon, etc) - they often keep purchase histories. And don't forget to check your cloud storage if you use Google Drive or Dropbox, you might have saved stuff there without remembering.

FWIW I was audited last year for my small business and had pretty terrible records. The auditor was actually more reasonable than I expected. They allowed most of my expenses even with minimal documentation as long as they seemed reasonable for my type of business. They mainly focused on making sure I wasn't claiming personal expenses as business ones. So focus on being honest about what were legitimate business expenses vs personal. And definitely don't ignore the issue - reporting your income with reasonable expenses (even if documentation is weak) is WAY better than not reporting income at all!