Most business owners don’t have perfect records
You run a business. You’re managing clients, handling employees, putting out fires. Keeping a receipt for every lunch you bought during a client meeting last March is not top of mind.
Then you get an audit notice. And the first thing the IRS asks for is documentation for every deduction on your return.
This is where a lot of people panic unnecessarily — and where others make costly mistakes because they don’t understand what the IRS will and won’t accept.
There’s a legal doctrine that protects you. Partially.
The Cohan Rule comes from a 1930 Second Circuit case — Cohan v. Commissioner, involving Broadway producer George M. Cohan. The court held that when a taxpayer can prove an expense definitely occurred, the IRS cannot disallow it entirely just because the exact amount isn’t documented. The IRS has to allow a reasonable estimate.
What that means in practice: if you can show an expense happened — through an email, a calendar entry, a bank statement, a vendor record — the IRS generally cannot zero it out. They may challenge the amount, but they have to acknowledge the expense existed.
This is not a license to make things up. There has to be some corroborating evidence that the expenditure actually took place. But it means missing receipts are not automatically fatal to a deduction.
The exceptions that matter most
Congress carved out specific expense categories where the Cohan Rule doesn’t apply at all. For these, estimates aren’t enough — you need actual documentation.
Vehicles. The IRS wants a mileage log: dates, destinations, business purpose, and miles. No log, no deduction. The Cohan Rule does not apply to vehicle expenses — this is one of the clearest rules in the tax code. I’ve seen clients lose $15,000 or more in vehicle deductions because they kept no contemporaneous log.
Business meals. Even at 100% deductibility in 2026, you still need documentation: the date, the amount, the place, the business purpose, and who was there. Without those specifics, the deduction is disallowed.
Business gifts. The $25-per-person limit requires strict documentation — amount, date, recipient, and business purpose.
If you’re planning to rely on the Cohan Rule, confirm it actually applies to what you’re claiming. For anything vehicle-related, it doesn’t.
How the IRS reconstructs your income when records are missing
Here’s what most people don’t know: when records are incomplete, the IRS has established methods for figuring out what they believe your actual income was — and they use them.
The Bank Deposits Method. The IRS totals every deposit into every account — business and personal — over the audit period. They subtract documented non-income items: transfers between your own accounts, loans received, insurance proceeds, gifts. Everything left over is treated as taxable income. If your deposits are $300,000 but you reported $180,000 in income, you have a significant problem to explain.
The Net Worth Method. They compare your net worth at the start of the year to the end. If your net worth grew by $200,000 and you reported $80,000 in income, the IRS’s position is that you earned the difference and didn’t report it.
These methods are most common when the IRS suspects underreported income — not just a few missing receipts. But they can produce alarming numbers, particularly if you had large deposits that were legitimately non-taxable (a business loan, an insurance settlement, an inheritance) but you can’t document them clearly.
If you've received an audit notice and you're worried about your documentation, the single worst thing you can do is respond to the IRS on your own. Get a professional involved before you send anything.
What to do when you’re missing records
If you’re already in an audit and documentation is incomplete, here’s the practical path:
Start with bank and credit card statements. They show what you actually paid and when. Many deductions can be reconstructed from these alone — vendor names, transaction dates, amounts. The IRS accepts bank statements as supporting documentation for most business expenses.
Look at your email. Vendor confirmations, invoices, travel bookings, client meeting confirmations — your inbox is often more useful than you’d expect.
Contact vendors directly. If you paid a contractor $25,000 and can’t find the invoice, ask them to reissue it. Most will.
For vehicle deductions, use calendar entries and location history to reconstruct. Not perfect, but it demonstrates good faith and gives the auditor something concrete to evaluate.
Don’t inflate your reconstruction. If you can substantiate $45,000 of the $55,000 you claimed, fight hard for the $45,000. Overstating your reconstruction and getting caught on it creates a credibility problem that follows you through the rest of the audit.
The accuracy-related penalty
Missing documentation doesn’t just cost you the deduction. If the IRS determines there was a substantial understatement of tax — defined as more than 10% of your correct tax liability or $5,000, whichever is greater — they add a 20% accuracy-related penalty on top of the taxes owed.
On a $40,000 deficiency, that’s $8,000 in penalty, plus interest that compounds from the original due date.
There are arguments that can reduce or eliminate this penalty — reasonable cause, good faith reliance on professional advice. But the cleanest way to avoid it is documentation from the start.
What actually keeps you out of trouble
The businesses that win audits are the ones with clean, organized records going in — not the ones with the best explanation after the fact. Separate business and personal bank accounts. Categorize expenses in real time. Keep receipts digitally. A photo with your phone is fine — the IRS accepts digital images.
For the categories where strict substantiation is required — vehicle use, meals, gifts — keep a log. Five minutes a day. An audit notice three years later takes months.
Good records are the foundation of everything else. If your books are behind or your documentation isn't where it needs to be, let's get ahead of it — before the IRS asks.
See also:
- Running Your Business Through a Personal Account? That’s the First Thing an Auditor Looks For
- Viral Tax “Hacks” That Quietly Trigger Audits
- You Got a CP2000 From the IRS. Don’t Panic — and Don’t Just Pay It.
This content is for general informational purposes only and does not constitute legal or tax advice. Tax rules are complex and change frequently. Consult a qualified tax professional before acting on this information. Geiger Tax & Accounting serves clients in New York and nationwide.