IRS audit with lost receipts: How the Cohan Rule works
Receiving an audit notice from the Internal Revenue Service when paper receipts have been lost, damaged in a move, or faded to illegibility is a taxpayer's worst scenario.
Many believe that without original receipts, every deduction is automatically forfeit.
While that is the auditor's opening position, federal tax law provides an extraordinary century-old judicial safety valve known as the Cohan Rule.
The origins of the Cohan Rule
In 1930, Broadway legend and theatrical producer George M. Cohan was audited by the IRS. Cohan spent lavish sums entertaining actors, producers, and theater owners in cash across New York and Europe, but kept zero receipts or ledgers.
The Board of Tax Appeals disallowed all of his entertainment and travel deductions.
On appeal, the famous Judge Learned Hand of the Second Circuit Court of Appeals issued a historic ruling (Cohan v. Commissioner, 39 F.2d 540):
"Absolute certainty in such matters is usually impossible and is not required; the Board should make as close an approximation as it can, bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making."
The core principle: If a taxpayer can demonstrate that an ordinary and necessary business expense was actually incurred, the court cannot disallow the deduction completely simply because exact receipts are missing. The IRS must allow a reasonable, credible estimate.
Where the Cohan Rule works today
The Cohan Rule remains active federal common law, applicable to many ordinary Schedule C and business deductions:
- Supplies and materials: If you are a carpenter who completed $80,000 of remodeling projects, the IRS cannot claim you spent $0 on timber, nails, and drywall. Under Cohan, supply costs are reasonably approximated based on project size.
- Utilities and phone bills: If you used home internet or a cell phone for consulting work, utility records and carrier bills substantiate an estimated business percentage.
- Advertising and software costs: Bank records showing monthly recurring payments to Google Ads or Adobe substantiate the deduction even if monthly PDF invoices were not downloaded.
Where Cohan is strictly forbidden: IRC § 274(d)
Because taxpayers frequently abused the Cohan Rule to claim extravagant travel and dining deductions, Congress passed Internal Revenue Code § 274(d) to strictly nullify Cohan for specific categories.
The Cohan Rule does NOT apply to:
- Travel expenses (airfare, hotels, taxis).
- Business meals and entertainment.
- Business gifts.
- Listed property (passenger automobiles, unless using standard mileage).
For any expense governed by § 274(d), no estimates are permitted. If you do not have written contemporaneous substantiation showing amount, time, place, business purpose, and business relationship, the deduction is disallowed 100%.
How to reconstruct records for an IRS auditor
If you are facing an audit without receipts, you must compile secondary proof before invoking Cohan:
- Third-party statements: Contact vendors, utility companies, and software providers for historical ledger reprints.
- Bank & credit card transcripts: Match every cleared charge to client projects or calendar entries.
- Client & vendor affidavits: Written, signed statements from contractors or clients confirming the services rendered and payments made.
- Industry benchmark data: Showing that your supply ratio (e.g. 25% of gross revenue) aligns with IRS Statistics of Income (SOI) benchmarks for your NAICS code.
The best defense: Never rely on court estimates
While the Cohan Rule exists as a safety net, Judge Learned Hand emphasized that courts will "bear heavily upon the taxpayer whose inexactitude is of his own making."
Auditors will slash estimated claims by 30% to 70% if forced to guess. Maintaining digital receipt scans with itemized details ensures 100% deduction preservation without court battles.
Sources
Common questions
What is the Cohan Rule?
The Cohan Rule stems from a landmark 1930 federal appeals court decision (Cohan v. Commissioner) holding that if a taxpayer establishes that an allowable expense was incurred, the IRS or Tax Court must make a reasonable estimate of the deduction even if exact receipts are missing.
Does the Cohan Rule apply to travel, meals, or gifts?
No. Congress explicitly overturned the Cohan Rule for travel, meals, and entertainment when it enacted IRC § 274(d). For these categories, strict substantiation (date, place, amount, business purpose) is mandatory by federal statute.
Can bank statements save an audit under the Cohan Rule?
Yes. Bank statements, vendor affidavits, canceled checks, and industry average benchmarks can be submitted as credible secondary evidence to establish an estimate under Cohan.
Every figure on this page is checked against the ATO's own guidance and linked in the sources above. Last checked . Thresholds change each financial year, so if you are reading this well after that date, confirm the current figures before you rely on them. Terms.
Keep reading
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