The Cohan Rule: Estimating Deductions When Records Are Missing

Missing records are the most common problem I see in audits. Not fraud. Not aggressive positions. Just paper that no longer exists. The good news is that the law has dealt with this problem for almost a century.

What Cohan actually held

George M. Cohan was a Broadway producer. In the course of his business he spent heavily entertaining actors, employees and, as the court put it, dramatic critics, and he traveled a great deal. He kept no account of these expenses. Before the Board of Tax Appeals he estimated what he had spent, and the Board allowed nothing because it could not tell how much he had actually spent.

The Second Circuit reversed on that point in Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930). Judge Learned Hand wrote that absolute certainty in such matters is usually impossible and is not necessary, and that 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." To allow nothing at all, the court said, was inconsistent with finding that something was spent. The case was sent back to make some allowance.

Read that holding carefully, because both halves matter:

• The fact of the expense must be established. The court started from a finding that Cohan had spent substantial sums on allowable expenses. Cohan does not create a deduction from nothing.
• The estimate can be harsh. The court expressly allowed the decision-maker to bear heavily against the taxpayer whose lack of records caused the problem. Expect a conservative number, not your best guess.
• There must be some basis for computing it. The opinion noted there was obviously some basis for computation. Your job is to supply one.

Where Cohan does not apply: section 274(d)

Here is the part most people miss. For certain expenses, Congress overruled Cohan.

IRC 274(d) denies a deduction for traveling expenses (including meals and lodging while away from home), gifts and listed property, such as vehicles, unless you substantiate them by adequate records or by sufficient evidence corroborating your own statement. The regulation says it directly: this limitation "supersedes the doctrine found in Cohan v. Commissioner," and section 274(d) "contemplates that no deduction or credit shall be allowed a taxpayer on the basis of such approximations or unsupported testimony of the taxpayer" (Treas. Reg. 1.274-5T(a)).

So if the missing records are for travel, gifts or a vehicle, a Cohan estimate is not available. You need the stricter proof described in section 274(d) substantiation. There is one important safety valve inside 274(d): where records were lost through circumstances beyond your control, such as fire, flood or other casualty, Treas. Reg. 1.274-5T(c)(5) gives you a right to substantiate by reasonable reconstruction.

Which expenses can be estimated

For ordinary business expenses outside section 274(d), such as supplies, utilities, repairs, contract labor and many operating costs, the Cohan principle remains the framework. That does not mean an examiner will accept any estimate. It means a credible, documented estimate is worth presenting.

Remember the baseline obligation too. IRC 6001 and Treas. Reg. 1.6001-1 require records sufficient to establish your deductions. Cohan is a fallback when that obligation was not fully met, not a substitute for it. See IRC 6001 recordkeeping.

How to rebuild a record the right way

A good reconstruction looks like an accountant built it, because ideally one did. Here is the process.

1. Start with what still exists. Bank statements, credit card statements and canceled check images are almost always recoverable from the institution. They prove payment, date and payee.
2. Go to the other side of the transaction. Vendors, suppliers, landlords and utilities keep account histories. Ask for a statement of account for the year. Payment platforms keep transaction histories too.
3. Use your own systems. Email confirmations, online order histories, calendars, invoices you sent to customers and contracts all fill gaps.
4. Build the schedule. A spreadsheet listing each expense: date, payee, amount, business purpose and the source document that supports it.
5. Explain the gaps. Where you are estimating, explain the method. "Average monthly fuel purchases for the documented months, applied to the two months for which statements were unavailable" is a basis. "About $5,000" is not.
6. Document why the originals are gone. Insurance claims, disaster declarations, moving records or a statement from a former bookkeeper. If the loss was a casualty, this matters even more because of the 274(d) reconstruction rule.

Common expenses and the best substitute evidence

Expense	If the receipt is gone, look for
Supplies and materials	Card and bank statements, vendor account histories, online order histories
Rent and utilities	Lease, landlord ledger, utility account history, bank drafts
Contract labor	Forms 1099 you filed, invoices from the workers, payment app records
Repairs and maintenance	Vendor invoices on request, warranty records, before and after photos
Professional fees	Engagement letters, billing statements from the firm
Phone and internet	Carrier account history, with an allocation for business use

Notice what is missing from that table: travel, gifts and vehicles. Those are 274(d) items, and they need the stricter proof described above.

One more practical point. Third parties often charge for or delay copies of old records. Start requesting them the day the audit letter arrives, not the week before the appointment. If they will not arrive in time, tell the examiner what you requested, from whom and when.

How examiners see reconstructions

The 274(d) regulation states a principle that is useful far beyond travel and vehicles: written evidence has considerably more probative value than oral evidence alone, and its value is greater the closer in time it relates to the expense (Treas. Reg. 1.274-5T(c)(1)). Examiners think the same way about any reconstruction.

So lead with third-party documents created at the time, then your own contemporaneous documents, then the reconstructed schedule, then your explanation. A reconstruction built on bank data and vendor statements is persuasive. A reconstruction built on memory is the weakest version of a Cohan argument, and Cohan itself warned that the estimate may bear heavily against you.

Presenting it in the audit

• Respond to the document request honestly: state that the original receipts are unavailable, say why, and provide the reconstruction with its sources.
• Do not overreach. If the reconstruction supports $11,000 and the return claimed $14,000, say so. Credibility on the numbers you can prove is worth more than a fight over the ones you cannot.
• Offer to walk the examiner through the method. A reconstruction the examiner understands is one the examiner can accept.
• Keep your workpapers. If the case goes further, to a manager, to Appeals or to court, you will need to show exactly how every number in the reconstruction was built and where each source came from. Who carries the burden at each stage is covered in burden of proof in an audit.

When the audit is already closed

If deductions were disallowed because you could not produce records, and you have since rebuilt them, that rebuilt record may be exactly the kind of new information that supports audit reconsideration on an unpaid balance.

Lost records are a problem. They are rarely the end of the story. Prove the expense happened, give the examiner a method, and keep travel, gifts and vehicles in their separate, stricter box.