The Cohan Rule Will Not Save You If You Bring No Records

The Cohan Rule Will Not Save You If You Bring No Records

When the IRS challenges your Schedule C deductions, many owners assume the Tax Court will "ballpark" something if they show they were in business. That hope rests on a nearly century-old idea called the Cohan rule. A recent Summary Opinion shows how thin that hope is when you walk into court with nothing behind the numbers.

If you run a sole proprietorship or other Schedule C activity, the practical question is simple: can you prove what you spent, for what business purpose, and when? If the answer is no, guessing in court is rarely a backup plan.

What the Cohan Rule Actually Does

Ordinary and necessary business costs are deductible under section 162, but you have to prove them. Section 6001 and the related regulations expect you to keep books and records that support the amounts on your return.

In Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930), the Second Circuit faced a taxpayer who clearly spent money promoting his work but kept almost no detail. The court said absolute certainty is not required. If the record shows that deductible costs were incurred, a court may estimate an amount, even while weighing the estimate against the taxpayer who created the mess. Later Tax Court cases add an important limit: there must be some basis for the estimate. A blank slate is not enough.

Think of Cohan as a narrow safety net for incomplete proof, not a license to invent numbers. You still need evidence that a deductible expense happened and a foothold for approximating how much.

Where Cohan Stops: Section 274(d)

Congress later carved out categories where estimates are off the table. Under section 274(d) and the substantiation regulations, certain items require strict proof. You generally must show, with adequate records or other corroborating evidence:

• Travel away from home
• Business gifts
• Listed property, including passenger automobiles
• Entertainment and certain meal expenses that still require careful documentation under section 274

For a vehicle, that usually means the amount of each expense, business miles, total miles, the date of each business use, and the business purpose. A mileage log kept close in time to the trips, plus receipts or similar documents, carries far more weight than a story told years later. For travel meals, the amount, time and place, and business purpose matter.

On these items, the regulations expressly say Cohan-style approximations and unsupported testimony do not get you a deduction. Even for expenses that can still be estimated, you need a factual peg. No peg, no estimate.

How Lance Stevens Lost Every Schedule C Deduction

In Stevens v. Commissioner, T.C. Summary Opinion 2026-10 (Docket No. 10807-25S, filed November 2, 2026), Special Trial Judge Leyden decided a 2023 Schedule C dispute under the small-case procedures of section 7463. Summary Opinions are not precedent and are not appealable, but the reasoning tracks long-standing rules and is a clear warning for small business owners.

The petitioner lived in New Hampshire and ran an appliance repair business. On his 2023 return he reported $64,000 of Schedule C gross receipts and $24,775 of business deductions, including car and truck costs, insurance, office expenses, meals, utilities, and credit card processing charges. He also reported more than 22,000 vehicle miles. After a correspondence exam, the IRS issued a Notice of Deficiency dated April 21, 2025, disallowing the Schedule C deductions (and initially proposing other adjustments). He petitioned the Tax Court.

By trial, the Commissioner conceded that the $64,000 of gross receipts was correct. What remained were the expense deductions and an accuracy-related penalty. The parties filed no stipulation of facts. The petitioner introduced no exhibits about the expenses and gave no testimony explaining them. His focus at trial was on process complaints, including that he had not been told to bring documentation.

The Court walked through both pathways. For insurance, office, utilities, and processing charges, Cohan might have helped if there had been any basis to estimate. For passenger automobile costs, section 274(d) required strict substantiation. For meals, the Court noted it could not even tell which standard applied, because there was no evidence either way. Under either standard, he failed. The Court disallowed all of the contested Schedule C deductions.

Separately, the Court upheld the section 6662(a) accuracy-related penalty of $1,327.20 from the Notice of Deficiency after finding written supervisory approval. It declined an extra penalty amount the Commissioner asserted later, because that increase lacked the required supervisory approval. The expense holding, though, is the lesson for day-to-day operators: without records or even a narrative that gives the Court something to work with, Cohan never gets off the ground.

Recordkeeping Habits That Hold Up

You do not need a complicated system. You need a habit that creates a trail while the year is still open:

1. Separate business money. Use a dedicated business checking account and card. Mixing household and business spending makes every audit harder.
2. Capture the "why" when you spend. On receipts, calendar notes, or your bookkeeping app, record the business purpose the same day. "Lunch" is not a purpose. "Discussed repair bid with supplier" is.
3. Keep a real mileage log. For each business trip, note the date, miles, destination, and purpose. Apps are fine if they store the required elements. Year-end reconstructions are weak, especially for vehicles under section 274(d).
4. Match categories to documents. Insurance policies and invoices, utility bills for the business location or documented home-office allocation, merchant processor statements, and office supply receipts should line up with the lines on Schedule C.
5. Store documents where you can find them. Cloud folders by year and category beat a shoebox. Keep returns, bank statements, and key invoices for at least three years after filing, and longer when carryovers or other issues apply.
6. Reconcile monthly. Short monthly reviews catch missing receipts while you still remember the transaction.
7. Do not treat Cohan as Plan A. If an exam starts, gather what you have early. Going to trial with only objections to the process, and no expense proof, is how every deduction disappears.

If your books are thin for a prior year, start cleaning the current year immediately and talk with your advisor about what can still be reconstructed with bank records, calendars, and third-party statements. Reconstruction is harder than contemporaneous logging, but it is better than silence.

Key Takeaways

• Cohan lets a court estimate some business expenses only when the record shows costs were incurred and supplies a basis for the estimate.
• Section 274(d) blocks Cohan-style estimates for travel, gifts, listed property such as passenger vehicles, and related items that demand strict substantiation.
• In Stevens (T.C. Summary Opinion 2026-10), the petitioner contested disallowed Schedule C deductions but offered no expense exhibits or explanatory testimony, so the Court could not estimate and disallowed the deductions in full.
• Mileage, meals, and vehicle costs are especially unforgiving without contemporaneous detail.
• Good records are cheaper than litigation. Separate accounts, dated purpose notes, mileage logs, and organized invoices are the real defense.

If you are unsure whether your Schedule C support would survive an exam, schedule a consultation with SMB CPA Group or reach us through our contact page. We can review how your expenses are documented and help you tighten the process before the next filing season. For engagement options, see our pricing page. Owners thinking about entity structure after a Schedule C exam may also find our posts on S corporation benefits and who really earns S corporation income useful.

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