Why the IRS disallows deductions

The IRS disallows deductions when a claimed expense fails to meet legal or substantiation requirements. Common reasons include missing receipts, expenses that are partly or wholly personal rather than business, failure to follow specific rules for categories such as home office or meals, or mathematical or classification errors on a return. The burden is usually on the taxpayer to substantiate claimed deductions with adequate records and contemporaneous documentation (see IRS Publication 535, Business Expenses, and Publication 463, Travel, Entertainment, Gift).

Disallowances occur in different contexts:

  • Automated correspondence examinations (e.g., CP2000 or a notice querying a specific line item).
  • Field or office audits where an examiner requests backup documentation.
  • Examination adjustments after an audit that change taxable income and tax owed.

Consequences range from an adjustment and additional tax to interest and penalties if the IRS determines negligence or substantial understatement.

Step-by-step: How to challenge a disallowed deduction

  1. Read the notice carefully and note the deadline
  • Every IRS notice includes instructions about how to respond and the time frame. Deadlines vary: many correspondence notices ask for a response within 30 days (for example, a CP2000 or similar letter), while a Notice of Deficiency gives the taxpayer 90 days to petition U.S. Tax Court (150 days if you are outside the U.S.) (IRS, “Notice of Deficiency” and IRS correspondence guidelines). Always confirm the deadline on the notice you received.
  1. Don’t ignore the notice
  • Ignoring an IRS notice may convert an administrative dispute into a collection action or close off appeal routes. Responding on time preserves your rights.
  1. Gather and organize documentation
  • Collect receipts, invoices, canceled checks, credit-card or bank statements, appointment calendars, contemporaneous mileage logs, client contracts, and emails that show the business purpose. For home office claims include a floor plan, square-footage calculations, and utility bills; for vehicle use, provide a mileage log showing dates, miles, purpose, and destinations.
  1. Prepare a concise response package
  • Create a cover letter that states the item under dispute, summarizes your position, lists enclosed documents, and references the specific page and line of the tax return or the IRS notice number. If you are submitting records electronically, follow the IRS’s instructions for secure uploading.
  1. Submit the response and request clarification if needed
  • Send the documentation using the address or online channel on the notice. If you need more time, ask the examiner or the contact person on the notice for a reasonable extension in writing.
  1. Escalate if the IRS maintains the disallowance
  • If the examiner still disallows after you submit substantiation, you have administrative and judicial options: request an Appeals Office conference (informal conference), request an audit reconsideration in certain circumstances, or, if you received a Notice of Deficiency, petition the U.S. Tax Court within the statutory window (generally 90 days). Each route has pros and cons; Appeals is often faster and less adversarial than litigation. See IRS Office of Appeals guidance for details.

Documentation checklist (what the IRS wants to see)

  • Original receipts or digital copies showing the vendor, date, amount, and business purpose.
  • Bank or credit card statements that corroborate payments.
  • Written business purpose: client names, meeting notes, agendas, or contracts.
  • For travel: itineraries, conference schedules, hotel folios, and meeting confirmations.
  • For vehicle use: contemporaneous mileage log (date, starting point, destination, business miles, business purpose).
  • For home office: square footage of home and office space, method of allocation, utility bills, and a simple sketch of the workspace.

Tip: The IRS accepts electronic records if they meet authenticity and legibility standards—see IRS guidance on electronic records and audit support.

Appeals options and timelines (how disputes are resolved)

  • Informal response/correspondence: If the disputed item is small and clearly documented, a correspondence response may resolve the issue.
  • Audit reconsideration: If you have new evidence after an audit—such as newly discovered receipts—you can request reconsideration. This is not guaranteed but is an established process.
  • IRS Office of Appeals: If you disagree with an examiner’s decision, you can ask for Appeals to review the case. Appeals officers are independent of the audit team and may reach a settlement based on hazards of litigation and the merits of your case (see IRS Office of Appeals).
  • U.S. Tax Court: If you receive a Notice of Deficiency, you generally have 90 days to file a petition in Tax Court (150 days if outside the U.S.). Filing in Tax Court lets you dispute liability before paying the deficiency, but rules and procedures are formal and often require representation.
  • Refund claim in court: If you already paid the tax and want a refund, you generally must file a claim for refund with the IRS (Form 1040X or the applicable amended return) or sue in federal district court after refund claim denial. The statute of limitations for refund claims is generally three years from the date you filed the original return or two years from the date you paid the tax, whichever is later—check IRS Publication 556 and related guidance.

Important: Timelines and procedural steps differ by notice type—always follow the instructions specific to the notice you received.

Common penalties and how they affect a challenge

  • Accuracy-related penalty (20%): Applies to substantial understatement due to negligence or disregard of rules.
  • Civil fraud penalty (up to 75%): Rare but severe; applies when the IRS proves fraud.
  • Failure-to-file and failure-to-pay penalties, plus interest.

If an adjustment is solely due to lack of documentation, a timely, well-documented response often avoids penalties. However, if the IRS finds reckless or intentional misreporting, penalties may apply even if you later substantiate part of the claim.

Real-world examples (how challenges succeed)

  • Home office deduction restored: A self-employed consultant was disallowed a home office deduction during an exam because the taxpayer had not supplied square footage or utility allocations. The taxpayer provided a floor plan, utility bills, and a contemporaneous calendar showing client work at the space; the examiner allowed the deduction in part and negotiated a reasonable allocation.

  • Travel expenses reinstated: A small business owner had travel and meal deductions disallowed because the agent considered the trips personal. The owner supplied itineraries, client emails confirming meetings, and hotel folios. After an informal Appeals conference, the taxpayer recovered most of the disputed amounts.

These outcomes are illustrative; success depends on the quality of evidence and the legal sufficiency of the claimed deduction.

Practical tips to reduce the chance of a disallowance

  • Keep contemporaneous records: record expenses when incurred and maintain a single organized system (digital or paper).
  • Reconcile accounts monthly: ensure expenses recorded in your books match bank and credit-card statements.
  • Understand category rules: some deductions have special rules (e.g., home office uses Form 8829; business meal deductions have different substantiation requirements—consult IRS Publication 463 and Publication 587).
  • Avoid overly aggressive positions without support: a reasonable, documented deduction is more defensible than a large, speculative claim.

For best recordkeeping practices, see our guide: “Top Tax Recordkeeping Practices to Speed Up Refunds and Audits” (internal link: https://finhelp.io/glossary/top-tax-recordkeeping-practices-to-speed-up-refunds-and-audits/).

When to hire a tax professional

Consider professional help when:

  • The disallowed amount is large relative to your means.
  • The IRS alleges fraud, substantial understatement, or willful evasion.
  • You face a formal audit or a Notice of Deficiency and you are considering Tax Court.

A qualified CPA, enrolled agent (EA), or tax attorney can craft persuasive documentation, negotiate with Appeals, and represent you in court. See our article on resolving audit outcomes: “How to Appeal an Unfavorable Audit Determination” (internal link: https://finhelp.io/glossary/how-to-appeal-an-unfavorable-audit-determination/).

Common mistakes to avoid when challenging a disallowance

  • Waiting until the last minute to assemble records.
  • Sending incomplete or irrelevant documents without a clear cover letter or explanation.
  • Assuming electronic uploads will be accepted in an unsupported format—confirm the IRS instructions on the notice.
  • Failing to address both the legal basis and the factual evidence for the deduction.

Resources and authoritative references

For additional practical prep before an audit, see our related glossary entry “How to Prepare for an IRS Audit: Documentation Checklist” (internal link: https://finhelp.io/glossary/how-to-prepare-for-an-irs-audit-documentation-checklist/) and “Understanding Field Audits vs Correspondence Audits” (internal link: https://finhelp.io/glossary/understanding-field-audits-vs-correspondence-audits/).

Final checklist before you mail or upload a response

  • Read the IRS notice and follow its exact instructions.
  • Organize documents with a clear cover letter and an indexed list of enclosures.
  • Retain copies of everything you send and proof of mailing or electronic transmission.
  • If you need more time, request it in writing and explain why.

Professional perspective: In my practice I’ve found that well-organized, contemporaneous documentation resolves many disallowances without penalties. When documentation is thin, early engagement with an experienced tax professional improves outcomes and preserves options for Appeals or Tax Court.

Disclaimer: This article is educational and does not constitute legal or tax advice tailored to your situation. For individualized guidance, consult a qualified tax professional or attorney. The IRS is the authoritative source for tax rules; always confirm deadlines and procedures from IRS notices and publications cited above.