Reconstitution of Records is Legal in Tax Court
This case shows that in tax court you can use reasonable figures, instead of figures that cannot be correct. You can also reconstruct lost paperwork to substantiate your deductions and business expenses.
Further you can claim a percentage of business expenses and profit for a business enterprise, even if you have no records to substantiate your business expenses. For example, a plumbing subcontractor could claim as expenses 60% of the form 1099s that the IRS received from the contractors.
If one wants to reconstruct expenses and deductions, one invokes the Cohan case [as in "George M.", the entertainer—Cohan v. Commissioner, 39 F.2d 540, 543-544 (2nd Cir. 1930)].
In the '20s Cohan was notorious for pursuing business contacts and contracts and so did much entertaining and traveling...but very little bookkeeping and/or recordkeeping. Consequently, in an early flexing if their muscle, the Board of Tax Appeals (predecessor of today's Tax Court) brought him in for non-payment of enough taxes based upon his earnings, but without consideration of the expenses and deductions for which he had no or poor receipts. Through negotiation and brow-beating, a sort of balance was struck, though the 2nd Circuit Court of Appeals had to make it: Cohan (and future taxpayers AND the Tax Court) could use reasonable reconstructed figures in Tax Court, instead of figures conjured by the IRS that cannot be correct, for expenses.
Click here to read the case in its entirety.