Self-Employed With an SFR: Getting Your Business Expenses Back

If you are self-employed and the IRS prepared a substitute for return, look at the income line. Odds are it matches the total of your 1099s. Now look for your expenses. Rent, materials, fuel, equipment, subcontractors, insurance. They are probably not there.

That is not an oversight. It is the rule.

The rule in the IRS manual

IRM 4.12.1.25.2, updated in November 2025, is titled Substitute for Return (SFR), Business Expenses. It says:

And then:

The examiner may consider business expenses only "if the examiner has actual taxpayer information/documentation to support business expense deductions." The same IRM update added a related rule at IRM 4.12.1.25.4: deductions and credits, with the qualified business income deduction named as an example, will not be allowed on an SFR. Individuals still get the standard deduction.

The manual says these updates incorporated a December 2023 interim guidance memorandum on business expenses, deductions, and credits on substitutes for return. In other words, this is the IRS's current, deliberate position.

Why this hurts so much

The Internal Revenue Code allows a deduction for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business" under IRC 162(a). That is how business income is supposed to be measured: revenue minus the cost of earning it.

An SFR built without your records skips the second half. Consider a hypothetical:

The SFR taxes more than twice the real profit in that example. The numbers are illustrative, but the structure is exactly what the manual describes.

It hits self-employment tax too

Self-employment tax is a separate tax on top of income tax. IRC 1401(a) imposes it on self-employment income, and IRC 1402(a) defines net earnings from self-employment as gross income from the business "less the deductions allowed by this subtitle which are attributable to such trade or business."

So expenses do double duty. They reduce income subject to income tax, and they reduce net earnings subject to self-employment tax. When the expenses are missing, both measurements are overstated, and the penalties and interest that are figured as a percentage of tax are overstated along with them.

The one opening the manual gives you

The rule is strict, but it is not hopeless. The manual includes a note that matters for people whose records are gone:

Translated: if you filed in earlier years, those returns showed the expense pattern of your business, your business did not change, and you have a credible reason why the records for the SFR year do not exist, the examiner may take that into account. It is discretionary, and it requires a real explanation. But it is a door.

The real fix: your own return

The manual's rules control what the IRS will do on its own. They do not limit what you can claim on your own return. When you file an original return for an SFR year, you claim your ordinary and necessary business expenses like any other taxpayer, subject to the normal recordkeeping rules.

IRC 6001 requires every person liable for tax to "keep such records... as the Secretary may from time to time prescribe." Your return will be measured against that standard. The returns that sail through reconsideration are the ones with organized support. The ones with large round numbers and no backup tend to get examined. See the SFR reconsideration process.

Where to find expense evidence years later

Most self-employed people have more evidence than they think. Good sources include:

• Business and personal bank statements, which show payments to suppliers, landlords, and subcontractors
• Credit card statements, which often capture fuel, materials, software, and travel
• Vendor account histories, where suppliers still have them
• Forms 1099 you issued to subcontractors, and their invoices
• Vehicle records, such as service logs, registration, and calendars showing job locations
• Lease agreements, utility bills, and insurance policies for business premises
• Prior filed returns showing your historical expense pattern
• Payment app and marketplace reports for prior years, where available

We go deeper on this in rebuilding business expenses for late returns.

When income on the 1099s is wrong

Expenses are only half the problem. Sometimes the 1099s themselves are wrong: duplicates, payments that belonged to a partner or a corporation, or amounts that included reimbursed costs or sales tax. IRC 6201(d) requires the IRS to provide reasonable and probative information beyond the information return when a taxpayer asserts a reasonable dispute about an item of income and has fully cooperated. IRM 4.12.1.25.1 also tells examiners to verify income with third parties when an information return looks out of line with prior years or inconsistent with the taxpayer's known occupation.

The key words are reasonable dispute and full cooperation. Silence is not a dispute. An organized reconciliation of what was reported versus what you actually received is.

What not to do

Do not plug in an industry percentage and call it your expenses. The IRS will not estimate expenses for you on an SFR, and an unsupported estimate on your own return invites examination.

Do not overstate expenses because you think the IRS cannot check. A return signed under penalties of perjury that you know is false is a crime under IRC 7206(1). Turning a filing problem into a false return problem is the worst trade you can make.

Do not wait. Bank and vendor records get harder to obtain as years go by.

Why records matter more for the self-employed

Wage earners have an employer reporting their income and withholding tax every pay period. The self-employed have neither. That is why the IRS's fraud screening for non-filers specifically mentions failing to maintain adequate records and large numbers of cash transactions as potential indicators (IRM 25.1.7.2). Good records are not just about lowering the tax. They are also the clearest proof that a missed filing was a missed filing, and not something worse.

If your recordkeeping fell apart during the unfiled years, fix it now for the current year, even while you are rebuilding the old ones. A clean current year shows the IRS the problem has stopped.

A short plan

1. Pull the wage and income transcript for the SFR year to see every 1099 the IRS used.
2. Reconcile those 1099s to your deposits. Make sure your return reports at least that income, or explains the difference.
3. Build expense totals by category from bank, card, and vendor records.
4. Document anything the records do not show, such as cash purchases, with whatever corroboration exists.
5. Prepare an original return, Schedule C and Schedule SE included.
6. File it as a reconsideration of the SFR, with a brief cover letter.

The IRS's version of your business has revenue and no costs. Nobody's business works that way. Your return is where you prove it.