IRS Allowed $977 Million in Dubious Car Loan Interest Deductions

The IRS accepted more than 470,000 e-filed returns for tax year 2025 that claimed $977 million in questionable car loan interest deductions, with an estimated tax effect of $122 million, the Treasury Inspector General for Tax Administration reported on October 20, 2026.

The finding concerns the car loan interest deduction IRS systems were meant to screen at filing. Inspectors found the agency had no timely rule in place to reject returns that failed the criteria, and as of August it had no plan to pursue the claims after processing.

For practitioners, the exposure is on both sides of the filing. Clients who claimed the deduction without meeting the rules may receive notices later, and preparers who filed those returns may be asked what they checked. The $122 million figure is the revenue at risk if the claims are never corrected.

The average questioned claim works out at about $2,080 of deduction and about $260 of tax. That is small per return and large in aggregate.

What TIGTA found on the car loan interest deduction

The report reviewed how the IRS put four new deductions into effect: qualified tips, overtime compensation, passenger vehicle loan interest and a deduction for seniors. All four came from the One Big Beautiful Bill Act, enacted in July 2025, which Republicans have rebranded as the Working Families Tax Cuts.

TIGTA found the IRS was generally successful in implementing the four deductions. It had limited time to issue guidance, update forms and build processing and compliance controls before the 2026 filing season, and it did so after cuts to staffing and budgets.

The car loan interest deduction was the weak point for the IRS. The IRS uses business rules to reject e-filed returns that do not meet required criteria before it accepts them. For this deduction, it did not put such a rule in place in time.

The reason, according to TIGTA, was concern about the legal implications of rejecting otherwise valid returns. A return that is complete on its face can still contain a deduction the taxpayer is not entitled to, and a rejection at the front door risks turning a eligibility question into a filing barrier.

The result was that the questionable claims passed through IRS e-file without a stop. The report does not say how many of the 470,000 returns will prove to be wrong. It describes the claims as questionable, not as confirmed errors.

How the car loan interest deduction rules work

The car loan interest deduction covers up to $10,000 a year on a loan taken out after December 31, 2024, according to the IRS guidance on the Working Families Tax Cuts. It runs from 2025 through 2028 and is open to both itemisers and taxpayers who take the standard deduction.

The loan must be secured by a lien on the vehicle and must finance a personal-use vehicle that the taxpayer was the first to use. Interest on a refinanced qualifying loan is generally eligible. Lease payments do not qualify.

The vehicle must be a car, minivan, van, sport utility vehicle, pickup truck or motorcycle with a gross vehicle weight rating under 14,000 pounds. Final assembly must have taken place in the United States. Taxpayers can check the assembly location on the dealer label, in the vehicle identification number or with the National Highway Traffic Safety Administration’s VIN decoder.

The deduction phases out above $100,000 of modified adjusted gross income, or $200,000 for joint filers. The taxpayer must put the VIN on the return for every year the deduction is claimed.

Lenders carry a separate duty. They must file information returns with the IRS and give borrowers a statement of the interest received. Treasury and the IRS issued proposed regulations on December 31, 2025 that set out which recipients must report, when, and what the form must contain. The IRS earlier gave lenders transition relief for 2025.

Why the IRS did not reject the returns

Each condition above is a candidate for an automated check at filing. The VIN is a field on the return. The income thresholds can be tested against the adjusted gross income already on it. The $10,000 cap is a number.

The report says the IRS did not apply a business rule in time, and cites legal concern over rejecting otherwise valid returns. The source material does not say which of those checks TIGTA wanted applied, and it does not say how many of the 470,000 returns failed on the VIN, the income limit or the cap.

The IRS disagreed with two of TIGTA’s four recommendations, both about which business rules to use for checking the car loan interest deduction. It also disagreed with the report’s assertion on the overtime deduction.

The agency’s view is that it has limited jurisdiction over guidance on the Fair Labor Standards Act, which sets the overtime exemptions. Kenneth Corbin, chief of the Taxpayer Services Division at the IRS, set out that position in the agency’s written response.

“The IRS and the Office of Chief Counsel repeatedly informed TIGTA throughout the course of the audit that the IRS does not have jurisdiction over the FLSA and was therefore limited in the guidance it could provide.”

Kenneth Corbin, Chief, Taxpayer Services Division, IRS

Corbin wrote that both Notice 2025-69 and the January 23, 2026, frequently asked questions directed taxpayers to Department of Labor materials. After coordination with Treasury, the Department of Labor and the Office of Personnel Management, the IRS updated the FAQs on August 6, 2026.

What the IRS will do about the claims

The IRS agreed with the recommendation to develop a post-processing compliance plan to address potentially improper claims. As of August, it had not established one, which TIGTA said raised the risk that improper claims would go undetected or uncorrected.

The IRS has not published the plan. Nothing in the report as summarised sets out a timetable, the notice programme or the method for recovering money from returns already processed. Whether affected taxpayers will receive correction notices, and how soon, is not yet known.

The report also covers the overtime deduction. TIGTA found that the IRS’s initial guidance did not adequately explain exemptions under the Fair Labor Standards Act, which raised the risk that taxpayers would misjudge their eligibility. The IRS addressed that recommendation by adding guidance to its FAQs.

That matters to payroll teams as well as tax preparers. Employers and bureaus that handle payroll year-end reporting will be the first place clients turn when they question an overtime figure on a W-2.

What preparers should check on the car loan interest deduction

With no published enforcement plan, the safest assumption for practices is that the IRS will review car loan interest deduction claims after the fact. The deduction depends on four documents or facts that a file should already hold: the lender’s interest statement, the VIN, the assembly location and the taxpayer’s income.

Firms that claimed the deduction for clients in the 2026 season can test their own files against that list. The questions are the same as those in the rules above. Was the loan taken out after December 31, 2024? Was the vehicle new, assembled in the United States and bought for personal use? Did the client’s income put them inside the phase-out?

A written review step is worth having for any deduction that is new and that the IRS has not yet tested. An internal controls register gives a firm a place to record the check, who performed it and what evidence was kept.

The TIGTA finding is a reminder that acceptance by e-file is not approval of a claim. The IRS accepted the returns because no rule stopped them, not because it had validated the deduction.

The next facts to watch are the IRS’s post-processing compliance plan, which it has agreed to develop but has not yet described, and its response on the business rules for tax year 2026 returns, when the 2027 filing season opens.