The Cohan Rule: Can a Taxpayer Estimate His Deductible Expenses?

The Cohan Rule: Can a Taxpayer Estimate His Deductible Expenses?

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Anyone who has filed a tax return has probably heard the axiom “if you don’t have records, the IRS will disallow the expense.” 

But is it accurate?

George M. Cohan was a 1920’s vaudevillian who is probably most known to modern audiences as the man who wrote the song “I’m a Yankee Doodle Dandy.” But to us tax attorneys, Mr. Cohan is better known for being the plaintiff in one of the most famous and enduring tax cases in American history.

Mr. Cohan was audited and unable to produce receipts that showed the actual amount he spent for certain business expenses. The IRS said if you can’t prove how much you spent, you don’t get the deduction.

So Cohan tapped dance to Court . . . and he won.

In short, the Cohan Rule, as it has come to be known, stands for the proposition that taxpayers may use estimates when they can show that there is some factual foundation on which to base a reasonable approximation of the expense (i.e., when they can prove that they had made a deductible expenditure but just cannot prove how much that expenditure was). But remember, if you rely on Cohan (which means your records are incomplete) expect the IRS to put up a fight as to the proper amount of the allowable expense.

Here is what then Circuit Court Judge Learned Hand said in an opinion that has been part of our common law for more than three quarters of a century:

In the production of his plays Cohan was obliged to be free-handed in entertaining actors, employees, and, as he naively adds dramatic critics. He had also to travel much, at times with his attorney. These expenses amounted to substantial sums, but he kept no account and probably could not have done so. At the trial before the Board he estimated that he had spent eleven thousand dollars in this fashion during the first six months of 1921, twenty-two thousand dollars, between July first, 1921 and June thirtieth, 1922, and as much for his following fiscal year, fifty-five thousand dollars in all. The Board refused to allow him any part of this, on the ground that it was impossible to tell how much he had in fact spent, in the absence of any items or details. The question is how far this refusal is justified, in view of the finding that he had spent much and that the sums were allowable expenses. Absolute certainty in such matters is usually impossible and is not necessary; the Board should make as close an approximation as it can, bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making. But to allow nothing at all appears to us inconsistent with saying that something was spent. True, we do not know how many trips Cohan made, nor how large his entertainments were; yet there was obviously some basis for computation, if necessary by drawing upon the Board’s personal estimates of the minimum of such expenses. The amount may be trivial and unsatisfactory, but there was basis for some allowance, and it was wrong to refuse any, even though it were the travelling expenses of a single trip. It is not fatal that the result will inevitably be speculative; many important decisions must be such. We think that the Board was in error as to this and must reconsider the evidence.

Here’s the Cohan opinion in its entirety Cohan vs. Commissioner, 39 F. 2d 540 (2d Cir. 1930).

Also, Section 274(d) of the tax code requires substantiation for travel, entertainment and gift expenditures only, thus, by inference allowing the estimation of other categories of business expense.

By the way, here are the scintillating lyrics to Yankee Doodle Dandy:

I’m a Yankee Doodle Dandy
A Yankee Doodle, do or die
A real live nephew of my Uncle Sam
Born on the Fourth of July

I’ve got a Yankee Doodle sweetheart
She’s my Yankee Doodle joy
Yankee Doodle came to London
Just to ride the ponies
I am the Yankee Doodle Boy

No wonder they audited him.

About Peter Pappas

Peter is a tax attorney and certified public acccountant with over 20 years experience helping taxpayers resolve their IRS and state tax problems.

He has represented thousands of taxpayers who have been experiencing difficulty dealing with the Internal Revenue Service or State tax officials.

He is a member of the American Association of Attorney-Certified Public Accountants, the Florida Bar Association and The Florida Institute of Certified Public Accountants and is admitted to practice before the United States Tax Court, the United States Supreme Court, U.S. District Courts - Middle District of Florida

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Comments

  1. Richard Otier says:

    Reaffirmed by 5th Circuit of Appeals 2009 TNT 109-15

  2. Richard,

    Thanks for visiting and thanks for the update.

  3. In April 2012 the IRS had us fill out a form justifying our 2009 tax returns which we owed additional taxs and paid. July 18, 2012 they said we owe $ 3,500 because our business expenses were disallowed. We have submitted business expenses since 1993 when we began consulting with subcontractors & they were all legitimate. Guess Obama is again redistributing the wealth. Wall Street Journal said that 2009 tax returns were the lowest in years and needed to recoup them. We are now retired ( 2010 ) and our kids used our nest egg and we do not have the money to pay right now. Amazing that there are 1,000’s in Wash DC who owe back taxes of $ 1.8 billion dollars and they are again trying to hose the middle class American. Geeze, Charlie Rangel is still going strong and so is Tim Geither.