Using the “Cohan Rule” to take record-less deductions

Most taxpayers realize they must keep adequate records in order to substantiate tax deductions and credits. Adequate business records can also be critical for a host of other situations, i.e., insurance losses, wage and hour claims, and civil litigation, to name just a few. The burden of proof to document these expenses and credits is evidentiary – it is the taxpayer’s responsibility, not the IRS.

However, there are occasions when records are unavailable, lost, or destroyed.  Deductions and credits, in spite of this lack of records, can still be taken using what is known as “The Cohan Rule”.

In the late 1920s, a famous Hollywood composer, George M. Cohan, deducted business expenses that he could not document.  The court determined, on appeal, that the expenses were business-related and deductible, but required an approximation as to the amount of the deduction.

Taxpayers attempting to take deductions that lack documentation may still be able to use the “Cohan Rule” but there are a number of hurdles that the taxpayer must overcome in order to convince the IRS or a Court to allow this type of deduction.  When citing the “Cohan Rule”, the taxpayer must provide the following:

  • sufficient evidence as to the relevancy of the expense to the business.
  • the fact that the expense was actually paid.
  • the reasonableness of amount to be deducted.
  • the date(s) of the transaction.
  • the reason for the failure to maintain records.

This determination of allowing “Cohan Rule” deductions is discretionary and not binding on a court.  It is based on facts and circumstances and is not a substitute for adequate recordkeeping.  The reason for the lack of records will be a critical factor that will influence the court.

The taxpayer, for expenses to be allowable under Cohan, must convince the IRS or a Court that the expense actually happened and was reasonable. The underlying existence of the expense must be demonstrated by the taxpayer.  The Cohan Rule only allows for the amount of the expense to be deducted.

There is no substitute for good records.  If you are concerned about your record-keeping procedures, please contact your ShindelRock tax professional.