IS THERE LIFE LEFT IN THE COHAN RULE?
For income tax purposes, taxpayers are required to maintain permanent books of account and records sufficient to sufficient to establish the amount of gross income, deductions, credits, or other matters reported to the IRS (Treas.Regs. §1.6001-1(a)). Some taxpayers are less fastidious than others in maintaining adequate books and records, so the question often comes up whether a given level of record and bookkeeping will be sufficient to uphold a deduction.
In 1930, it was held that a famous actor, playwright and producer could deduct entertainment expenses based on estimated expenses, rather than having to produce detailed records of each expenditure. The holding in this case became known as the "Cohan Rule" - that is, that if a taxpayer can substantiate that a legitimate deduction was incurred, courts will be willing to use the documentation available to estimate the deductible amount.
In opposition to the Cohan Rule, Congress by statute does require more detailed receipts and records for certain types of expenses before a deduction will be allowed. These expenses include travel and entertainment expenses, business gifts, deductions relating to listed property (certain types of property that are prone to taxpayer abuse, such as autos, computers, cell phones, and property used for entertainment), and charitable contributions.
In a recent article in Practical Tax Strategies, Paul G. Schloemer conducted a survey of tax cases where the Cohan Rule was invoked, to see if the rule still has viability today. Happily, he reports that the rule is alive and well.
Of course, all invocations of the Cohan Rule will not result in deductibility. Mr. Schloemer notes that there are two key variables that courts will look for in allowing a taxpayer to rely on the Cohan Rule. The first is that SOME documentation will be needed - oral testimony alone probably will not cut it. The second variable is the veracity of the taxpayer's testimony, since the court will need to have some level of trust in the taxpayer's assertions before it will allow deductions under the rule.
Schloemer, Paul G., Cohen Rule Still Secures Some Deductions Despite Statutory Limits, Practical Tax Strategies (WG&L)