IRS AUDIT, ANYONE?

For as long as I have been providing tax-related solutions, I have seen many cases where taxpayers do not have supporting documentation or the support they have is inadequate. Well, while it is ideal to have supporting documentation for every single item on your tax return, that’s not always practical. For example, natural disasters are a common scenario where information often gets destroyed with potential negative impact on the taxpayer.   

 

Think about this: Between 2010 and mid-2019, major storms and climate-related events caused a total of $761 billion in property damage. Many of the folks affected by those events, I would imagine, were unable to support items on their tax returns. If those tax returns were subject to audit, they may lose some of their deductions.  But, taxpayers running afoul of various tax provisions requiring documentation or just impacted by events beyond their control to support tax deductions may be saved by the “Cohan Rule.” The Cohan Rule stems from a famous court case, “Cohan v. Commissioner, 39 F. 2d 540 (2d Cir. 1930)”. 

 

Who is Cohan?

George M. Cohan began his career as a child, performing with his parents and sister in a vaudeville act known as "The Four Cohans”.

Beginning with Little Johnny Jones in 1904, he wrote, composed, produced, and appeared in more than three dozen Broadway musicals. Cohan wrote more than 50 shows and published more than 300 songs during his lifetime, including the standards "Over There", "Give My Regards to Broadway", "The Yankee Doodle Boy" and "You're a Grand Old Flag”.

Known in the decade before World War I as "the man who owned Broadway", he is considered the father of American musical comedy.


What is the Cohan Rule?

Cohan was audited by the IRS and was told that he was not allowed to deduct many of his business and entertainment related expenses because he did not keep all of the necessary receipts. Mr. Cohan appealed this ruling and the courts actually sided with him, forcing the IRS has to accept estimates of his expenses.

The Cohan Rule is now a law that allows taxpayers to deduct some of their business-related expenses even if the receipts have been lost or misplaced so long as they are reasonable and credible.

How does the Cohan Rule work with the IRS?

Based on the Cohan ruling, the IRS must allow you (a business owner) to deduct some of your business expenses, even if you do not have each and every receipt to back them up. The idea is that you incur expenses as you run your business, which aren’t, can’t or weren’t always documented. Keep in mind, however, that the IRS expects that you to provide credible evidence of these expenses and while you might not have an actual receipt, you can also show pertinent records like calendar notice, canceled checks, or other notes to indicate that you are not fabricating this expense.

While the Cohan Rule allows the taxpayer to deduct some reasonable expenses even without receipts, there is a catch. If you do not have receipts, you may not be reimbursed for the full amount of your expenses. The IRS will only allow you to deduct the least amount of money that you could have possibly spent, not the entire sum.

Can you use the Cohan Rule?

So if you ever find yourself under audit and, either feel like an  auditor is not giving you credit for legitimate deductions or that you do not have documentation to support, the Cohan Rule may be used to appeal the auditor’s position and even allow you to raise this issue in court.
The IRS is not required to grant you these deductions, but it is certainly worth trying. You may find that you end up getting credit for a portion of your deductions. Have questions, concerns or want to discuss your issue?  Make an appointment here!  Or, call toll-free 1-855-254-1892.

 

THE CASE COHAN V. COMMISSIONER

The case of Cohan v. Commissioner, settled in the 2nd Circuit US Court of Appeals on March 3, of 1930, is one of the top ten most cited tax cases in history. Among other matters of little long-term significance, the case addressed deductions for travel and entertainment expenses claimed by actor, songwriter, and playwright Mr. George M. Cohan (Below, shown on the cover of Time magazine) between 1921 and 1923.

The IRS (or the ‘Board’ as it is referred to in the Court’s opinion) attempted to deny all of Cohan’s travel and entertainment expenses due to insufficient accounting and documentation, even though it conceded he had traveled due to the income earned in various cities across the country. The Court disagreed with the Board’s conclusions, and expounded in the following remarks (written by Circuit Judge Learned Hand, at left, who has been quoted more by the Supreme Court than any other lower court.

“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.”

“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.”

Since this case, there have been hundreds of spin-off cases where the Cohan rule has been applied to different circumstances. In one of the more recent cases, Doffin v. Commissioner, 1991, the tax court applied the Cohan rule to gambling loss deductions. In Doffin, the court considered statistical probability based on the gambler’s gaming style to estimate the deductible losses. Doffin has frequently been cited in other cases involving gambling loss deductions.

The IRS will always interpret the application of tax law in a manner adverse to the taxpayer. The burden of defending your rights is yours, and if you choose, ours.

IMPORTANT: We highly recommend readers to reach out to our firm first. Our clients never have to talk to the IRS, and tax resolution through our firm can save you money and time in the long run. You might also be eligible for other relief programs or get your penalties and interest forgiven. Reach out to our firm today for a consultation.  Click to make an appointment! Or call Toll-free 1-855-254-1892