George Cohan (Petitioner) was a theatrical manager, known for his contributions to Broadway and his over-the-top entertaining of both fans and critics. Petitioner deducted his business expenses on his tax returns but because he failed to keep adequate records of how much he actually spent, his deductions were based on estimations.
The Tax Board of Appeals (Tax Board) refused to allow Petitioner any deduction as it was not possible to determine how much Petitioner had spent due to the lack of information provided. Petitioner appealed the decision of the Tax Board.
Are deductions of estimated business expenses allowable?
The Court ruled that the Tax Board was wrong to disallow any deduction for Petitioner’s business expenses. Instead, the Court stated that the Tax Board should approximate the taxpayer’s expenses, and while the Tax Board’s conclusion may be unsatisfactory, outright denial of what would otherwise be a legal deduction was erroneous.
Key Points of Law:
- The Court acknowledged that in determining the amount of a taxpayer’s deductible business expenses, “absolute certainty in such matter is usually impossible and is not necessary.”
- However, a taxpayer must establish the right to deduct the estimated amount, and provide some basis for the deduction, such that a reviewing party is able to understand the expense incurred and its corresponding deduction.
The “Cohan Rule” remains good law today, providing taxpayers who lack detailed proof of expenses incurred, the ability to claim a lawful deduction based on estimations. For the Tax Court to estimate the expenses a taxpayer incurred where the taxpayer lacks receipts or other records, the taxpayer must provide a reasonable basis for incurring the disputed expense. And while the deduction allowed by the Tax Court will inevitably be speculative, the Court concluded such uncertainty as being non-fatal, acknowledging that many important decisions must be speculative.
While the Cohan Rule is still successfully applied to a multitude of deductions, it is done so stringently, and in many instances, is superseded by IRC § 274(d). IRC § 274 limits, or eliminates entirely, deductions that would otherwise be allowable under, among other IRC provisions, IRC § 162 as “ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” IRC § 274(d) dramatically increases the substantiation requirements necessary to take certain listed deductions. For deductions included in IRC § 274(d), the Cohan Rule cannot save the day.
 IRC § 274(d) Substantiation Required. No deduction or credit shall be allowed – (1) under § 162 or § 212 for any traveling expense (including meals and lodging while away from home), (2) for any expense for gifts, or (3) with respect to any listed property (as defined in § 280F(d)(4)), unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer’s own statements (A) the amount of such expense or other item, (B) the time and place of the travel or the date and description of the gift, (C) the business purpose of the expense or other item, and (D) the business relationship to the taxpayer of the person receiving the benefit. The Secretary may by regulations provide that some or all of the requirements of the preceding sentences hall not apply in the case of an expense which does not exceed an amount prescribed pursuant to such regulations. This subsection shall not apply to any qualified nonpersonal use vehicle (as defined in subsection (i)).