Give Your Regards to the Cohan Rule
If you lack records to back up your deductions, the Cohan rule may help you out with the IRS.
George M. Cohan is a Broadway legend--a hugely successful songwriter, singer, dancer, actor, playwright, theatrical producer, and director. One of his most famous songs is the classic "Give My Regards to Broadway."
Among tax nerds, however, George M. Cohan is famous for something else--something all taxpayers should thank him for: the Cohan Rule.
The Cohan Rule came about when the entertainer was audited and the IRS disallowed his numerous business travel and entertainment expenses because he lacked receipts. Cohan appealed, and the court held that the IRS should accept his estimates of his expenses. Thus, the Cohan Rule stands for the proposition that taxpayers who lack receipts may provide estimates of their expenses and the IRS may accept them if they are reasonable and credible.
The Cohan rule recognizes that all businesspeople must spend at least some money to stay in business and so must have had at least some deductible expenses, even if they don’t have adequate records to back them up.
If you’re audited and lack adequate records for a claimed deduction, the IRS can use the Cohan rule to make an estimate of how much you must have spent and allow you to deduct that amount. However, you must provide at least some credible evidence on which to base this estimate, such as your own testimony, receipts, canceled checks, notes in your appointment book, or other records. Moreover, the IRS will only allow you to deduct the least amount you must have spent, based on the records you provide. In addition, the Cohan rule cannot be used for travel, meal, entertainment, or gift expenses, or for listed property (things that can be used both for personal and business purposes such as cameras, cars, and computers).
If an auditor claims you lack sufficient records to back up a deduction, you should always bring up the Cohan rule and argue that you should still get the deduction based on the records you do have. At best, you’ll probably get only part of your claimed deductions. If the IRS auditor disallows your deductions entirely or doesn’t give you as much as you think you deserve, you can appeal in court and bring up the Cohan rule again there. You might have more success with a judge. However, you can’t compel an IRS auditor or a court to apply the Cohan rule in your favor. Whether to apply the rule and how large a deduction to give you is within their discretion.