Tax deductions

Estimating Tax Deductions: Cohan’s Rule | Free human rights


The “Cohan rule” is derived from the Second Circuit decision of 1930, Cohan v. Commissioner, which allowed the taxpayer to approximate travel and entertainment expenses in the absence of documents indicating an exact amount.[1] The rule has since defended the proposition that, with few exceptions, taxpayers who are unable to produce complete records may nonetheless be allowed to estimate certain tax deductions.[2]

This exploitation can be attributed to the one and only, George M. Cohan. Mr. Cohan was perhaps the original Broadway pioneer. He has been credited with having written and published over 300 songs (including ‘You are a Big Old Flag ‘), over a dozen musicals, being a fabulous artist, networker and generally credited with making Broadway the world landmark it is today (see his status and plaque in the famous Duffy Manhattan Square).[3] Perhaps his most memorable accomplishment, however, is his commemoration in the tax code. After failing to get his substantial Broadway spending under control, Mr Cohan proposed his tax code debut for court approval. Despite very insufficient records, Mr. Cohan obtained a deduction based on precise approximations provided to the court.[4] The court then recognized that strict proof of otherwise deductible business expenses is not always available.[5] In the words of the Cohan Tribunal, “absolute certainty in such matters is generally impossible” and it is “not inevitable that such results are inevitably speculative; many important decisions must be such. [6]

The Cohan Rule, however, is not a free pass. Courts pay particular attention to how and even when the rule can be applied. A taxpayer must adequately establish a clear right to a deduction[7] as well as to provide a basis for such an estimate.[8] Likewise, the courts have ruled that a deduction should be denied entirely if there is no justification for each expense.[9] Moreover, even a successful request may not give the result that some taxpayers expect.[10]While some deduction is preferable to none, the court will weigh heavily on a taxpayer “whose inaccuracy is on its own initiative”, which can result in “insignificant and unsatisfactory” amounts. [11]

Successful Uses of Cohan’s Rule

The Cohan Rule can and has been applied successfully to many deductions, including, but not limited to: patents, patent applications, and copyrights; stock confiscated by a foreign government; and coin collections.

Patents, patent applications and copyright.

The Tax Court has consistently applied Cohan’s rule to estimate the unproven costs of patents. The court has traditionally applied annual royalties or proof of R&D costs as a factor in the estimate.[12] The Tax Court also applied the Cohan rule for patents even in cases where the patent files were destroyed, although the final amounts entered by the Tax Court were well below taxpayers’ estimates.[13]

Store.

The Tax Court applied Cohan’s rule to estimate the basis of the stock. The Tax Court applied the highest possible base when it came to a loss deduction, [14] and the lowest possible basis when the amount of a win was contested [15] when the stock basis is estimated based on the evidence submitted. When it was not possible to determine how the taxpayer acquired shares held by a private company (by gift, purchase, etc.), the court determined that the basis of the action was at least equal to its nominal value. [16]

Stock confiscated by a foreign government.

The Tax Court used the Cohan rule to assess a quantity of shares confiscated by a foreign government.[17] In William, the stock was valued at the time of forfeiture at $ 1.5 million.[18] However, the taxpayer in question was at no time relieved of his burden of proof (justification) despite the unavailability of relevant company documents.[19] In addition, the basis granted was a significant reduction from the taxpayer’s estimate of $ 3 million and the Commissioner’s certified loss estimate of $ 9.5 million.[20] The Tax Court specifically mentioned in the opinion that it considered the taxpayer’s testimony regarding his investments and interests to be credible in large part due to the filing of a prior claim with the Claims Settlement Commission. foreigners.[21]

Coin collections.

Even deductions for earnings from coin collections were estimated and applied under Cohan’s rule. When a taxpayer was unable to prove that he had any basis in the parts sold, the court (confirmed by the Sixth Circuit) allowed a basis of 75% of the sale price due to the treatment by the IRS gains like a capital gain. [22]

The above list is not exhaustive. The standards of justification derived from the Cohan rule were previously used for deductions concerning legal fees,[23] interest,[24] stolen property,[25] and home offices.[26]

Cohan rule replaced by article 274 (d)?

Today, however, even the casual Mr. Cohan would have had great difficulty in pushing through his expenses. The Service maintains that 26 USCA § 274 (d) replaces the Cohan Rule by prohibiting certain categories of expenses (including most entertainment, travel and gift expenses) and replaces the Cohan Rule.[27] As such, a court may decline to apply Cohan’s rule to assess expenses covered by section 274 (d).[28] In general, Section 274 limits or prohibits deductions for certain meal and entertainment expenses that would otherwise be eligible, primarily under Section 162 (a) which allows a deduction for ordinary and necessary expenses paid or incurred in during the tax year in the exercise of any trade or business.[29] These strict rules generally require that a taxpayer justify with adequate records or sufficient evidence to corroborate his own statement: (1) the amount of the expenditure; (2) the time and place where the expense was incurred; (3) the business purpose of the expenditure; and (4) in the case of an entertainment expense, the business relationship between the person received and the taxpayer.[30] The central part of the Cohan however, there remains the possibility of substituting the estimate of the Tax Court for a total cancellation of expenses not covered by Article 247 (d).[31]

Cohan’s rule, in general

For the Cohan Rule to apply, a taxpayer must provide a justified basis for any estimate.[32] This is also true for taxpayers alleging loss of documents through no fault of their own.[33] Usually, the justification is provided by such elements as: the amount, the date, the place, the commercial object and the reasonably direct commercial relationship.[34] In tax law, however, the concept of “evidence” means more than just keeping track, it can also mean documenting or proving the fair market value of any item or deduction in question.[35]

[1] Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930).

[2] Cohan, at 544; See also Dunn v. CIR, 301 F.3d 339, 358 (5th Cir. 2002).

[3] “Father Duffy Square Monuments – George M. Cohan: NYC Parks (nycgovparks.org)”, NYC Parks, https://www.nycgovparks.org/parks/father-duffy-square/monuments/282.

[4] Username. to 544.

[5] Username.

[6] Username.

[7] Rodman v. Commissioner [76–2 USTC ¶ 9710], 542 F.2d 845, 854 (2nd Cir. 1976) (“[r]regardless of Cohan rule regarding the amounts admissible, courts have always held that at least the existence of an expense must be proven before any deduction can be made. ”) (Emphasis in original).

[8] Vanicek v. Commissioner, 85 TC 731, 743 (1985)).

[9] Coloman v. CIR, 540 F.2d 427, 432 (9th Cir. 1976) (“to allow the invocation of Cohan’s doctrine by taxpayers would be essentially to condone the use of this doctrine as a substitute for the burden of proof. court will not. ”); Dowell v. United States [75–2 USTC ¶ 9819], 522 F.2d to 714; Williams v. United States, 245 F.2d 559 (5th Cir. 1957); Haskins v. Comm’r of Internal Revenue, 118 TCM (CCH) 63 (TC 2019), confirmed, 820 Fed. NS. 994 (11th Cir. 2020).

[10] See Reese v. CIR, 35 TCM (CCH) 1228 (TC 1976), confirmed, 615 F.2d 226 (5th Cir. 1980) (the court estimated the cost of the patents to be $ 15,000 as taxpayers testified that they cost $ 50,000).

[11]Cohan, at 544.

[12] See Prosperity Co. v. CIR, (1951) 17 TC 171, acq, affd (1953, CA2) 43 AFTR 178, 201 F2d 499, 53-1 USTC 66047.

[13] See Reese at 226 (5th Cir. 1980) (the court estimated the cost of the patent to be $ 15,000 when taxpayers testified that it cost $ 50,000).

[14] See Timek v. CIR, TCM (CCH) 1622 (TC 1976).

[15] See Biggs v. CIR, 27 TCM (CCH) 1177 (TC 1968), confirmed, 440 F.2d 1 (6th Cir. 1971).

[16] See Kerr v. CIR, 59 TCM (CCH) 193 (TC 1990).

[17] See William A. Powe Tr. V. CIR., 44 TCM (CCH) 933 (TC 1982).

[18] Username.

[19] Username.

[20] Identifier.

[21] Identifier. to n12 (“Indeed, if a complaint had not been lodged with the Commission, it is likely that we would find the petitioner’s complaint here much less credible.”)

[22] See Inst. v. CIR, 37 TCM (CCH) 619 (TC 1978), confirmed, 629 F.2d 1160 (6th Cir. 1980). (The tax court authorized the deduction related to the sale of collector’s items.)

[23] Chancellor, at 5.

[24] Rogers v. Comm’r of Internal Revenue, 115 TCM (CCH) 1232 (TC 2018).

[25] See Partyka, at 5.

[26] Rogers, to * 18.

[27] 26 USCA 274

[28] See Sanford v. Commissioner, 50 TC 823, 827-828 (1968), aff’d by curiam, 412 F.2d 201 (2d Cir. 1969).

[29] See Gill v. United States, 296-81T, 1997 WL 820963, at * 43 (Fed. Cl. 9 Oct. 1997), aff’d sub nom. Charron c. United States, 200 F.3d 785 (Fed. Cir. 1999); See Danville Plywood Corp. vs. United States [90-1 USTC ¶ 50,161], 899 F.2d 3 (Fed.Cir. 1990).

[30] See Balyan v. Comm’r, TC memo. 2017-140, at * 7; second. 1.274-5T (b).

[31] Cohan, at 544 (L. Hand, J.) (“But not allowing anything at all seems inconsistent to us… The amount may be insignificant and unsatisfactory, but there was a basis for some allocation, and it was wrong to refuse all… “).

[32]Vanicek, at, 742-743. (Cohan’s rule could not apply to utility expenses because the taxpayer had not substantiated them and presented no evidence that the expenses could be “reasonably allocated”).

[33] Chancellor c. Internal Revenue Comm’r, 121 TCM (CCH) 1392 (TC 2021) (“If a taxpayer claims that her records were lost without her being responsible, she must reasonably reconstruct the missing records through contacts with third parties and others. reasonable means. ”); see also Harlan v. Commissioner, TC memo. 1995-309, 1995 WL 412146, at * 3 (indicating that the Tax Court would not allow estimates when the taxpayer’s documents were destroyed by a windstorm and hail and the taxpayer did not made efforts to reconstruct the records), confirmed in part, revised in part for other reasons, 103 F.3d 138 (9th Cir. 1996).

[34] 26 CFR § 1.274-5T (b); see also Sham v. Commissioner, TC memo. 2020-119, at * 58.

[35] See Partyka v. Comm’r of Internal Revenue, 8573-16S, 2017 WL 4973229, at * 5 (TC October 25, 2017). (The court rejected nearly $ 7,000 in deductions because of “the lack of sufficient detail for the court to objectively estimate a value.”)

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