The Cohan Rule—What If I Have Terrible Records?

Ever hear of an entertainer and songwriter named George M. Cohan?

He’s the guy that wrote “Yankee Doodle Dandy” and “You’re a Grand Old Flag”.

It seems that Mr. Cohan’s income tax returns were audited in the 1940’s for a year during which he had travelled with his show for more than 30 weeks during the year.

Unfortunately, Mr. Cohan had not maintained records to back up the expenses he claimed on his tax return. So the IRS examiner disallowed most of his business expenses out of hand.

Fortunately, the story doesn’t end there.

He appealed the IRS’ disallowance, and eventually the U.S. Tax Court found in his favor.

Thus, his estimated expenses were all allowed and the “Cohan Rule” has held up since then. We have cited it in numerous cases where original records are found to be lacking or even non-existent.

What does this mean for business owners everywhere? It means that if you can reasonably estimate valid expenses for which you have no original records, it is acceptable for you to claim a deduction.

The “Cohan Rule” came in very handy indeed for the thousands of professional drivers, construction contractors, and even doctors and lawyers from the New Orleans area that were left with no records after Hurricane Katrina wreaked havoc on that area just over ten years ago.

Separate from the Cohan Rule, you may have had a situation where you actually had good records for, say, three or more consecutive months of the year. The IRS will often allow you to estimate or reconstruct your expenses for the periods for which you don’t have records, if your income was relatively steady throughout the year.

Both of these remedies can make a huge difference when the auditor has initially said “no receipts, no deduction”. They will likely need to be brought up on appeal. But they can save you from writing a 5-figure check to your least favorite government agency.

Even if you handle your own IRS audit, be sure to seek out a tax firm that specializes in dealing with tax audits also in the IRS Appeal process.