Understanding the Cohan Rule: Estimating Deductions When Records Are Missing

What is the Cohan Rule?

The Cohan Rule allows taxpayers to estimate certain tax deductions when they lack proper documentation. It originated from the court case Cohan v. Commissioner, where the court ruled that taxpayers should not be denied deductions solely because they lack records, as long as there is a reasonable basis for estimation.

Key Takeaways:

• Taxpayers can estimate expenses when they lack receipts or other records.
• Estimates must be reasonable and supported by some factual basis.
• This rule does not apply to all deductions—certain expenses, such as travel and entertainment, require specific documentation under §274. Disallowance of certain entertainment, etc., expenses.

When Does the Cohan Rule Apply?

The rule can be useful when:

• Receipts are lost, destroyed, or never existed.
• A taxpayer remembers incurring expenses but lacks supporting records.
• Transactions were conducted in cash without documentation.

Examples:

• A self-employed individual missing office supply receipts may estimate costs based on past spending patterns.
• A taxpayer who made charitable donations but lost receipts may use bank statements to approximate the amount given.

Limitations of the Cohan Rule

The rule is not universally applicable. Courts will only allow estimates if the taxpayer can prove the expense occurred. The IRS or courts will not accept a taxpayer’s guess—there must be credible evidence supporting the estimation.

The Cohan Rule does not apply when:

• Specific statutory requirements mandate documentation (e.g., travel, meals, entertainment, and gifts under IRC Section 274).
• A taxpayer cannot provide any proof that an expense was actually incurred.

Why Proper Recordkeeping is Essential

While the Cohan Rule can help in some cases, it is not a substitute for good recordkeeping. Taxpayers should:

• Keep detailed records of business expenses.
• Retain receipts, bank statements, and invoices.
• Use accounting software or apps to track expenses.

Final Thoughts

The Cohan Rule remains relevant in cases where documentation is missing, but it has limitations. Taxpayers should aim for accurate recordkeeping to avoid reliance on estimates. If using the rule, ensuring a reasonable and well-supported estimate is crucial to IRS acceptance or court approval.

Source: Cohan rule , “Cohan Rule” Estimates, When to Apply the ‘Cohan Rule’