Cohen Rule

It has been constantly been advised by every licensed tax practitioner and/or accountant across the country that when someone is in business, he/she should always keep receipts, in case one gets audited by the Internal Revenue Service, and/or any other state tax enforcement agency.  While, yes that is always the rule and advice, there are cases where one does not have such backed-up specific receipts, one could still prevail in audit (albeit the chances would be slim) without specific receipts, but still has other extrinsic and/or other circumstantial evidence that can be used to prove that one was in business, and such expenses were naturally part of the business’s operations.

One major tax case brings to mind is Cohen vs. Commissioner of Revenue (39 F.2d. 540 (1930)).  Mr. George Cohen was a famous and prominent American musician, and playwright throughout the 1920s and 1930s, and yes he was audited by the Internal Revenue Service for, among other things, his traveling expenses on his 1920 personal income tax return.  Yes, Mr. Cohen may not have any receipts to prove his traveling expenses but in the opinion of federal appellate court judge Learned Hand (a very prestigious jurist in his own right):

In the production of his plays Cohan was obliged . . . to travel much, at times with his attorney. These expenses amounted to substantial sums, but he kept no account and probably could not have done so. At the trial before the Board [of Tax Appeals, the forerunner of today’s Federal Tax Court] he estimated that he had spent [$11,000]  in this fashion during the first six months of 1921, [$22,000], between July [1st], 1921 and June [13th], 1922, and as much for his following fiscal year, [$55,000] in all. The Board refused to allow him any part of this, on the ground that it was impossible to tell how much he had in fact spent, in the absence of any items or details.

The question is how far this refusal is justified, in view of the finding that he had spent much and that the sums were allowable expenses. Absolute certainty in such matters is usually impossible and is not necessary; the Board should make as close an approximation as it can, bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making. But to allow nothing at all appears to us inconsistent with saying that something was spent. True, we do not know how many trips Cohan made, nor how large his entertainments were; yet there was obviously some basis for computation, if necessary by drawing upon the Board’s personal estimates of the minimum of such expenses. The amount may be trivial and unsatisfactory, but there was basis for some allowance, and it was wrong to refuse any, even though it were the travelling expenses of a single trip. It is not fatal that the result will inevitably be speculative; many important decisions must be such. We think that the Board was in error as to this and must reconsider the evidence.

Thusly what judge Hand concluded that for the Internal Revenue Service to deny any of Mr. Cohen traveling expense, with the established fact that he did indeed traveled for business purposes during the year in question, is too much for the Internal Revenue Service to deny.  Of course the question remind opened of how much could Mr. Cohen substantiate, was left back to both to the IRS and the appellate administrative board.

So what this “Cohen Rule” stands for is that if someone (especially in business) could prove through other means that he/she incurred deductible expenses, then he/she could sustain such deductible expenses.  However, this “Cohen Rule” does not negate that one should save receipts and records, so it would be easier to claim deductible expenses.

So if you are in the midst of a tax audit, and it appears that the IRS is going to denial all of your business expenses, even though you do actually operate a business, then let us know at info@kayatax.com, and we would be more than happy to apply to this “Cohen Rule” on your tax audit case.