Typically, when a taxpayer is audited by the IRS, the burden of proof falls on the taxpayer. In order to prove income and expenses, the US Tax Court has ruled that the taxpayer must keep “contemporaneous” records, per Reg. § 1.6001-1. But what if the taxpayer has some sort of accident, an act of God, or something else happens where they can’t produce contemporaneous records?
Cohan v. Commissioner is a very interesting case. In 1918, George M. Cohan was a theatrical manager and producer doing business in partnership with a gentleman by the name of Harris. Cohan had originally been an actor, like his parents. After 1899, the parents with their two children, Cohan and his sister, divided their earnings – one-quarter to each of the children and one-half to the parents. Cohan was in charge of the collection and distribution, collecting for all and distributing to the others.
In 1899, they hired a manager and, after his death, employed another manager who married Cohan’s sister in 1905, and they both left the business. Cohan and his parents then employed Harris as their manager and made a change in the distributions. Cohan had begun to write plays, on which he was receiving royalties, which he withdrew from the net earnings. The parents began to take out $500 a week, and the remaining four divided what was left by designating half to Harris, a quarter to Cohan, and the rest to the parents. Before 1914, Cohan and his father had left the stage and spent their time directing their plays until the father’s death on July 31, 1917. After his father’s death, Cohan divided his portion of the proceeds from the partnership with his mother.
The IRS fixed Cohan’s income as the whole of what he received from the firm of Cohan & Harris, while it lasted, and later as the whole of his own profits. Cohan declared that his mother was always his partner and that he was entitled to deduct from his receipts the sums that he paid to her. If the father was a partner at the time of his death, that partnership ended and Cohan, the survivor, had to account to the legatees or next of kin. The court did not know if there was a will but presumed there wasn’t. If there was a will, the mother and siblings would have been entitled to a portion of the proceeds from the partnership.
In the production of his plays, Cohan was obliged to entertain actors, employees, and dramatic critics. He also had to travel a lot, often with his attorney. These expenses amounted to substantial sums, but he had no accounting of these expenses.