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Tax Court: Roadblock to Using the “Cohan Rule”

Sep 7th 2018
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For decades, taxpayers have relied on the “Cohan rule” to deduct expenses when they didn’t have all the requisite records, but a recent Tax Court case ruled otherwise.

Even though this hallowed tax principle originally stemmed from a landmark Tax Court case involving travel expenses, the case of Dimitrov, TC Summary Opinion 2018-21, 4/9/18, ironically found a taxpayer could not use the Cohan rule to salvage his travel deductions.

First, let’s examine the Cohan rule: As you might have guessed, the plaintiff was the legendary showman George M. Cohan, the “Yankee Doodle Dandy” born on the Fourth of July. Cohan claimed deductions for business travel and entertainment expenses, but said he was too busy with his show business activities to take the time to document all the expenses.

After a long wrangle in the courts, Judge Learned Hand approved an approximation of expenses because Cohan clearly had incurred some costs, although he could not substantiate the exact amount. In the often-cited summary, Hand said “… to allow nothing at all appears to us inconsistent with saying that something was spent.” (Cohan, 39 F2d 540, CA-2, 1930).

In the case at hand, in 2013 and 2014 the taxpayer held down two jobs at Whole Foods and a debt collection agency. He earned a total of about $56,000 in 2013 and $55,000 in 2014.

While pursuing his version of “the American dream,” the taxpayer bought several real estate properties in Hagerstown, Maryland, intending to renovate them for future sales or leasing. At the time of the purchases, the taxpayer lived in Montgomery, MD., a suburb of Washington D.C. A year later, he relocated to Owings Mills, MD., which is closer to Baltimore.

On his tax returns for the two years in question, the taxpayer deducted travel expenses of more than $13,000 and $15,000, respectively. But he failed to substantiate his travel expenses as required by the Section 274 regulations. Instead, he told the court that he kept “some kind of log” on paper in his car, but didn’t provide any written record to the IRS.

It is undisputed that the round trip from Montgomery to Hagerstown was about 95 miles, while a round trip from Owings Mills to Hagerstown was closer to 145 miles. Clearly, the taxpayer made these trips sometimes to perform renovations himself and meet with contractors about other work. But the number of times he made those trips was suspect.

As an example, the taxpayer stated that he made at least one round-trip every single day from Owings Mills from June 13, 2013 to December 23, 2013. But then he later testified at trial that he spent several days in November visiting his parents in Boston. He simply didn’t have the proof to back up his claims.

The Cohan rule might have bailed out the taxpayer, but he was precluded from this option because of the Section 274 regulations. Specifically, no deduction is allowed for business travel unless every element of the trip, including the amount, time, place and business purpose, is substantiated.

The lesson to be learned is that there is no substitute for your clients keeping detailed business travel records. The Cohan rule may be used as a last resort for certain other expenses.