George M. Cohan, the iconic vaudevillian and showman, was known for writing and performing songs such as I'm a Yankee Doodle Dandy and Give My Regards to Broadway. But his most enduring legacy may be traced back to a US Tax Court case (Cohan v. Comm'r, 39 F.2d 540 (2d Cir. 1930). In the landmark decision, Cohan was permitted to deduct certain business expenses, even though he didn't have all the receipts needed to back up his claims.
The Tax Court's allowance of deductions based on estimates has come to be known as the "Cohan rule." It's been used time and time again in the courts.
Latest example: A taxpayer was an independent contractor who helped relocate families by moving their household items, appliances, and furnishings. He was responsible for packing up the goods, loading them on a truck, transporting them to the destination, and then unloading and unpacking them.
Generally, the taxpayer hired other workers to assist with the moving duties. The workers, who varied from job to job, were paid $10 to $15 per hour. Typically, a worker's payment wouldn't exceed $600. Because the workers were paid in cash, the only record the taxpayer kept was a logbook.
The logbook records were spotty, at best, and inaccurate, at worst. They didn't reflect any names or Social Security numbers, nor did the taxpayer issue any Form 1099s. Nevertheless, he claimed deductions for labor costs ranging from $42,250 to $55,729 for tax years 2006, 2007, and 2008.
Under the Cohan rule, the court can approve deductions if it's convinced that expenses were actually incurred, even if the records don't measure up. In this case, the Tax Court permitted annual deductions of approximately $12,000 based on the ratios found in the BizMiner report, an independent industry guideline (Bauer, TC Memo 2012-156).