Taxpayer Fails To Meet Cohan Rule’s Tax Deduction Requirements

Arizona’s Leading Tax Attorneys Discuss The Recent Case Of Fagenboym v. Commissioner

When undergoing an audit, it’s common to utilize the Cohan Rule, which enables a taxpayer or business to claim reasonable expenses even if they do not have receipts for those expenses. In the recent case of Fagenboym v. Commissioner, we see a taxpayer who attempted to utilize this frequently cited rule, but ultimately failed because he did not fully meet the requirements.

Taxpayer Fails To Meet Cohan Rule's Tax Deduction Requirements

What Is The Cohan Rule?

In essence, the Cohan Rule is a precedent from the 1930s that was set after George M. Cohan, a Broadway star, was audited and did not have receipts for some of the business expenses he had claimed on his tax return. After the IRS would not accept these undocumented deductions, Cohan took the IRS to court and got the IRS ruling overturned. The court ruled that the IRS was required to accept the expenses without receipts, provided they were “reasonable and credible.” With this precedent, taxpayers can submit business expenses without receipts. However, the taxpayer must provide a rational basis for these expenses to be estimated and other documentation, such as a canceled check, may be needed to verify their reasonableness.

Fagenboym V. Commissioner

Cohan’s rule can be beneficial to business owners in many situations. Unfortunately, it also leaves the taxpayer in a weak position, because the taxpayer must provide a rational basis for the Court to make an estimate of expenses. Secondly, when there is a lack of records, it’s less likely that the Court will believe the taxpayer has a rational basis for calculating these expenses.

In this case, Mr. Fagenboym was a shareholder in a corporation, Alcor Electric, that was unable to document some of the purchases they had made from a supplier. Instead of producing receipts, a contract, or other documents of sale, Mr. Fagenboym submitted four pages of handwritten calculations. In this paperwork, he attempted to recreate an estimate of the expenses. He testified that was able to make this estimate by subtracting Alcor Electric’s 12% profit margin and then by calculating the known costs of the labor and materials on three similar contracts.

Insufficient Evidence

Unfortunately, the tax court found that this information was insufficient to qualify under Cohan’s rule and was not a rational basis upon which they could calculate a deduction. This was partially because Mr. Fagenboym did not provide any bank statements or other documentation that would have supported his estimates. The Court also stated that creating an estimate based on profit margin was not a rational basis for determining the validity of these expenses. Ultimately, the IRS did not accept the deductions on that portion of the corporation’s tax return.

What is interesting and unusual about this case is that the judge believed the taxpayer’s testimony to be credible and honest, however, still believed there were too many flaws in the methodology to be able to accept the estimates. This is an excellent example of how important it is that you always talk with an experienced tax attorney in Mesa to justify your expenses and minimize your tax obligations during an audit.

Get Representation From Experienced Tax Lawyers In Phoenix

The experienced tax attorneys at Silver Law PLC are ready to help answer your questions about your business tax obligations. Don’t wait to be audited or fined before you find a Phoenix tax lawyer; get the help you need right away. The attorneys at Silver Law PLC are former IRS employees, so they fully understand the nuances of tax law and are ready to support you, before or after the IRS comes knocking. To schedule your consultation with a Phoenix tax lawyer, contact us today.


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