When planning for the next tax year, taxpayers should keep accurate records and receipts of any expenses they plan to deduct. However, if no records exist, the Cohan Rule may benefit the taxpayer in such that it states expenses may be reasonably and credibly estimated.
IRC Section 6001 states that taxpayers must retain documentation and records to prove claimed deductions. The court case of Cohan, allows the court to estimate the amount of expenses if a taxpayer can prove it was incurred, even if there are no records to document the exact amount. The taxpayer is responsible for providing a foundation for estimation. The lack of record-keeping weighs against the taxpayer’s proof.
In one situation, the IRS agreed that a taxpayer did in fact run a restaurant business for the tax year and allowed expense deductions. Labor costs are part of doing business, so the taxpayer should have incurred the expenses for his cook, waitress and dishwasher, as well as cost of goods sold in relation to the food served at the restaurant. Because he didn’t have appropriate records, the court estimated the expenses using the Cohan rule.