Legal Definitions - Cohan rule

The Cohan rule is a principle in tax law that allows taxpayers to estimate certain business expenses for tax deduction purposes, even if they do not have exact records or receipts.

This rule applies when:

• The taxpayer is unable to produce precise documentation of actual expenditures.
• There is a reasonable factual basis or other evidence to support the estimated amount.

The underlying idea is that while absolute certainty in record-keeping is ideal, it's not always possible. Therefore, tax authorities should make the closest possible approximation based on available information, though the burden of proof for the estimate's reasonableness falls heavily on the taxpayer.

It's important to note that the Cohan rule does not apply universally. For instance, specific types of expenses, such as certain travel, entertainment, and gift expenses, have stricter substantiation requirements under Section 274(d) of the Internal Revenue Code and are generally not eligible for estimation under the Cohan rule.

Here are some examples illustrating the Cohan rule:

• Example 1: Lost Receipts for Office Supplies

  Maria runs a small graphic design studio from her home. One month, a box containing several receipts for essential art supplies, software subscriptions, and printing services, totaling approximately $400, was accidentally thrown out. While she doesn't have the physical receipts, she has her bank statements showing the dates and amounts of these purchases, as well as a detailed inventory list of the items she acquired for her business.

  How it illustrates the Cohan rule: Maria lacks the exact receipts, but her bank statements and inventory list provide a strong factual basis to reasonably estimate her deductible business expenses for the lost items. The Cohan rule would allow her to claim these deductions based on her well-supported estimate.

• Example 2: Cash Expenses for Professional Development

  David, a freelance web developer, frequently attends local tech meetups and workshops. He often pays small entrance fees or buys coffee/snacks for networking in cash, and these vendors rarely provide formal receipts for such minor transactions. David meticulously logs all his professional activities in a digital calendar, noting the event, its business purpose, and the approximate cash spent.

  How it illustrates the Cohan rule: David doesn't have individual receipts for every small cash outlay. However, his detailed calendar entries and notes serve as a reasonable factual basis to estimate his professional development expenses, which are deductible business costs. The Cohan rule would permit him to make a reasonable approximation for these expenses.

• Example 3: Destroyed Mileage Log

  Sarah is a sales representative who uses her personal vehicle for extensive travel to client sites. She diligently maintained a mileage logbook for tracking her business travel, but unfortunately, it was damaged beyond readability in a minor office flood. While the logbook is gone, Sarah has her appointment calendar, client invoices, and GPS records from her phone that clearly show the dates, locations, and distances of her client visits.

  How it illustrates the Cohan rule: Sarah cannot produce her original mileage log. However, her appointment calendar, invoices, and GPS data provide robust alternative evidence to reconstruct and reasonably estimate her business mileage. Under the Cohan rule, she could use these records to approximate her deductible vehicle expenses.