The Cohan Rule: What Is It and When Can You Use It?

What is the Cohan rule?

The Cohan rule allows people to estimate the cost of certain business expenses even when they don’t have the records to support them. It's based on the 1930 court case Cohan v. Commissioner.

For instance, if you pay $100 for a business expense in cash and then lose the receipt, you might not have a record of that expense anywhere. Depending on what you’re trying to claim, the Cohan rule might still allow you to include a reasonable estimate of the expense on your tax return.

How did the Cohan rule start?

In 1930, the IRS audited Broadway star (and less-than-stellar bookkeeper) George M. Cohan. He had claimed thousands of dollars in business expenses over a couple of years, but he didn’t have the records to back them up.

Cohan appealed the audit, and the court ruled in his favor, stating that in certain scenarios, the IRS must allow estimates even if no documentation is provided. Thus, the Cohan rule was born.

What kind of documents do I need for expenses?

Before we explain how to use the Cohan rule, let’s clear up a common misconception. Contrary to popular belief, receipts aren’t the only form of documentation you can use to record an expense.

According to the IRS, supporting documents for your business expenses should include:

• Where or who the item was purchased from
• The amount paid
• Proof of payment
• The date of payment
• A description of the item

A receipt is one way to demonstrate that information. But the IRS says proof of the above can also be provided through: 

• Bank statements
• Credit card statements
• Invoices
• Canceled checks

You can also avoid having to worry about storing receipts with an expense tracking app like Keeper. Keeper automatically scans your transactions for eligible write-offs, and records each time you spend money on a business expense. Because the app takes care of documentation, you won’t have to rely solely on paper receipts!

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How does the Cohan rule work?

To use the Cohan rule, you’ll simply add the deduction you’re estimating to your Schedule C along with the rest of your business expenses. And because you don’t need to include receipts when you submit your return, that might be all you need to do.

However, if you’re audited by the IRS, you’ll need to be able to demonstrate why you’re eligible to claim the expense in question. (Keep in mind: The IRS can generally go back three years for audits.)

How do you prove your expenses with the Cohan rule?

There are a few ways, including data about your industry, statements from the people you worked with, and digital communications.

“As an IRS Revenue Agent in the Phoenix district office, I often assisted [taxpayers] to reconstruct business expenses using common sense and reasonableness as a guide,” said Whitney Sorrell, JD, CPA, who is currently a tax and estate planning attorney.

“For example, realtors drive many miles every year. While they may not have kept contemporaneous records, we can reasonably assume from the volume of clients and revenue generated that they indeed did what realtors do: regularly drive clients to prospective properties all over town.”

As a tax attorney, Sorrell has also provided “forensic evidence to support [a client’s] expenses, such as analysis of the amount of water it takes to wash clothes in a laundromat, or the amount of labor hours it generally takes to perform a service or build a product.”

Here are some other ways you might provide proof for your claim:

• Calendar entries: For instance, did you make an appointment or add a reminder relating to your claim?
• Written statements from third parties: You can reach out to the vendor or supplier and ask them to provide a statement about your claim. You could even ask for written statements from clients or fellow professionals you may have spoken to about the expense
• Emails or other forms of communication: Again, if you emailed a vendor, a supplier, or even a friend about the claim, this can be used as further substantiation

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Can I deduct the full amount with the Cohan rule?

Unfortunately, no. If you don’t have receipts or other documentation, then "more often than not, the amount the IRS will allow will be a little less than actual expenses," said Sorrell.

If you’re audited, the IRS will calculate the minimum average cost for the item. And that’s the amount you’ll be eligible to write off.

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Are there exceptions to the Cohan rule?

Yes, there are limits on the types of deductions you can estimate using the Cohan rule. Unfortunately, they can be pretty substantial.

The two main expenses you can’t claim without documentation are:

• Section 274(d) expenses: This includes things like business meals, travel, business gifts, and certain types of “listed property” that need to be depreciated and are used for both work and personal purposes
• Section 170 expenses: This includes charitable contributions

While the Cohan rule can be a useful tool in a pinch, it’s still best to keep some kind of record of your business expenses.

“Small business owners should not depend on the Cohan rule as their fallback," says Michelle Delker, CPA, founder and CEO of the William Stanley CFO Group. “It's always better to maintain comprehensive records for all business expenses as the IRS prefers concrete proof over estimated deductions.”

Luckily, Keeper can make bookkeeping a breeze by documenting your business expenses for you. If only George M. Cohan could’ve downloaded it. Alas, he did not have a smartphone.