I always like it when a taxpayer wins using the Cohan rule. Fortunato Gonzalez, who liked to play the slots on weekends recently took advantage of the rule. He had failed to report the $20,700 of winnings reported to him on Form W-2G by the Cache Creek Casino Resort. His reasoning was simple. He held the theory that “all gamblers lose money”. My affection for the Cohan rule actually comes from a misunderstanding I had about its origin.
Someone getting a CPA license in Massachusetts this year will have a license number well over 30,000. My number from 1983 is 7715. The framed certificate in the conference room at Joseph B. Cohan and Associates that belonged to the eponymous founder was two hundred something . The firm was founded in 1917 and lasted 80 years. I was the last person to become a partner in JBC. When I was starting out Mr. Cohan was still coming into the office for a few hours a day, when he was not in Florida. I think he was mainly attending to his other ventures as the firm was run by his son Herb, who it pains me to realize was younger then than I am now.
At any rate between Mr. Cohan and his sons Herb and Paul, there was over a century of public accounting experience distilled in that office. I sometimes thought they had boiled it down to the principles – “Money coming in is good. Money going out is bad.”, but there was more to it than that. One of the other principles I learned was that lacking receipts you could always try to have a good story. We called it the “Cohan rule” and many JBC staff accountants, some of whom were not that well read, were certain that the name derived either from our founder or his managing partner son. It was rather a shock to me when I learned that if was actually named for George M. Cohan, whose statue stands in Times Square.
Jospeh B. Cohan had already been running his firm for over a decade when, in 1930, the Second Circuit took up the case of George M. Cohan and handed down its famous ruling:
In the production of his plays Cohan was obliged to be free-handed in entertaining actors, employees, and, as he naively adds dramatic critics. He had also to travel much, at times with his attorney. These expenses amounted to substantial sums, but he kept no account and probably could not have done so.
Absolute certainty in such matters is usually impossible and is not necessary; the Board should make as close an approximation as it can, bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making.
Compare that to the Tax Court’s ruling in favor of Mr. Gonzalez:
Petitioners wrote checks to cash at least once a month for most of the year in issue, and most of the checks were negotiated near weekends and holidays. We are satisfied that at least some of these funds and some of the winnings were used to engage in gambling activities. Taking into account the credible testimony of petitioners, the fact that gambling winnings were used to engage in additional gambling activity, the cashing of checks on the weekends, and the fact that petitioners’ disposable income from other sources was otherwise limited, and using our best judgment to reasonably estimate the amount of gambling losses, we allow petitioners a gambling loss of $15,000. Accordingly, petitioners may deduct $15,000 of gambling losses against the $20,700 of gambling winnings.
Even though Mr. Gonzalez is still probably overpaying a bit, he should definitely give his regards to Broadway.
There are a couple of cautions that you need to bear in mind . The scope of the Cohan rule has been drastically narrowed by legislation. The meals and entertainment that George M. Cohan was so free-handed with now have to meet fairly stringent documentation requirements to be deductible. Charitable contributions also now have a high standard of proof. Also note the words in the decision – “bearing heavily on the taxpayer” – “whose inexactitude is of his own making”. Somebody told me that back in the day agents would allow $52 in contributions to your church under the Cohan rule. They would take your word that you went to church every Sunday but not that you were dropping C-notes in the plate. So you should keep good records, just like you should floss regularly, but don’t totally throw in the towel if you are audited without the good records, just like you keep going for cleanings so the hygienist can scold you.
You can follow me on twitter @peterreillycpa.
PS : You can read quite a bit about the Cohan rule on tax blogs, but I particularly recommend I’m A Yankee Doodle Tax Pro by Robert Flach, the Wandering Tax Pro, who is a great fan of Broadway musicals.
Originally published on Forbes.com on August 25th, 2012