Paul L. Caron

Monday, April 30, 2018

Lesson From The Tax Court: The Cohan Doctrine Cannot Always Save You

One of the first clients I had after graduating from law school in 1987 was a fellow in the construction business. I forget what dispute brought him to us, but I will never forget the “records” he brought: a truckload of paper bags. Turns out that each year he would set a paper grocery bag on the floor and, as the year went by, he would dump anything he thought important into the grocery bag ... if he remembered to do so. You can guess who got to go through all his paper bags.

I am sure many of you have encountered clients with similar, if not more pathetic, record-keeping practices. Readers well know that taxpayers bear the burden of production to show why they are entitled to claimed deductions. To do that they need to keep good records.

If taxpayers don’t keep good records, however, they can sometimes get lucky under what is commonly called the Cohan doctrine. For those interested, my blog here explains the doctrine and its history.  Basically, the doctrine says that if the taxpayer can prove the fact of an expense, but not the exact amount of the expense, the Tax Court will make its own estimate of the amount, “bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making.” Cohan v. Commissioner, 39 F.2d 540, 544 (2d Cir. 1930).

Two weeks ago I blogged here about a taxpayer who got lucky when the Tax Court judge spotted an issue that both the taxpayer’s attorneys and the IRS attorneys had overlooked, saving the taxpayer some $42,000 in taxes.  This week we look at a case, Stanislav Antoniev Dimitrov v. Commissioner, T.C. Summary Opinion 2018-21, that teaches a lesson about the limits to getting lucky under the Cohan doctrine.

In 2013 and 2014 Mr. Dimitrov held two wage-paying jobs, one at Whole Foods and one from a debt collection company called Euler Hermes Collections. He earned $56k in wages in 2013 and $55k in 2014.

For many folks, the American Dream is to escape the woeful world of wages and build their own business. Mr. Dimitrov started pursuing that dream in 2013 when he bought two properties in Hagerstown, Md.: a triplex, and a commercial/residential mix-used building. His plan was to renovate them for future lease or sale.

When he first bought the properties, Mr. Dimitrov lived in Montgomery Village, Md., a suburb of Washington D.C. Later that year he moved to Owings Mills, Md., a suburb of Baltimore.

The reason these locations are important is because Mr. Dimitrov attempted to deduct the cost of driving to Hagerstown to attend to his business. It was undisputed that it was 94.8 miles round trip to his Hagerstown properties from Montgomery Village and it was 144.6 miles round trip from Owings Mills. It was also undisputed that Mr. Dimitrov did, in fact, travel to those properties to perform some of the renovations himself and to meet with contractors about other renovations. Judge Arman writes “the Court does not doubt that petitioner incurred expense in driving to the Hagerstown properties.”

What was very much in dispute was how often Mr. Dimitrov made trips. Mr. Dimitrov did not keep good records. He told the Court he had some kind of log that he “was keeping on paper in my car” but he did not give that to the IRS during audit. Instead he spent some time before trial reconstructing the dates of his trips into a summary document.

Judge Arman was not impressed with this record-keeping. For example, Mr. Dimitrov claimed on the summary document that he made at least one round trip every single day from June 13, 2013 through December 23, 2103, but then at trial he testified that he had spent a number of days in November visiting his parents in Boston.

In short, his records sucked. In the more polite language judges have to use, they contained “far too many...irregularities, errors, and questionable and improbable entries to be considered reliable.” Still, since it was undisputed that Mr. Dimitrov did in fact travel to his Hagerstown properties in 2013 and 2014 the Cohan doctrine would permit the Tax Court to allow him at least some deduction, heck even for just one trip.

Unfortunately for Mr. Dimitrov, the Tax Court was precluded from using the Cohan doctrine for these kinds of expenses because of §274(d) and its regulations. Treas.Reg. 1.274-5A(b) provides that no deduction will be allowed for this kind of travel unless the taxpayer substantiates every element of the claimed expense including the amount, the time and place of the travel, and the business purposes of the travel. Mr. Dimitrov’s reconstructed mileage summary failed miserably to meet the time and place requirement of §274(d).

The lesson is that taxpayers like Mr. Dimitrov need to keep good mileage records because they cannot get lucky. If your client comes in with paper bags of records, help them buy a paper mileage log, like this one. Or tell them “there’s an app for that.” Here’s one for your iPhone.

Coda: Judge Arman was also highly skeptical that Mr. Dimitrov could hold down two wage-paying jobs while attending to his properties on a daily basis when the travel involved between 2 and 3 hours round-trip especially when Mr. Dimitrov was also claiming mileage as an unreimbursed employee expense in 2013. Although I suspect Mr. Dimitrov was exaggerating his travel, I’m not nearly as skeptical as Judge Arman. For example, nothing in the record says that Mr. Dimitrov was employed by either employer full time. Nothing in the record says what his hours were at Whole Foods. He might well have followed a daily schedule as follows: up at 6 am, on the road to Hagerstown at 7 am, work on the properties and meet w/contractors, report to his collections employer at noon and work on collections (involving business travel) until 4 pm, report to the Whole Foods job at 6 pm, work until midnight, then home to grab some Z’s. Sure, that’s a hard schedule, but I have known many hard-working folks who keep similar schedules.

 Bryan Camp is George H. Mahon Professor of Law at Texas Tech University School of Law

Bryan Camp, New Cases, Tax | Permalink


Thanks for this. I talk with my clients regularly about the perils of this sort of record keeping. I highly recommend trying a different mileage log. It is so user-friendly my clients are actually keeping it current. MileIQ. It's the best! Now we need an app for everything else!

Posted by: Stephanie Council | Apr 30, 2018 12:25:28 PM